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Jon Cleborne: Good evening. I’m Jon Cleborne, and welcome to tonight’s live webcast. As you might recall, we were originally scheduled to talk about emerging markets tonight, and we will get to that. But tonight we have to talk about the topic that’s on everyone’s mind, the election results. We’ll share a bit of perspective about how the election results may impact major global financial markets, global economy, and most importantly how you should be thinking about your portfolio.

Joining us tonight to discuss this topic are Jonathan Lemco of Vanguard’s Investment Strategy Group; Joe Davis, Vanguard’s Chief Global Economist; and a special guest, Allison Fisch, of Pzena Investment Management. Allison is a portfolio manager on the Vanguard Emerging Markets Select Stock Fund. Thanks for coming tonight, Allison.

Allison Fisch: Thanks for having me.

Jon Cleborne: Sure. We’ll spend most of the broadcast tonight answering your questions. And so before we get to that there’s two items I’d like to point out. There’s a widget at the bottom of your screen for accessing technical help. It’s the yellow widget on the left. And if some of you would like to read Vanguard’s perspective on tonight’s topics for review, some replays of some past webcasts, you can click on the resource widget on the far right side of the player. Okay.

So quite a night last night. Let’s talk just a little bit about it. Just how did the markets react today? And Joe, maybe I’ll kick that to you.

Joe Davis: Yes, just at a high level, you know clearly for those investors that were watching the futures market overnight as the election results were coming in, equity markets were down substantially. But as the day progressed throughout today, the equity markets in the U.S. were up fairly robustly. And more interesting, in bond markets, long-term interest rates were markedly higher. And you know, primarily expectations for inflation were the investors demanding a little bit more risk for the financial uncertainty of perhaps higher future inflation, and that rose substantially. Still at low interest-rate levels.

And the probability of the Federal Reserve raising rates dropped substantially, you know, for December, and they went back. And we ended the day ironically at the same odds that we were before the election results. So some volatility in the way. But the markets I think was a better outcome for equity markets than some would have anticipated as recently as last evening.

Jonathan Lemco: Well, we were expecting an awful day, frankly, in the fixed income markets. And as it turns out, particularly on the EM side, the emerging market side, there was mild weakness. Mexico took a pretty big hit and so did the Ukraine. But overall they averaged about five basis points wider. So the good news is that most of the countries that we invest in the world held in reasonably nicely, at least for today. You know I do expect volatility going forward, but pleasant surprise.

Jon Cleborne: So you say it’s a little bit of a surprise, Jonathan; I’m interested. Why do you say it was a surprise?

Jonathan Lemco: I expected there to be a lot of fear in the markets. And certainly looking at the, what happened in Asia overnight would signal that, but starting with what happened in Europe and then subsequently in North America, the mood set tended to change. And so the obvious question then is, so why did it change? I think a couple of things occurred.

One, there’s a perception in the markets that the Fed, which was going to raise rates in December, and then Bloomberg told us, that according to surveys there was a 71% chance they said of a 25-basis-point increase in December. Now there’s, it’s less clear. And that was somewhat reassuring I think the markets on the one hand.

Also when Donald Trump made his speech, his victory speech, he was somewhat conciliatory. And that was also a bit reassuring to the markets. And then the notion that there’s going to be fiscal stimulus because he wants to spend a lot, approximately $500 billion on infrastructure, in turn gave some confidence, particularly in the corporate bond side, and that there will be some spending here. It might be inflationary, of course. But it might help the economy to grow somewhat. So it is a combination of factors which in turn gave some reassurance to our broader market.

Jon Cleborne: So on that front, maybe I, I’d be interested, you think about some of the anti-free-trade policies that President-elect Trump has talked about. And repelling NAFTA and opposing the TPP, you know, generally speaking, I would assume that those might be bad for equities, and yet equities in the U.S. had a really strong day. I’m interested, how do you think that these trade deals might end up impacting the equity markets?

Allison Fisch: Well, it’s hard to say how they could impact the equity markets overall, what will happen. But if you look at what happened to international equities, they did finish the day down. Now part of that might be timing because global markets were very negative last night, which, and earlier this morning, which is a lot of international markets. But these sorts of trade deals do benefit our international partners, particularly in emerging markets where, if some of these things do get rolled back, that would affect a lot of markets.

 In particular you see China and Mexico which have been trade surpluses with the U.S. Then you have within Asia, Hong Kong and Singapore, which are sort of financial centers. So should we see a lot of protectionism, there is a fear that that would affect those economies very harshly. But again there was this timing difference where we started off the day everywhere very negative. So I think it will be interesting to see where things open up overnight.

Joe Davis: Yes, and I think the one thing, just to echo what Allison said, you know I think for the U.S. as well, where we saw a strong lift in equity prices, and again this is just one day, which we all know, so let’s keep, we’ll keep that in mind. But if you’re just saying, hey, why wasn’t it, to Jonathan’s point, perhaps more negative? I think there’s going to be in the next several months, there’s just going to be this question of at the margin, fiscal policy, potentially more infrastructure spending potentially, significant tax reform. All else equal that would be a somewhat stimulant for short-term growth. So obviously that would be generally beneficial for equities, certainly higher inflation, prospects for higher short-term rates by the Federal Reserve over the next year or two.

But that, then there’s going to be, well, but there’s also a clarity or a lack of clarity or a risk of, you mentioned trade restrictions, potential in immigration, which can act as a near-term depressant on global activity for sure. So I think it’s going to be, I just, one day seems like to focus on the near term, positive impacts. I’m not saying to dismiss that, but I think in the course of the next months we should be prepared at times as we get more details and just how natural government works. That we may have somewhat of a seesaw pattern with the respect to the forces on the U.S. economy.

Jon Cleborne: So Jonathan, you’ve done some work on that too, looking at volatility around elections. I wonder if you might comment on that?

Jonathan Lemco: Sure. Published a piece that’s on as a matter of fact. Looking at elections, U.S. presidential elections, dating back to 1853, and found that in aggregate, in subsequent election years, whether it’s a Democratic victory, whether it’s a Republican victory, the equity returns are virtually identical.

Now to be fair, you get periods of time in the ’20s when, for example, the Republicans were ahead. You get a period of time from the 1960s through ’80 when the Democrats tended to be ahead. But if you look at the aggregate, you find that, maybe surprisingly, the difference is almost nothing. And so I’m not a soothsayer here, I’m not forecasting that that’s what it might be going forward, but history does teach us to take the long view, to take a broad perspective here, and this is an important lesson that we learned in all this.

We also looked at volatility prior to elections since 1991, and as measured by the VIX to the present, and found that in the days up to an election, volatility spikes up. But in the 100 days after, it stabilizes substantially and then in the days following up to 200 days, it plummets to almost nothing.

So here again, this is consistent since, in this case 1991 when we started using the VIX. So bear in mind that we want to take a longer-term perspective on all of this.

Jon Cleborne: Yes, so maybe on that front, I mean I’d be interested to understand, and Allison, maybe this is a question for you, how does this change your sort of longer-term outlook for emerging markets? And we’ve got a question that came in, Craig has asked, in light of the presidential election, is this a good time for an entry investment into international or specifically emerging markets?

Allison Fisch: Well, for us and the way that we invest, we are looking to create portfolios of fundamentally undervalued businesses. So does the event of yesterday change the value of a particular business? Maybe, but it’s a little hard to say. And so on that basis, if you think that a certain business is worth a certain target, and then there’s increased volatility because of an election, more fear certainly is what we’re hearing in a lot of the questions coming in. That can be a great opportunity in fact to enter into an investment that you believe in over time.

Jonathan Lemco: The Vanguard view, and it’s one that I share as well, that in a well-diversified portfolio there should be a role for EM equities, and/or EM debt, that if an entire portfolio, approximately 20 to 40%should be international, 20 to 40 depending on your risk acceptance level. Of that 20 to 40 perhaps 25%of that should be emerging market. So 20%international, let’s say 5% of your total portfolio should be EM debt or equity as well, as a rule of thumb. As long as it’s part of a broadly diversified portfolio, there really is a place for this.

Jon Cleborne: So one of the things that folks were asking a little bit about coming in is, is this an opportunity to think about trying to move into a particular asset class? So thinking about buying on a dip so to speak, outside the U.S. How do you guys think about that more generally?

Joe Davis: Well, maybe I’d say one thing just in terms of our capital markets outlook and in the process now of having it that we do it every year. And you know it’s in many ways our longer-term outlook is unchanged from the past several years. And Jon, you know, I mean many of the investors may know, we’ve not been bearish on the capital markets, we’ve viewed the low-interest-rate environment as more secular than cyclical. Which means it’s just going to be with us for some time. You know we may have ups and downs, but we don’t foresee a rapid rise in interest rates.

And at the equity markets, the valuations are certainly not cheap like they were in 2009. So strong equity performance over the past couple of years has also led us to have lower expected returns going forward. And you know the recent environment with Brexit or the recent election results in the U.S. doesn’t substantially change that in our minds in terms of the risk profile.

So I’d be guarded against investors. I’d just say, eyes wide open if one would be heroic in such an environment because it’s unclear to me that investors are going to be overly rewarded for very aggressive risk positions, whether that’s in corporate bonds or, you all know better, outside the U.S. markets. But our expected-return outlooks, they’re not bearish, but they’re for a balanced portfolio for the next five or seven years, they’re in the mid- to single digits. They’re not what we have had historically. So that’s what’s been, once planned, but it’s also, I would be cautious of aggressively changing one’s allocation based upon the recent events.

Allison Fisch: Well, I think just to touch on that, an interesting phenomenon that we’ve noticed, because we’re value investors, is that over the last several years although the market overall may look fairly valued in some people’s opinions, the bifurcation and spreads is pretty close to historic highs. And as in the expensive stocks keep getting more expensive and the cheap stocks keep getting cheaper, over the last few months we’ve seen a bit of a reversal of that, which certainly we’ve enjoyed.

Now whether the uncertainly of today calls that into question in the months ahead is a bit of a question mark. But I would just say, even when the market may look fairly valued overall, these pockets of very, very undervalued companies certainly exist. And we see them in every region around the world at the moment.

Jon Cleborne: That’s great to know. Any industries stand out or is it just it depends on the region, it depends on the industry?

Allison Fisch: Within the developed markets, and this would include the U.S. as well, financials really stands out as quite an opportunity in terms of how cheap the stocks are. And I know you mentioned that the Vanguard view is and interest rates staying low is a secular not a cyclical event. And so some people may take the opposite side of that view. But what we’ve noticed is that even if you think it’s a secular event, there’s a lot of self-help that these companies can do, and you’re starting to see that in Europe. And also in some other places around the world. And so that’s a particular opportunity we see in developed markets.

In emerging markets the opportunity set is a bit broader. Financials there haven’t experienced the pain that we’ve seen in the developed markets. So within emerging markets it’s less sector-specific within financials, and more widespread, though certainly everything is cyclical. And anything that was related to the China boom of the previous decade has really sold off over the last five years.

Jonathan Lemco: ‘Although just quickly on China. I’d mentioned that for the first time we’ve noticed in the last quarter that they do seem to be making a meaningful change from that export-driven growth to domestic or consumer-driven growth. And from a market perspective that’s got to be seen as a positive. We don’t think there’s going to be a hard landing; it’s a soft landing, in the 6 to 7%range. It’s not great, it’s adequate. But the fact that it’s adequate means that China going forward will continue to buy commodities from emerging market countries worldwide. So I think that bodes reasonably well for EM as a whole. There are all kind of factors that go into this, but China at least stabilizing has got to be seen as a positive of some kind.

Jon Cleborne: So Jonathan, maybe to build on China for a second, we do have another live question that came in, and Steven asked, President-elect Trump has stated that in his first 100 days he was going to direct his secretary of state to label China as a currency manipulator. And I’m just interested, the questions, thoughts, effects of that type of a statement on the Chinese economy and on the Chinese markets.

Jonathan Lemco: Well, at first glance I think that will make Chinese government authorities very defensive, and that will not contribute to diplomatic relations between the two countries. Now, back-channel relationships, you never know what they can come up with. But if you come out as a president and you say really stark things in that fashion, it doesn’t help the broader commercial relationship, and that’s just a fact of life. And that may be an incentive for China to continue to develop its relationships with other countries in Asia, not just financial and not just economic, but strategic and elsewhere, all because they may feel more and more threatened.

So I’m not suggesting—You know China owns over $3 trillion of U.S. securities, Treasuries, and dollars and so on; it’s in China’s interest to retain those too. But the two economies are complementary in a lot of ways. And we have to strive to find ways to work together.

Jon Cleborne: So maybe shifting gears for a second, Joe, I want to go back to something you’ve talked a little bit about earlier. And that was inflation. And inflation expectations and some movement in long-term interest rates today. I’d be interested in your question, or in the question that came in here was, should we be worried about inflation given the projected ‘deficits that might be coming?

Joe Davis: Yes, we went into, I mean just for context, this time last year, and we said two things. One is hey, listen, you know over the next five or ten years the inflation outlook is fairly muted, relative to the ’80s and ’70s, clearly. And central banks have struggled to generate 2% core inflation as is commonly measured, right. We’ve been below the target for the past ten years more than we’ve ever been above it.

Now that is context; we also have said, for the first time since 2006, on a modest cyclical basis, at least in the U.S., and perhaps less so in emerging markets and other economies, or Japan, that we would see the likelihood of some domestic inflation pressures, modestly building. And now that was delayed to be fair, right. We had the commodity price, the veracious drop to begin the year. We’ve had some depressants in the healthcare prices. Some of the Affordable Care Act. But when you strip out some of that, ‘I think even the election aside, I think we’re going to have just, with near-full employment in the U.S. economy our long-held view of the economy. You throw a lot of shocks at it, but it’s still fairly resilient, even though growth we would all, I’d like to see a little bit higher.

But that leads us to modestly higher inflation. Now what the markets I think are picking up is that regardless of what inflation is, one year, two years, three years, that has a distribution shift so that there’s a material risk of inflation 10 years, 15 years down the line, because of high debt levels and some sort of fiscal motivation that we may see a higher risk premium with markedly higher inflation.

I think where it is today feels more appropriate than where we were three or four months ago. We’ve talked about that, right, in our own active strategies team. But I don’t see a meaningful risk of a sharp rise in inflation, at least over the next several years. But that’s also conditional on the Federal Reserve over the next year or two, removing some of the success of an accommodation measure.

Jon Cleborne: And can you talk a little bit about that, what do you think?

Joe Davis: Well, you know they’ve raised rates 25 basis points from a range of between zero to 25 basis points over a year to now we’re modestly above the zero between 25 to 50 basis points. We’ve only held two views. One is we believe the Federal Reserve has a strong case to raise rates to roughly around 1%. We could debate the number after the decimal. And at that point then we would have removed emergency measures in 2008, 2009. The U.S. economy is not in a state of urgency by the board metrics at the Federal Reserve from their mandate.

After that, I think it becomes a higher hurdle, global conditions, the state of emerging markets, other developed markets, and there’s still some healing that has to go on at some parts of the economy. So I think if we get any sort of modest fiscal stimulus in the near term, I think it’s only going to give a little bit of cover to the Federal Reserve to actually raise rates.

But I think increasingly they acknowledge that they want to be a little bit, have a little bit more, they want to get a little bit further above zero, a cushion, because at some point we may very well have another recession. I mean if the consensus is right, two years from now we will then have had the longest expansion in U.S. history. Now, that doesn’t mean we have to have a recession. But I don’t think the unemployment rate and core inflation says that we should have such trivially low short-term rates either.

Jon Cleborne: So the question that just came in I love, and Elaine asks, “So this is all interesting for people who are playing the markets, but what should I as a basic 401(k) investor do, given what happened last evening?”

Allison Fisch: I would say remain calm. Now you go.

Jonathan Lemco: No, but I think that’s exactly the first point is remain calm, this too shall pass. It’s important to be invested, first of all. We’re not market timers, the market will go up, it will go down. So be invested. The second thing I’d say is set a plan and then stick to that plan and have a long-term perspective. Because there are always going to be challenges of one kind or another, be it an election, be it a national calamity, be it some positive surprise, there will always be something. So have a plan. You stick to it and you be as broadly diversified as possible.

Now you’ve heard this from Vanguard people before, but I think it remains absolutely true. This series of goals, if you will, has just stood the test of time. And going forward, we suspect the same. But first things first, try and invest in a way that you’ll earn something more than what the bank will offer, and then try and detach yourself emotionally from all the ups and downs and everything else. You don’t have to watch your portfolio every day. I know it’s sometimes hard to ask, it’s a big thing to ask, but in the real world, get on with your life. So that’s what I would suggest.

Jon Cleborne: Well said, well said. So maybe to talk a little bit, there were a few sectors that were particularly impacted today. And I’d be interested in your ‘guys’ perspectives on as you look at the potential policy contours that could come out over the next couple of years, do you see particular sectors that might be adversely impacted or favorably impacted by the Trump economic agenda?

Joe Davis: You got the hot seat.

Allison Fisch: I’ll take it. So the Trump economic agenda, that is a question mark. He did lay out a 100-day plan. Big infrastructure projects, big fiscal spending. That obviously would be helpful for the material segment. He’s talked about deregulation in the banks, so financials had a nice day as well. Healthcare stocks, particularly on the pharma side, performed well because they were afraid of a Clinton presidency, less about I think anything that Trump has said.

All of these movements, again on the day, are hard to read into as really being the way that the future unfolds. And certainly I don’t think the four of us are going to have a crystal ball to prognosticate on that.

Jonathan Lemco: And I think that’s right. He’s talked as you say about getting rid of the Affordable Care Act and replacing it with a market-focused health plan. If so, theoretically that’s a good thing for pharmaceutical companies. We’ll see. He’s talked about expanding defense. Well, if that’s true then the defense industry should benefit to all of this. But the truth is, so much of this so far has been to a large part rhetoric, I think, and let’s see what the real plans are in some detail. And ideally this will come out in the next few weeks. But one step at a time.

Allison Fisch: And I think on top of that, I mean we have to see what the plans are and then we have to see what he can actually accomplish. I mean we do have a Republican Congress, but it’s not clear that they’re really ready to work together. 

Jon Cleborne: Yes, I think that’s fair. So we’ve got another live question that came in. So Akeel asks, “So what is Vanguard’s outlook for the dollar going forward, strengthening versus weakening? And what does that mean for emerging markets?” Obviously the dollar moved pretty dramatically over the course of the day today.

Joe Davis: Well, I think part of that too comes to, it’s the outlook for the Federal Reserve is clearly one prominent driver. And if we’re right, and if the Federal Reserve is able to still gradually but more deliberately raise rates, at least up to a less-trivial level, that would be, and I don’t think markets are anticipating that. They’re still, at least as of today, the bond market is still seeing that perhaps one, maybe two, interest rate hikes over the next two years. So if it’s modestly higher than that, that would obviously be almost equal. You know modest upward pressure on the dollar.

But I think there’s a limit to how far that the U.S. dollar can personally rise. And I think the past year has shown that, because if you have even markedly higher movements in the dollar, so it appreciates in value even more, there’s a knock-on effect, that it depresses some parts of the economy, the trade areas. It kind of lowers imported prices and at least now inflation has been below the Fed target. So which then reduces the expectations for Federal Reserve hikes. So that’s where there’s a self, a feedback loop that tends to, although you can see gyrations in the dollar and I don’t see it weakening substantially. But you have that oscillation.

So I’d be hard-pressed to see material rises in the U.S. dollar. I also think it would be hard-pressed to see material declines in the dollar. That would suggest that U.S. economy is okay, but we see a significant increase in global economic activity, which I’m hard-pressed to see. But you know that’s just from the U.S. dollar perspective, I don’t know if there’s other views on other markets.

Jon Cleborne: So we’ve got another question that came in. So Richard asked, “Is there any risk of U.S. Treasury bonds being viewed as more risky by foreign investors, and if so what might any of the implications be for individual investors who often put those in their portfolios?”

Jonathan Lemco: Well, central banks grow—Go.

Jon Cleborne: I want to hear the answer; it’s a controversial question.

Jonathan Lemco: As I understand it, there are more Treasuries in circulation outside the borders of the United States today than there are inside the United States. Central banks around the world, starting with China, but in Korea, I think Chile, in Mexico, and in many, many different countries, both developed and in the EM, hold Treasuries. And Treasuries are the most popular with euros a distant second and so on. Treasuries are a reflection of the underlying U.S. economy, and that is the U.S. economy is still seen as the most dynamic in the world. So it’s no accident that so many countries place faith in that.

In the event of trouble, is there risk of sell-off? I think in certainly in the short to medium run very unlikely. The credit quality of the United States will remain very high. This is still a AAA with Moody’s and Fitch, a AA+ with Standard & Poor’s. I don’t see any erosion of that anytime soon, despite the fact that the U.S. debt-to-GDP is apparently, according to the IMF now 107% of GDP.

But the U.S. has such other major strengths starting with this dynamic economy, starting with labor mobility, starting with some great diversification of industry, on and on and on, especially the reserve currency, the dollar, which is the most important of all, that it’s hard for me to imagine a situation for the foreseeable future, where there would be a massive sell-off because of fear. It would take some tremendous calamity, obviously by definition, that would be a major surprise, and I’m not in the business of predicting black swans. So I think it’s, I think that’s unlikely. Never say never. But I think it’s unlikely.

Joe Davis: Yes, because the alternatives to our value, in global fixed income markets, I’m hard-pressed to see. I mean you have some in the Japanese market, but the vitality of the economy is a distant cry from the U.S. Europe doesn’t have a global central sovereign bond market. And China doesn’t, haven’t opened their capital account. So there’s not that piece. So what is the alternatives to our value? And we’ve seen that in the taper tantrum. One year ago, the debt downgrade; several years ago there was actually U.S. long-term interest rates fell, not rose, not, you know, it didn’t rise.

So inflation concerns of future inflation clearly put upward pressure on that. But again I think in a global integrated capital market, it’s tough to see the material divergence of U.S. long-term interest rates from other parts of the world, where still 60 to 70%of global long-term bond yields are negative, right, and given all the characteristics that Jonathan just mentioned, that looks like a pretty good long term, not without risk, but a good long-term investment.

And so I think there’s still going to be that dynamic that I don’t see changing materially. You would have to see things not only change in the U.S., you have to see other material conditions change outside of the U.S. and separate that dynamics.

Jonathan Lemco: You look at Treasuries, relative to every other similar security from any other country, and it’s not offering a great yield, but it’s better than any other developed country in the world today. You have to go to EM to find a higher yields. It’s a signal in part I think of the world’s faith in the underlying strength of the U.S. economy. Are there challenges here? Absolutely. But the resilience of this country is over a long period of time has been tremendous.

Jon Cleborne: So one of the questions that came in before the webcast this evening was around Brexit. And thinking about the events of last night, comparing and contrasting them a little bit to what we saw with Brexit and maybe the market experience following Brexit, I’m interested in your guys’ perspective. Is it similar to Brexit? Does it feel like it’s going to be materially different?

Jonathan Lemco: My own view is some of the conditions that led to the Brexit are very similar. Starting with this whole populous notion that we’ve seen in the U.K., that we saw in parts of Western Europe, and parts of LATAM, and now we seem to be seeing in the United States as well. Part of it is fear, and helped to prompt the Brexit as well, just broad-based fear of immigrants, fear of other, what’s going on in other countries, fear of trade, fear of change of everything you think you know. And so some of the conditions, I think, are underlying this, are there.

But a sense that your job is somehow not secure, which we heard so much during the U.S. election campaign, with some of the same discussion that we heard during the Brexit debate as well. And why is it not secure? For all kinds of reasons. But maybe if you close your country off, you take a big step to protect your job, you protect your lifestyle, to protect what you value. So I think that underlying a lot of the typically right-wing populous moments that we’re seeing around the world is this basic fear and this sense that if we close ourselves off to some extent, we protect what we have.

Joe Davis: You know we did some research internally, Jon, and you know I think the one thing that has been lost, and I don’t disagree with anything, Jonathan, you’ve said. But so why and why now? And I know there was a lot, and I’ve got to be careful here right, because it’s a politically charged argument. And but I think a lot of focus, and you heard it on both sides of the political aisle. We heard it in the Brexit. You hear it in other parts of the world of is globalization. Right. Treated as a zero-sum game.

And I think there’s another force that has been at work for 20, 30 years, that to my knowledge, was not uttered once by any political party over the past year. Which I think correlates both highly with Brexit and what occurred at parts of the U.S. election. And so we may see some more parts of this.

And this is this disruption related to technology. So it gets to the job-loss anxiety. So I’m not saying there hasn’t been a closure of a factory in some part of the United States that you could trace to some other part of the world. And I’m not, I’m just saying there’s a broader force at work around automation, some will call it productivity, but in a global, digital economy. And that’s why we’ve seen the income levels between those that have certain skills or work in certain industries, outpaced by a significant margin over 40 years, other certain skills, or other certain education levels.

And we see this rise in income disparity across every single economy in the world. Which means it cannot solely be globalization. There’s a global force that’s impacting on all economies. And by our research we’ve found that the technology, and technological advance, is good, but in a global digital economy there can be winner-take-all effects. And so I don’t want to push this argument too much, but I think there’s that. It’s been slowly building that you can miss day to day, but I think on a grand scheme of things, that relates to some of the voting patterns, or the dialogue that we’re seeing.

My only frustration as an economist, it is solely all those arguments are then hung on globalization. When I said, well, there’s a global force at work called technology, more recently digital technology, it could be automation, it could be manufacturing, and so that enforcement has been in play. And I think that was something I think will come out and be recognized more wildly over the next several months and years, right.

Because we’re seeing this. I mean you’re seeing it in parts of China now, right. So this is not a U.S. phenomenon, it’s not a United Kingdom phenomenon, and that’s not to be an alarmist saying. I’m just trying to say what is going on here and there’s multiple forces well beyond just the economy that can play into a political sort of environment. But as an economist, I say well, this is something I don’t think is getting enough attention. And when you start to see these data points which occur infrequently, you start to put that mosaic together that I think is helping to explain some of what’s going on to provide some context.

Allison Fisch: I think that’s a really interesting point. And beyond that, I think there are similarities and differences, right, between these two events. And those are some similarities. So that’s a really interesting point about technology I hadn’t completely thought through. But I would say also on top of that you have this sort of force of people rejecting the establishment and rejecting being told what to do.

So here, it’s fatigue with the status quo of Washington dysfunction. In the U.K., it’s not wanting to be told what to do by some people far away on the continent. But I would say also what both of these events have in common is that they were a surprise, right. Nobody expected the vote to go this way as of yesterday afternoon. Nobody expected the Brexit vote to go in that direction.

In both instances the middle of the night, I’m sure this is true for all of you as well. I’m exchanging emails with my colleagues, and we’re watching the market’s opening overnight. And the whole thing is a big surprise. I think the difference though is that we had forecasts coming out of the IMF and other organizations about the effects of Brexit on the British economy. And that it would be very negative. So the dire reaction of the stock market post–Brexit vote sort of made sense.

Now contrasting that with what we experienced here in the U.S., we really don’t know. We don’t know. And so I think sort of the seesawing that we’re seeing in markets makes sense.

Joe Davis: Yes, and we didn’t see that initial immediate drop off in the U.K. economy, right.

Allison Fisch: Yes, we haven’t seen anything yet.

Joe Davis: Even though that was the forecast. Yes, we haven’t seen anything yet.

Jonathan Lemco: So far it’s held up, but these things take a while.

Jon Cleborne: So maybe to build on that just a little bit, Jon sent in a question asking, “Realizing you’re not prognosticators, do you see any other surprises potentially lurking?” And Joe, you talked a little bit about other environments where this might potentially play out. Are there other things that maybe we should be watching out for?

Joe Davis: Well, it’s a, you know, my colleagues, I see there’s two sort of scenarios. So if you paint sort of status quo of what the market is expecting, right, it’s kind of more of the same, you know. Low-growth environment. China will continue to gradually decelerate. The U.S. economy will chug along as it has been around 2%. Okay, well, it’s up to three or four without recession either, right. Europe will not see a reignition of the banking concerns, the sovereign debt crisis. Japan, I guess, is more of very meager growth. But again a low-growth environment, but one we’re not recession risk.

So that doesn’t seem unreasonable, but I get concerned when everyone has the same view. So I’ll turn it to my colleagues. The one thing focusing on it could be a sort of something that perhaps we’re not widely discussing. And it’s not all pessimistic, because I think when you go through risks in the market, I always think of all the negative things. And I don’t mean to dismiss them, that’s what I do initially.

One thing that could be, would actually be a little bit, just the next year or two, perhaps modestly stronger growth in the U.S. And I’m not handing off fiscal stimulus, it’s just we’re already growing at two, but there’s parts of the economy that are growing a little bit stronger than that. And so a little bit higher than expected inflation.

And so not going back to the old days of 3 or 4%growth. But we could see, that could be, and I’m not saying that’s not bad for the market, but that could be a surprise. So that’s one. But that’s in the U.S. I don’t know if there’s other areas.

Allison Fisch: I would say globally, I mean I have a colleague as well who is afraid of and constantly bringing up this idea that we could see, after all this accommodative policy, inflation spike up unexpectedly and that that would be a risk as well. So sort of along those lines.

Joe Davis: And that’s something that not many people are talking about. And I think we had, and I think there’s a cycle. So again, there’s a secular force, but there’s still a deep disinflationary force in the way. It’s technology. It’s the Moore’s Law. It’s the fact that computer prices will drop, 10% a year almost. There’s still access to the supply in the global commodity space. I mean the state of the enterprise in parts of China, probably represent alone 50% of the global access capacity in certain commodity markets.

I don’t see them being reformed overnight, although that’s part of the longer-term plan. But yes, it’s some of those, if everyone has the view that, well, inflation is not a concern, as deflation. At least the sentiment can shift that, the margin. So I agree with you. I think, I don’t know, Europe, although it’s clearly turned the corners from some of the dark days in 2010, 2011, I don’t think we’re fully out of the woods in pressures there. So whether it’s Italy or elsewhere. So I think headlines from Europe and the European Union, right. That’s I think another thing that could be bumped in the night over the next six months.

Jonathan Lemco: And I agree. I really have a, hard to call them surprises, but more trends that are maybe under the radar. On the negative side, and you mentioned Europe, we’re seeing negligible economic growth, and it ticked up slightly from zero, but it’s still negligible. We used to talk about, in 2011, the so called PIGS countries, the five that were so problematic. Well, Greece is still awful, and Portugal is going through trouble, and Spain is still slow. Italy is having its trouble. Ireland has been in a major recovery.

The bottom line in the case of western Europe though is they have not yet begun to deal with any of the fiscal problems that were so problematic five years ago, and this will keep coming back again and again that causes me to worry in particular about much of what is happening, not just in those countries but some of the other richer countries of western Europe. Germany excepted, which is doing fine.

On the upside, and it’s fallen under the radar of many investors, is look what’s happening in Latin America. And we all, many of us are familiar with the so-called good countries, the Chiles and the Mexicos, and the Perus and the Colombias for sure. But Argentina, which just came out of default has a president that many in the market now can respect and think things are, they’re turning things around, we think we can believe some of the numbers, and for years we couldn’t. It’s looking so much better now from a fundamental point of view, at least on the political side and to some extent on the economic side, although they have a ways to go.

Brazil, the big player in the region, which also is mostly through the most awful scandal in the history of South America, the car wash scandal. And they’ve changed the major players and we’re seeing mild recovery. Under the radar. Even the big exception here is Venezuela, which most of us in the market think will default in 2017, and once that happens we expect substantial quick improvement in that credit too, although they still have to go through a lot of problems before then.

The bottom line here is that this, and we don’t pay enough attention, I think, but there is opportunity, particularly in that region and so many of these countries are adopting policies that are clearly market-friendly. And it’s time to pay more attention, not just to the countries we’re most familiar with, but to some that have been under such terrible pressure for a sustained period of time.

Jon Cleborne: This may be, and Allison, I turn to you on that front, obviously you guys are taking a little bit of a different approach rather than necessarily looking at sort of the macro trends, looking at some of the more bottoms-up fundamentals. But are there particular spaces that you would be excited about?

Allison Fisch: Well, from a valuation standpoint when we look around the world, emerging markets is the cheapest on the metric that we focus on, which is normalized earnings power of companies. Because there’s just so much pain in the profitability of these businesses today. And so we like emerging markets. Also Europe, sort of for a long time Europe was the cheapest region globally. It’s sort of switched places with emerging markets, first quarter of 2015, by our metrics.

It’s still very attractive and actually the European portion of emerging markets, so we have significant holdings in Russia, also in Hungary and Turkey. Those are very small markets relative to the size of EM, but we do have significant holdings there.

And your comment on Latin America is interesting to me, because from our perspective we have been hard-pressed to find anything cheap enough to own in Mexico and Chile. We own none of that in our portfolio. But Brazil has been a significant holding. Now this year we’ve had a huge run in these stocks. I mean several of them up over 100%because of this renewed optimism now. I mean it was very dark days at the end of 2015.

Joe Davis: I think you’ve hit on another point as it goes back to, I’m thinking more from the asset allocation perspective. And we’ve talked about this with investors in the past that, don’t necessarily, because this is done all the time I think in the common business practice of associating an economic outlook with an investment strategy. So because some of those areas you mentioned in the world, not the highest growth levels, but it could actually have a higher expected return. And even at the margin our outlook was U.S., don’t— I mean, U.S. investments are clearly a key part of the portfolio. But at the margin our outlook for the equity market for the U.S. was certainly not higher than emerging markets, right. Even though the U.S. economic prospects were stronger than many parts of emerging markets.

I think it’s that the valuations and the money and the price that investors are paying for growth has to be married with, and just take economic growth as is, because look at China, right. I mean some of their strongest stock returns in the past have been associated with their growth rate being halved, not going up but going down. And even hearing you speak on it was a good reminder for me.

Allison Fisch: Yes, I think in emerging markets in particular people think it’s all about growth. But there’s no reliable correlation between economic growth and stock price performance.

Joe Davis: No, there’s not. That’s one of our favorite charts. Which as an economist is kind of weird.

Allison Fisch: Yes.

Jonathan Lemco: Search exactly on those topics.

Allison Fisch: But valuation really rules the day in emerging markets. And it’s just not intuitive to people, which is why I think it does work so well.

Jonathan Lemco: I think you’re right. The starkest difference is to look at EM Asia, which is the fastest growing emerging market area. But it’s priced in. With the possible exceptions of Indonesia and India, in every other country that we would care about that’s investable is even though they’re growing fairly rapidly for the most part, the market knows it. And they’re priced either rich or fair value at this point. And they’re from a fixed income perspective, there’s not a lot of opportunity.

Joe Davis: Totally with that, and in addition to that it’s the, it’s not just the, sometimes growth is the wrong benchmark even if you are focused on economic fundamentals, right. It’s the composition of growth. Okay, so it’s China in one sense, in the slowdown in many ways is a good thing, it’s not 10% because you’re continuing to overinvest. Or stimulate certain industries with excess capacity, chronic excess capacity, right.

So, or it could be lower growth globally; we’ve talked about for years in part there’s a demographic element to it. Okay, well it’s output per person that could matter more and the productivity, which gets to earnings power of corporations. So that’s often lost in the current weekly, monthly data flow when it comes out. Growth is higher or lower than expected, or it’s high here. But it’s important to look through that. And it’s, I know you both do that very well. But I think sometimes that’s a loss from a broad asset allocation perspective.

Jon Cleborne: Yes, so maybe you could build off of that for just a second, and we’ve touched on this a little bit. But how should you think about incorporating if you wanted to get back to the original theme of tonight’s webinar around emerging markets, if you wanted to incorporate emerging markets into your portfolio, how should you think about doing that? Jon, you touched a little bit about fixed income versus equity. I’d love to expand on that just a little bit.

Jonathan Lemco: Well, I’m kind of personally agnostic. I believe there’s a role for emerging markets and let’s call it 5% of a portfolio. I’m kind of agnostic whether it should be equity or a fixed income, that’s kind of personal choice. And it’s kind of it’s also sort of case by case, I suppose. But you just don’t want to ignore it. It should be a part of every well-diversified portfolio.

These countries and the emerging markets since 1997, in the Asian financial crisis, have improved their macroeconomic fundamentals enormously. In ’97 a large majority were, particularly in Asia and LATAM, were junk. And today a majority of countries that we call emerging market are of investment grade, which means the risk of their default is very, very low.

This is a remarkable thing. And again for many investors this falls under the radar too. When you look to debt-to-GDP ratios of these EM countries and you find that their performance is so much better than the best of the developed economies, you sort of, you sit back and you say, no wonder they’re doing so well and should give you as investors comfort and it’s time to sort of pay attention I think to the performance.

And here I’m talking more in the fixed income side because that’s so intimately tied to the macroeconomic fundamentals. There’s less carryover to, there’s some, but less carryover to the equity side here too. But either one I think should have a place in the world of a balanced portfolio.

Jon Cleborne: Well, amazingly enough we’re about out of time here. So I’d maybe ask if you guys, given all that we’ve covered, we’ve covered a lot of ground here, closing thoughts? Maybe Jonathan?

Jonathan Lemco: Oh, ladies first.

Jon Cleborne: All right, fair enough.

Allison Fisch: Closing thoughts.

Joe Davis: Well, you also do the plane, you do an extra duty.

Allison Fisch: All right, so my closing thought I guess on this conversation would be that everyone should remain calm. The world hasn’t really changed overnight in terms of the election. And in terms of emerging markets, we think it’s a great opportunity. But similarly to other markets around the world, the way to be invested at this moment is to really be picking your spots because there are portions of the market that are overvalued, just as there are portions that are very, very cheap.

Joe Davis: Yes, I mean I haven’t altered mine personally. Or I would suggest to investors not materially alter their asset allocation either. I mean, this too shall pass. It’s not— We’ve had a lot of adventures over the past four or five years. If you pull up the measure of the equity market, and then every dip you can see something there was addressed is a concern for something.

I’m not here to be Pollyanna, I’m just saying, it’s important not to overreact, and I look at my portfolio and I have comfort that I have, I own the world. It’s globally diversified. And I mean for the record I have both, we both have passive investments and actively managed investments, full disclosure. And I’m an investor in your fund as well, right, because I believe there’s active managers regardless of what the macro economy is doing, can identify pockets of value. And I’m willing to hold that to benefit from that skill longer-term.

So I, yes, so even though I’m asked for perspective on events such as these, and that’s important. And I may ratchet my expectations up or down, I’m not fundamentally changing how I stick to my plan.

Jonathan Lemco: And I agree with my colleagues. The purpose of our talk today of course was to talk in part about emerging markets and in part about the U.S. election, and to the extent that the election matters for EM, and it does, over the long run. But keeping perspective, ‘that equally important, if not more so, would be the actions of the United States Federal Reserve.

If they raise basis, if they surprise us and do more than 25 basis points, say, in December, I don’t think that will, but if they did, historically that would be a negative for EM. If on the other hand they just raised 25 basis points and they sort of send signals they might, I think that will just be a second blip. And it shouldn’t be a surprise at all. That, if anything, is just as important if not more so than the U.S. election. The fact that China is maybe stabilizing and its impact on the rest of EM is just as important as the election and the Fed. 

The fact that we’re seeing lessening or market friendly policies in LATAM, similarly is just as important. The point is there’s so many inputs into the mix that you’ve got to keep these events in perspective. There will always be shocks of one kind or another. It’s another reason why you want as diversified a portfolio as possible. And a long-term perspective.

Jon Cleborne: Well, that’s probably a great note to end on, honestly. So thank you so much to all three of you guys. And thank you so much.

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