Tag: episode-1218

HARTNETT: TRANSFORMING WORLD THEMES TRANSCRIPT

October 23, 2015

CONSUELO MACK: This week on WEALTHTRACK, mapping the world’s changing landscape. In an exclusive interview, Bank of America Merrill Lynch’s Global Chief Investment Strategist Michael Hartnett explains the themes that are transforming the globe and how to invest in them, next on Consuelo Mack WEALTHTRACK.

Hello and welcome to this edition of WEALTHTRACK, I’m Consuelo Mack.
We pride ourselves on thinking long term on WEALTHTRACK. The reality is financial planning is a lifelong exercise and our portfolios have to last a lifetime.
Consequently our guests are chosen for their track records of investment success over many years if not decades.

This week’s exclusive WEALTHTRACK guest is taking that mandate very seriously. He is Financial Thought Leader Michael Hartnett, Chief Investment Strategist at Bank of America Merrill Lynch Global Research where he identifies key global market trends and provides strategic insights and solutions for both institutional and individual clients.

Since joining the original Merrill Lynch in 2005 Hartnett has served in several key strategy and economic leadership positions including Director of European Equity Strategy in London, Senior International Economist and Global Macro Strategist in New York and Chief Economist in Japan.

Hartnett and his global research team just published the inaugural edition of what they titled their “Transforming World Atlas”, a series of maps illustrating the firm’s favorite cyclical and secular investment themes that they expect will transform the world’s economies, markets and populations between now and 2050.

The 5 transforming world themes are:
First: People- the allocation of scarce human resources Second: Earth- the allocation of scarce natural resources Third: Innovation- the disruptive role of technology. Fourth: Government- the role of public policy, and Fifth: Markets- the allocation of scarce financial capital.

With about 40 pages of maps illustrating various aspects of these key themes it was hard to pick one or two for today’s show, but choose I did.

One major theme is the aging of the world population. One stunning statistic convinced me this was the chart. By 2050, the silver generation, people aged 65 and older will outnumber children under 14 for the first time in human history. What’s the significance of that demographic development?

The countries with the largest proportion of older people in 2050 will be Japan with 37% seniors,

Spain with 35% and Germany and Italy, each with 33%.

According to the report, the spending and savings of the silver generation is a huge $7 trillion dollar investment theme in three sectors alone: health, finance and consumer services.

Another major theme is the internet. Here are the top 10 countries by share of world internet usage. China leads the pack by a wide margin with 23% of the world’s usage. The U.S. with nearly 10% and India with 8-1/2% outdistance the others. Around 40% of the world’s population has an internet connection today, up from less than 1% in 1995. Internet users have increased ten-fold since 1999.

Bank of America Merrill Lynch estimates the rise of the internet could be a $7 trillion dollar industry as soon as 2020.

I began the interview by asking Hartnett why he and his team decided to create their “Transforming World” framework?

MICHAEL HARTNETT: We created the framework of the transforming world because a lot of our clients just love themes. They love thematic research, and it’s a growing part of the business and it has to be because if you think back over the past four or five years, you’ve had these epic returns from the equity market, the bond market. I think if you go between 2009 and 2014, the equity market is up 20 percent every year. High yield is up 18 percent every year. REITs are up 30 percent every year. It ain’t gonna continue forever. It just can’t, and now at least in the U.S. the QE stopped and suddenly the returns aren’t as ample. You’ve got to find a way to outperform, and the way that people are thinking about outperforming in the coming years is thematically. It could be a tech theme. It could be a demographic theme, but people are looking to concentrate more of their investments in themes, hoping that they will outperform lower returns from the bond market and the equity market going forward from here.

CONSUELO MACK: So how important are these themes to your investment process and decisions?

MICHAEL HARTNETT: They are terrifically important because a lot of them right now are good explanations as to why you’re living in this quite deflationary world. They help a lot in explaining why interest rates are, you know, so low. So when you look at demographics and you look at technology, there’s a lot of good explanation there as to why interest rates may remain at remarkably low levels over the next couple of years and, of course, this is very problematic if you’re a pension fund. How do you fund your liabilities going forward from here if you don’t think that there are tremendous opportunities in just owning the equity market and the expected returns from fixed income are so low?

CONSUELO MACK: One of kind of the headlines of one of the pieces of research that you’ve sent out to clients recently was that this is the longest deflationary expansion in history.

MICHAEL HARTNETT: You take every single government bond in the world. Fifty-five percent of them are yielding one percent or less. You think of all the QE right now. I think at the beginning of the year it was supporting 55 percent of the entire economy of the world. So I think that deflation is writ large across the financial markets. I mean the numbers are the numbers. It is the lowest trend rate of inflation right now that you’ve seen since the 1960s.

CONSUELO MACK: How significant is that from an economic point of view, from an investment point of view? What does that mean for us?

MICHAEL HARTNETT: There’s explanations for it and then there’s what it means. I mean the explanations for it, they could be demographic. They could be due to technology, excess debt. The QE may also have been a factor in all this QE has allowed.

CONSUELO MACK: Central bank easing.

MICHAEL HARTNETT: Companies have been able to raise money, add capacity. You think about Asia. Is that capacity needed? I mean investors are genuinely asking. You think of my children. I’ve got an 11-year-old and a 13-year-old. They may never drive. They may never have to. It may be automated cars, or if they do they’ll share the cars. They don’t want to buy products. They want to mess around on their phones. You end up sort of thinking what is Asia for? Because Asia’s an enormous sort of manufacturing place with all this capacity that may never be sort of utilized. So that’s very deflationary, and I think it’s a big factor as to why this enormous asset class, fixed income, which is so important to so many things, is trading at incredibly low interest rates and may continue for the foreseeable future.

CONSUELO MACK: One of the themes that you have mentioned in this report, is that the 65 plus population will outnumber children under 14 for the first time in human history you’re projecting by 2050. So what is the significance of that demographic trend?

MICHAEL HARTNETT: One of the conundrums of 2015 is where is the U.S. consumer. I mean after all, unemployment rates are incredibly low. Mortgage rates are incredibly low. Gasoline prices are incredibly low. Where’s the consumer? Why are they saving and not spending? I’m not saying it’s the entire answer, but certainly demographics could be one factor in that not only are people aging but they’ve living longer. You live longer. Life extension means that you’re going to have the one thing that isn’t deflating, health care costs which are going to go up.

CONSUELO MACK: And housing.

MICHAEL HARTNETT: And housing, and so maybe part of it is just people saving because they’re aging and they think they’re going to live longer and they’re going to need more money basically to pay for health care costs. I don’t think it’s the full explanation, but certainly I think it’s part of the explanation.

CONSUELO MACK: Does this mean, therefore, that the world economy is going to grow more slowly than it has in the past, for instance?

MICHAEL HARTNETT: You can look to Japan as a bit of a forerunner of that. I mean that’s a society that’s aged very dramatically the last sort of 20 years or so. Japan as an economy has found it incredibly difficult to grow quickly. It’s found it very, very difficult to generate inflation and, of course, interest rates are the same as they were 20 years ago which is zero.

CONSUELO MACK: Twenty years ago. Right, and what about the impact on the financial markets of this aging global demographic?

MICHAEL HARTNETT: Well, it can be positive. If people save more, then more of that money can get channeled into institutions, pension funds, long-only institutions, et cetera, and of course they can invest that money. That investment obviously can create upward movement in asset prices. There’s no doubt about it, but one of the things that clearly old people want is yield. Right now you have a situation, and you can see it’s becoming a political issue now in the U.S. The low level of interest rates is something that is seen to be harming pensions.

CONSUELO MACK: Yes, savers.

MICHAEL HARTNETT: Savers. You cannot get a return on saving, and therefore you have to save more. So I think that what that has forced people to do is extend the risk that they’re taking in assets that generate yield, high-yield funds, emerging market debt funds, Master Limited Partnership, REITs, and I’m not saying that they’re all …

CONSUELO MACK: And actually dividend-paying stocks.

MICHAEL HARTNETT: Now it’s dividend-paying. Exactly. That’s the new thing. So it clearly is having big ramification in terms of mini bubbles and busts within the financial markets and in any asset basically that promises a decent yield.

CONSUELO MACK: How do we take advantage of it as investors? I know that in the report that you projected that $7 trillion in health, finance and consumer services is what’s being created by this aging global demographic.

MICHAEL HARTNETT: I think you have to think about where the people are. The Chinese story, obviously there’s a lot of concern about the economy, the banking system and they’re all legitimate concerns, but clearly the transition is away from a place that produces products to a place that …

CONSUELO MACK: Produces consumers.

MICHAELHARTNETT: …producesconsumers.Exactly,and they want to travel .I mean they really want to travel. So I think you’re looking for areas of the market that will benefit from Chinese tourism. They could be hotels in Tokyo. They could be real estate in Tokyo. Certainly we’ve seen Vancouver, Sydney, Toronto. We’ve seen a lot of places in the world that have benefited from Chinese money going after real estate. Another way is just the classic sort of aging of the population and what that means in terms of pharmaceutical companies, and I think clearly part of the explanation for their valuations doing very well in recent years is because of this Asian population theme because it’s a growth theme in a world where there’s not a lot of growth, and that’s what people want.

CONSUELO MACK: The other fact that stunned me in addition to this aging of the global population to these record numbers is the global transformative power of the Internet and social media, and you predict that the Internet of Things – is what you called it in the Bank of America Merrill Lynch report – is a potential $7 trillion industry. By 2020 which is right around the corner, so $7 trillion industry. What’s going on there? What are the dynamics there?

MICHAEL HARTNETT: I mean clearly it’s right across, writ large across the economy the impact of technology, and then again as a strategist there are negatives as well as positives. The positives I think are pretty clear when you look at some of the share prices that you see for the Googles and the Amazons. I mean these are very transformative companies, and I think you’ve seen it in the past. You saw it in the 1920s to a certain extent. You saw it towards the end of the late 1990s that if you’ve got a growth narrative, and they have, then I think you will find that your valuations inevitably sort of end up in a very excessive way.

CONSUELO MACK: So another really stunning headline was that Facebook has 1.4 billion active monthly users which is the equivalent of the Chinese population, and the other one was that … is it Tencent? Is that how you pronounce it? The Chinese social media network has 540 million monthly active users. These are enormous figures. So I’m asking myself as an investor, well, should I just be investing in Facebook and Tencent?

MICHAEL HARTNETT: Well, you’ve answered your own question because many people are, and again we’re old enough to know that these things can start off in a very sort of fundamental way and end up in a very irrational way. So you have to be a little bit careful that at some point the market can get ahead of itself in terms of the revenues that these companies can generate, but certainly if you go back to thinking about demographics, technology, the debt, the deflation, the bull story is really that we’re living in a world of very low and stable interest rates, and really the last time that that happened was the 1950s which again was after a major world event.

CONSUELO MACK: War.

MICHAEL HARTNETT: And of course what happened in the 1950s was that the equity market did very well, but what did really well was the Nifty Fifty.

CONSUELO MACK: Fifty.

MICHAEL HARTNETT: And again certainly I’ve got a tremendous amount of sympathy with the idea that again if we continue to be in this world of very low interest rates, a lot of liquidity, not a lot of growth, you can also see a very narrow bull market emerge in some of the names that you suggest.

CONSUELO MACK: You’re already seeing it.

MICHAEL HARTNETT: And you’re seeing it. You’re also seeing through the late summer of 2015 that it can be interrupted very dramatically. You’ve seen that with the biotech stocks. But again, until you see interest rates go up because economic growth goes up, the danger is that you end up having a speculative fervor in a very narrow bunch of high-growth stocks.

CONSUELO MACK: Are we seeing that now?

MICHAEL HARTNETT: Yeah. I think you’ve seen in the past 12 months or so unquestionably in biotech.

CONSUELO MACK: Where the Amazons, the Intels, the Googles that are…

MICHAEL HARTNETT: I’m not sure all of them are sort of significantly overvalued, but I think that that’s where the risk runs right now going forward.

CONSUELO MACK: Which leads me to another compelling theme again that your research pointed out in how dominant the U.S. still is, and 23 percent of global GDP, it’s still number one. So as a U.S. citizen and a U.S. investor and probably a U.S.-centric investor, I’m saying this is a really good place to be investing. Should I be U.S.-centric? Does that make sense?

MICHAEL HARTNETT: Well, I think that people have become very U.S.-centric, and that’s why the dollar earlier on this year was on such a steep ascent. I think what’s interesting as the year has progressed is that loving the U.S. and making the dollar go up has ended up causing earnings problems and economic problems in the U.S. So there’s an element of be careful what you wish for in your question. I think that without a doubt the U.S. has something that the rest of the world doesn’t, which is technology, and again if you look at the makeup of the S&P index, almost 20 percent of it is technology. It’s got a dominance in technology, and that is creating a tremendous amount of growth in the world right now which is why people want to own America, but what has also happened is the U.S. has become overvalued relative to other markets as a consequence. So if you look at Europe, you look at Japan certainly at the beginning of the year, there were deemed to be opportunities there particularly because the policy mix was still so actively pushing up asset prices. So it’s not just going to be U.S. every year, but I think without a doubt the dollar over the medium term because of technology should do well.

CONSUELO MACK: Two big trends have emerged in 2015 according to your research as well. One is the risk of a bubble in U.S. health care and technology. We just talked about technology. Is there a strategy that we can employ to take advantage of those two trends?

MICHAEL HARTNETT: Well, I think if they come to pass, if they come to pass, I certainly think what would be happening in conjunction with that would, number one, be a lot of strength in the U.S. dollar. Again, if you go back to the last time it really happened which was 1999, that was a period where you saw the dollar move up. I mean really what was happening was this small band of stocks was surging higher.

CONSUELO MACK: Yes, the Internet stocks.

MICHAEL HARTNETT: And it was dragging the dollar up. It was dragging Treasury yields up and, of course, what was fascinating at the time and also told you that something bad was going to happen was that gold was going up at the same time. When the dollar goes up and gold goes up simultaneously …

CONSUELO MACK: Watch out.

MICHAEL HARTNETT: Not a good sign, and again I’m pretty sure ’87 was another great example of that where you saw the dollar go up and gold go up in conjunction. So I don’t think it’s the reason right now, you know, gold’s back in fashion. I think gold’s back in fashion because people …

CONSUELO MACK: From turmoil.

MICHAEL HARTNETT: Well, I think it’s more policy failure. I think people are just saying QE, it ain’t working, and if you do it anymore it will be more harmful. So I think the policy failure thing is getting people into gold, but certainly if you were to see in 2016 a true bubble in technology, biotech, health care, all that sort of stuff, I’m pretty sure gold will be going up at the same time.

CONSUELO MACK: So that’s something to be watching. MICHAEL HARTNETT: Oh, without a doubt.
CONSUELO MACK: Exactly, and possibly invest in gold as a result.

MICHAEL HARTNETT: No, I like gold. I wouldn’t say it’s in a win-win situation, but certainly commodities generally because of all this deflation … I think it was Minsky that had that famous phrase.

CONSUELO MACK: Hyman Minsky.

MICHAEL HARTNETT: “There’s nothing more inflationary than a whiff of deflation,” and because things are so deflationary now and because there’s inequality in so many different walks of life, because the recovery is not particularly strong, because the markets are quite fragile, if you do get a hint of recession in the next six months I’m absolutely certain that they really have to panic policy-wise, and you have to see not just monetary but also fiscal policy used to boost economic activity, and that would be very, very bullish for gold.

CONSUELO MACK: One other trend that you said emerged in 2015 well was what you just mentioned, the crash in the emerging markets and the resources, commodities. Have they bottomed out? Do you think this is an opportunity for commodities in emerging markets?

MICHAEL HARTNETT: I’ve got a suspicion that you’re close. I mean I think it’s hard right now. Emerging markets again have changed, and we talked about China a little earlier on.

CONSUELO MACK: Well, the BRICS are no longer BRICS.

MICHAEL HARTNETT: That’s right, and the BRICS remember, tied up with that was the whole sort of commodity story. Right now first time ever, all the companies in emerging markets that are consumer products, consumer staples, consumer discretionary actually are now valued more highly than all the energy and material companies.

CONSUELO MACK: So first time ever.

MICHAEL HARTNETT: To the highest extent ever, and so it just tells you that that whole rebalancing of the economy in the EM markets, it happened. It happened in a very bad way because all the energy and the material stocks collapsed, but nonetheless it’s a different animal right now, and what is the big sector in emerging markets is the financials. What is going to make them click is lower interest rates. So right now you’ve got zero rates in New York. You’ve got zero rates in London. You’ve got zero rates in Berlin. You’ve got zero rates in Tokyo and you’ve got 15 percent rates in San Paulo. At some point that will become attractive. When it does and you start to get a rate-cutting cycle in emerging markets, that’s when the equities as well as the bonds will become quite attractive.

CONSUELO MACK: This deflationary cycle that we’re in, is there any end in sight? You just mentioned that possibly there could be a whiff of inflation, but is there any end to this deflationary cycle that you see?

MICHAEL HARTNETT: I mean I think it’s very difficult to reverse populations. It’s very difficult to reverse technology. There’s still a tremendous amount of debt around. So I think there are these sort of structural barriers if you like to higher prices, but we’re talking about the financial markets. We’re talking about greed and fear and hubris and humiliation. We always overdo it one way or the other, and I do think that there is a risk toward the end of 2015 with everyone predicting default in EM or commodities or this, that and the other, and other people are predicting recession that you could very be close to a trough, an inflection point in inflation expectations because they’re so beaten down right now. CONSUELO MACK: So low.

MICHAEL HARTNETT: Certainly looking into next year, I think if there is any weakness – I’m not sure there will be in the immediate future, but if there is weakness in financial markets, I want to start buying inflation assets, things like TIPS, commodities, gold because I think the policy response will be much more inflationary the next time around.

CONSUELO MACK: Last question we always ask every guest at the end of a WEALTHTRACK is if there’s one investment we should all have in a long-term diversified portfolio, what would it be?

MICHAELHARTNETT: Well,I think start raising your weighting of commodities,physical commodities, because I think equities are close to an all-time high. Bonds are close to an all- time high. Interest rates are certainly on some measures 5,000-year lows, and commodities obviously have been in a severe bear market. So I think if you’ve got a one, two, three-year horizon, I would imagine that the portion of commodities in your portfolio … maybe people still like gold, but I think some of the industrial metals. I think 2016 they’ll surprise on the up side.

CONSUELO MACK: And do we have to be specific as far as an industrial metal or is it ETF index fund?

MICHAELHARTNETT: No. I think probably the easiest way is to just have a broad exposure to it.

CONSUELO MACK: Broad-based commodity.

MICHAEL HARTNETT: You could use an ETF, mutual fund, however you want to do it, but I think it’s the physical commodity, not necessarily the company at this particular moment that you want to own.

CONSUELO MACK: Michael Hartnett, a treat to have you on WEALTHTRACK again.

MICHAELHARTNETT: Pleasure.

CONSUELO MACK: At the close of every WEALTHTRACK we try to give you one suggestion to help you build and protect your wealth over the long term.
This week’s action point is: Take advantage of the internet personally and professionally.
I have been a slow adapter of social media. No more. It has become the preferred way to connect with family, friends, you the audience and business. The numbers are astounding. Facebook has 1.4 billion monthly active users around the world, equal to the current population of China. The number of internet users around the world is growing exponentially and if Bank of America Merrill Lynch is correct, the rise of the internet will make the “Internet of Things” a potential $7 trillion dollar industry within the next four years.

It’s a phenomenon few of us can afford to ignore, let alone miss.

Next week, First Eagle Funds’ Great Investor Matthew McLennan will join us to discuss why we are now in an era of episodic crises and what he is doing to build an all-weather portfolio.
To see this program again and other WEALTHTRACK interviews please go to our website wealthtrack.com.

Also feel free to reach out to us on Facebook and Twitter. Thank you for watching. Have a great weekend and make the week ahead a profitable and a productive one.

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