We recently had the privilege to interview Luke Tilley, Chief Economist of Wilmington Trust for a new episode of our radio show and podcast In Process: Conversations about Business in the 21st Century. Tilley develops forecasts of the U.S. and international economies, as well as researches, emerging issues to support and enhance the firm’s investment strategies.
We had a lot of questions for him such as what are companies investing in? Are things getting better? Or are we due for another recession? According to Tilley, “Things are getting better. It’s the third longest economic recovery in U.S. history.”
BUSINESS CAPITAL EXPENDITURES
A key discussion point was regarding business capital expenditures. According to Tilley, “We are expecting stronger capital expenditures in 2018…for the first time during this recovery, companies are really turning to investing in that new piece of equipment or that new software package or that more efficient office space.” He noted that business confidence last year really picked up and it is expected to continue.
2018 CAPITAL MARKETS FORECAST
For our business and investor audience, Tilley shared details on Wilmington Trust’s new publication, the 2018 Capital Markets Forecast. It’s centered around three key themes that will be understandable for all investors. Theme one covers the U.S. economy , theme two covers inflation and growth, and lastly theme three covers valuations, yields and volatility.
According to the report, organic growth is expected to be 2.25% in 2018; fold in the partial impact of the tax reform and Wilmington Trust believes that it would add another 0.5% -0.75% of growth for the year from consumer spending and capital expenditures.
Click below for your copy of the new “2018 Capital Markets Report” by Wilmington Trust.
Listen to the podcast for the full discussion and to learn about:
- A quick recap of 2017 and what turned out to be the shock of the year
- The NEW 2018 Capital Markets Report (FREE Download, compliments of Wilmington Trust)
- An economist’s perspective on Bitcoin
- Thoughts on consumer debt for 2018
Stream the conversation in its entirety in the player below, or download it to your mobile device via iTunes. Don’t miss a single episode, subscribe to our podcast show ‘In Process Podcast’ on iTunes to receive this episode as well as future episodes to your smartphone.
Relevant article 12.17.2017: Chief Economist Luke Tilley comments on the markets and tax reform, in a recent Bloomberg article. Click here to read.
How’s it looking? The U.S. Economic Outlook for 2018
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Speaker 1: It’s time for In Process, conversations about business in the 21st century with Evelyn Ashley and John Monahon. Presented by Trusted Counsel, a corporate and intellectual property law firm. For more information, visit Trusted-Counsel.com. Now, with In Process, here are Evelyn Ashley and John Monahon.
John: Hello and welcome to In Process, conversations about business in the 21st century. Presented by Trusted Counsel, a corporate and intellectual property law firm. I’m John Monahon.
Evelyn: And I’m Evelyn Ashley.
John: We’re partners in Trusted Counsel.
Evelyn: Can you believe we’re at the end of the year, John?
John: No, I can’t. It’s been a really long here. But it’s good to be here.
Evelyn: But then very speedy. Long but speedy. Sometimes the pace has been just a little overwhelming.
John: Yes, exactly. It’s like the days are really long so everything feels very long, but then you just blink and you go, “Wow. I can’t believe the whole year went by.”
Evelyn: Is gone.
John: But, you know, what I think everybody’s looking forward to is how did this year go? It’s been an interesting financial year. Next year, people want to know what is it going to look like, so we’re very lucky to have Luke Tilley here. He’s the Chief Economist of Wilmington Trust, who you saw actually speak.
Evelyn: Earlier today. Excellent. Excellent presentation. So I think this is going to be great. Hopefully we’ll get some commentary from Luke, too, that our clients can use maybe as their thinking their strategy for 2018 and what they should be concentrating on.
John: Mm-hmm (affirmative). Absolutely. Let me introduce Luke. Luke Tilley is the Chief Economist of Wilmington Trust, a company that provides broad range of services to individuals in services. It gives financial trust and customer services for clients in all 50 states and over 90 countries. Wilmington Trust clients also benefit from investment advice, tax planning, and guidance in wealth transfer strategies. Mr. Tilley, as Chief Economist of Wilmington Trust, must follow closely what is happening in the economy, both in the United States and also abroad. He develops forecast of the U.S. and international economies, as well as researches, emerging issues to support and enhance the firm’s investment strategy. Luke is also responsible for communicating the economic outlook in investment strategy to clients and the public. We hope to benefit from his expertise and talk about some aspects of the economy that will be a benefit to the listening audience. Luke holds a PhD in economics from Temple University and a Bachelor’s degree in economics and history from James Madison University.
Luke: Thank you very much for having me.
Evelyn: It’s so great that you were able to join us today, Luke. So before we get to 2018, talk to us a little bit about what you think we’ve seen in the economy, where are we? What are the good things, and kind of where are the more questionable, maybe not bad, but the more challenging aspects what’s happened this year.
Luke: Certainly. So I think 2017 has really been an interesting year. Obviously we’re a good ways into this economic recovery, more than eight years now. 2017 had some distinctive features. If we think back over the course of the recovery where our growth has been kind of slow and meandering, right around two percent on average. That’s in terms of real gross domestic product growth. 2017 was quite a bit stronger about two in a half percent it looks like it’s going to come in at the end of the year. It might not sound like much, but in a multi-trillion dollar economy that’s quite a bit more activity. Really the big difference this year has been on business capital expenditures. So that’s when companies spend on plants, equipment, and machinery. So we’ve had continued consumer spending that’s been around for the entire recovery, but what’s happened this year that has been very different are those companies who have undertaken more expenditure on their ability to produce in the future, as the way we think about it as economists. That’s really been the difference between what’s been going on earlier in the recovery and what happened this year.
Evelyn: So do you think that capital expenditure undertaking is that because they did not do those things in the past or that there’s something driving it in a different way?
Luke: There’s quite a few different things here. This is where you’ll always hear from an economist, on one hand it was one thing, but on the other hand it might be another. So I’ll play my part and do that. We were expecting stronger cap ex., I’ll call it, this year. Mostly because the unemployment rate has now gotten so low that firms are having a hard time finding employees. They’re still looking for employees, but they’re having a very hard time finding them. That’s starting to drive up wages. For the first time during this recovery, companies are really turning to investing in that new piece of equipment or that new software package or that more efficient space, if you will. A lot of it is just coming from the natural progression of the economy as the unemployment rate has gone lower and lower. It’s at 4.1% now, down from a peak of 10% just after the recession. So some of it is just from the natural economic cycle. But I’d be remiss if I didn’t credit some of it with some optimism from firms about the possibility for lower corporate taxes, lower regulatory environment, and some of the things that are likely coming from the administration in D.C.
Evelyn: So do you think … Then based on what you’ve been looking at, have capital expenditures increased kind of in that latter part of this year or has that been a consistent increase through the year? I guess I raise that because you’ve actually just credited the President administration at some level.
Luke: Yeah. I think it started a little bit at the end of last year. The end of 2016. Really just in the closing quarter, not necessarily tied to the election but more tied to those economic fundamentals of the low unemployment rate and really the scarcity of labor and the cost of it. But as we’ve gone through the year, it’s very clear, if we look at any measure of business confidence, that is has really picked up through the year. I think as it gets clearer and clearer that there will some changes, perhaps on the tax side, and the certainly there have been some regulatory changes that has spurred some firms. So it’s a little bit of both.
Evelyn: So because you raised, and we don’t have to do a deep dive into the kind of potential reform in tax right now, maybe we’ll talk a little bit more about it, and of course it’s just prediction anyways at this stage still. But do you also believe that the potential for decrease taxation will actually lead to more capital expenditure, more hiring, and I guess I raise this because my understanding of what’s happened in the past economically is that has not necessarily been kind of the outcome for those kinds of changes.
Luke: Right. So here I’ll do another on one hand and on the other hand. Also, I’ll bring in another thing that economists say a lot and that’s there’s no such thing as a free lunch because if you could prompt economic growth without any sort of cost and cut all the taxes of that any kind of cost, that would be fantastic. But, of course, that’s impossible. So the way that we’re thinking about it is the possibility of legislation either lower corporate tax rate or the immediate expensing of capital equipment. Those are just some features of the plan that we think would prompt a little bit more cap ex. Could be beneficial for growth, for near term growth. Companies see higher profitability and more ability to expense that equipment right away. That would certainly prompt them to invest in more plants, equipment, and machinery. However, it does come at a cost. If it’s not revenue neutral in the end, then you do have a longer term concern because as the government, I’m sure most of your listeners are aware, already has a debt and deficit problem. As you look out further into the future, if you’re adding to that, then that sort of compounds the problem of the Federal Government’s debt over time, what that does to interest rates, and in the longer term, that can tend to, we use the term, crowd out investments. So if you need more and more dollars to fund the government deficit, that’s less dollars that are available to fund capital expenditures. So as with a lot of things, when we think about the impacts of something like the tax package, there’s something good in the near term with a cost in the long term.
Evelyn: In the future.
John: If you were in 2016 and we were doing this interview, what, I guess, sitting here now in 2017, what would you say would be the surprises of 2017 that stood out to you?
Luke: Well, we were anticipating some of those stronger growth this year along the lines of what I’ve been describing, the strong cap ex. We really expected that to happen because of the low unemployment rate and because of the stronger wages. The real big surprises for us have been on the international front. I think end of last year, beginning of this year there were very few, us included, who expected the kind of really strong economic growth that we’re seeing in the European Union, in Japan, in other developed parts of the word, and frankly, in emerging markets as well. Places like China, India, Brazil, and Russia. What we have going on this year that’s been really such a surprise is not necessarily the growth in the United States but the growth abroad and what is commonly referred to as a synchronized global recovery. Really the way that it comes home to us here is any firms that are dealing with exports or are exposed to any kind of growth overseas, they’ve really seen the benefits of that. If you think about large multi-nationals and even smaller manufacturers and smaller service companies have really see that benefit. That’s really been the surprise.
Evelyn: So were you shocked that Brexit did not have a more negative impact on England for the test?
Luke: Yes. So the Brexit impacts were … Some of them would be sort of expected. If you told me Brexit wasn’t going to have … That was a shock. The actual vote. But it hit currency markets right away, which plays through to some consumer prices. I won’t go through all the details of that. But I think the pain of Brexit and the impact of Brexit is still to come. They’re clearly still negotiating some of those details. We still don’t know what the trade arrangements will be. We still don’t know if financial firms will be able to operate across those borders. So I guess we’re still very much in the wait and see period to see how it’s going to effect the UK.
John: Welcome back to In Process. We are here with Luke Tilley, the Chief Economist of Wilmington Trust. Luke, one thing that I hear often when I’m talking to other people, and I heard you mention the economic cycle, they often talk about where we’re at in the economic cycle or, “Hey, I know there’s about to be a crash because it’s been eight/nine years since the last one. It always happens every eight or nine years. So get ready. There’s going to be another one.” What can we learn about economic cycles? I mean, from an economists’ perspective, not just this anecdotal perspective.
Luke: Right. Certainly. So happy to try to shed some light on it. Unfortunately, it’s not as easy as how many months has it been. So to give some perspective, this recovery started in the middle of 2009. It is currently the third longest economic recovery, which means the expansion of the economy. Things are getting better. It’s the third longest in U.S. history. Second only to a period in the 1960s, as well as the 1990 to 2000 recovery that was about a decade long. Should this recovery continue into the middle of 2018, we’ll actually pass the length of that recovery in the 1960s and be only second to the 1990s. So to your point, and we get this question a lot too, should we be near the end? Aren’t we due for a recession? That can certainly when you look at this data and you say that we’re at the second or third longest, that can be a little unnerving. But we don’t believe that economic cycles come with an expiration date, so to speak. It’s not an amount of time that determines how long this cycle is. Really it’s a question of what are the imbalances that have built up inside an economy and sort of need to be … They need to be cleaned out, if you will.
Luke: 2006, 2007. We know now it was housing. Before that, we had the tech bubble, of course, which ended in the stock market decline. Then a milder session in 2001. So at all times as economists and people were looking for what is it that sort of overheated right now. Right now, we do see some signs that we’re in late in the economic cycle. I already mentioned that the unemployment rate is very low. It’s actually at a 17 year low. It never got as low as it is today in 2004, 2005, or 2006. So that’s sort of a marker for us that we’re late in the cycle. We see a little bit of wage pressure. We see high valuations for equities. Those types of markers along with the number of months that you mentioned can make people nervous. But we think there are few very important things that say we’re not that far along. I could list a lot of them, but I think the most important one is inflation and the fact that it’s very low inflation right now. Not a whole lot of inflationary pressure. What that means is that the Federal Reserve, which of course implements monetary policy in the country, is not raising interest rates very quickly. We look back over time, what typically happens at the end of an economic expansion is the Fed hiking rates and then you have a recession shortly thereafter. We’re simply not there yet. It’s because of the low inflation. So this is something we’re thinking a lot about right now and goes into our outlook into 2018.
Evelyn: So do you not see though, I guess … Because I did suffer the tech bubble when it burst. Of course, for the past few years, we’ve had these incredible valuations for technology business, particularly, with their unicorns and now they’re calling them zebras when they’re even bigger than that. I think I understand it’s very different. You know, see the lack of what I would say development and substance in many of these companies that have grown and been so successful. But do you not see that there would be potential for a correction kind of in those markets where these valuations seem to be so out of this world, quite honestly.
Luke: Yeah. So valuations are high. When you look at the price, especially some sectors that you’re referring to compared to their earnings. We’re at some very high, lofty levels. We certainly could have a correction, as you suggest. Just a couple of points about that. Valuations are incredibly poor predictors of when the next correction is going to come. You could’ve made the same argument a year ago. You could’ve made it two years ago and you would’ve been essentially wrong both times. So they’re very poor predictors of the timing. Second, as long term investors, we really don’t think that you should try and time markets. We believe in diversification. We do believe in allocating assets across other geographies or different asset classes based on their merits. But it’s very hard to beat the market in terms of timing. So while we recognize that there could be a correction coming, we focus a little bit more on, or I should say a lot more, on the economic cycle that we were talking about because when you do enter a recessionary period … As the Chief Economist, of course, this is where I spend all my time thinking about is are we close to one. When is the next one coming? That does mean some very big things for a lot of different asset classes. That’s what we spend more time thinking about. But the thrust of your question is entirely accurate. You could have a correction. The technology companies do have a lot of value added. They do have a lot of earning power. I shop on some of them very easily because they do have added a lot of value to your lives and a lot of convenience. So it cuts both ways I think.
Evelyn: So, I’m sorry.
John: You said valuations aren’t a good indicator. What is a good indicator?
Luke: So market timing is just incredibly challenging. You know, there could be anything that could trigger the next correction. It’s very hard to spot. That’s why there’s always going to be somebody that did time the market correctly and dramatically more people who did not. If you spend a lot of time trying to do that, most people are not going to end up out on top, which is why we do try to focus on the economic cycle. So we don’t try to time the market cycle, but we do know when we think about that economic cycle that the financial market follows it. Our best research indicates that the … We also know, sorry, that the financial market sees recessions coming. Markets have a good way of sort of teasing out how are companies doing, how are the results coming in, how are their earnings looking, all of that sort of thing, and can even sort of get ahead of the economic data. In our estimation, about six to nine months ahead. So in the previous down turn 2007 or 2008, markets were about six months ahead of the actual economic data. So what does that mean for us if you always have a one year outlook, and you can sort of see when is the next turning point going to come. You have to be thinking forward. You have to be looking ahead to be ahead of that move in the markets.
Evelyn: So based on history and you’re going to know this much better than I am, Luke, but it seems like, and perhaps this is just kind of like my reading of newspapers, but it seems like politics and economics have some connection in a lot of respects, not necessarily the concept of legislation or the reality of legislation that’s being approved. But impact on what our leaders do and it seems to me that in the past year, particularly, perhaps the markets have not reacted quite the same way as what we might have seen in the past. Do you agree with that?
Luke: Yeah. So certainly there as a lot of surprises, especially if you think about to the election. There were a lot of people who were surprised, President and company included, because even if you looked at investor surveys. Surveys are the people who are actually trading the money. They expected a big decline in markets, if President Trump then Candidate Trump had won the election. That happened for all of an hour or two that night. Then markets have gone up since. I think if you look back on it, there are a few different impacts there. One, the strengthening economy that we already discussed. The strengthening international economy has been part of that, but you can’t deny that some of the upward movement has been in line with the election of the President. Importantly, the retention of both chambers of Congress by the Republican party. I think looking back it makes a lot of sense because they do have a platform of decreasing regulation, and they do have a platform of cutting corporate taxes and some of those policies. Whether you believe that’s right, wrong, or indifferent, it’s not necessarily a political statement to say if you cut a corporate income tax rate, that’s more dollars to the firm. That automatically goes into valuations. It goes to the denominator or price earnings ratio. That sort of enables the price to go up. So those are just some of the natural mechanics that you would expect if you give firms lower taxes. So looking back on it, you can certainly fit the activity of the market to what’s going on. Right now we actually see it in the second half of 2017, I should say, as the tax reform legislation gained and gained steam. You see some of those expectations playing through either to some of the sectors you were talking about or even to some of the capsizes, sorry, capitalization sizes. I’ll just give one brief example. You would expect the tax reform legislation to do fairly well for smaller firms, not these large multi-nationals, but smaller firms that don’t have as much ability to take advantage of the current tax code, and indeed we’ve seen markets that would reward them handily as the tax legislation gains steam. So some of it is the economy. Some of it fits very naturally with the policies that have been performed.
John: Welcome back to In Process. We are here with Luke Tilley, Chief Economist of Wilmington Trust. So, Luke, I’ve been dying to ask this question since basically we had you hired … Not hired, I shouldn’t say hired.
Evelyn: You agreed to do the podcast with us.
John: You agreed to do the podcast. Yeah. Not monies being exchanged.
Luke: All right. You’re scaring me. What are we talking about here?
John: So Bitcoin, it’s been in the news obviously a lot. I mean, we’re sitting here. It just started trading futures last night. It’s sitting around $16,500 as we speak. I’m kicking myself for not getting in a long time ago when people had mentioned to me, as I’m sure a lot of other people are, but at the same time, I’m sort of like, “Or am I really glad because it could be a bubble. I don’t really know what to think.” So from an economists’ perspective, do you have any thoughts on it as a currency or as some sort of reserve to some extent?
Luke: Oh, boy. I have a lot of thoughts here. I should first say as a person who lives here, I feel very much the same you did that I’m kicking myself for not getting in early, which is very different than my comments as an economist or as an investor for clients. As an investor for our clients, we really take in the position that it’s so new, it’s so challenging to predict what’s going on, or even identify what’s going on that we don’t recommend it as an investment right now despite the fact that it keeps going up. To your point, it could go down. I just made the point to somebody two hours ago that if we walked out of this room and you told me Bitcoin was trading at $25,000 or $2,000, I couldn’t be surprised on either side of that.
Luke: Because it is so unpredictable. So we are, I would say, conservative investors. We try to keep the ball on the court. We are looking out for wealth that people have built up and preserving them. So we don’t entertain it as an asset class right now. I think the most interesting thing about Bitcoin, and other people have said this too, is the underlying technology, the blockchain technology. This really has the ability and the potential to transform financial transactions and a lot of the things that go on in our society, a lot of the things that we don’t even aware of on a daily basis. But to change cost and to change efficiencies. I think that’s really interesting because it could lead to, as I said, a big structural change. I think there’s a parallel here. If you think back to the late 1990s and the invention of the internet and even at that point, I think we all knew and recognized that the internet could and would change our lives forever. But we weren’t 100% sure exactly how it was going to happen. In the aftermath of that, there was a lot of euphoria as well, right? There were a lot of companies that saw these sky high evaluations. People that I knew who just had an idea and a website address were able to get a lot of money to start a firm. A little bit too much euphoria around that too. But the underlying technology has changed our lives now 20 years later and more. I think the blockchain technology that underlies Bitcoin and some of these other cryptocurrencies has the ability to do the same.
John: Do you think that if it burst … Let’s say that it is a bubble and it burst. Does it really carry systematic risks? I’ve been thinking of that. I’m like, “Well, do that many people really own it. I don’t know that many people that really own it.” It seems like the few that do, have a large amount of money in it. Yeah, it’s $250 billion, but that’s not really that large in the whole scale of the economic world.
Luke: Yeah. So I don’t see how right now it would translate to directly. To your point, who owns it, who would be losing the value? It could potentially, I think, cross over not people’s fear about other asset markets, that type of thing. But it seems to be fairly isolated, to me, at least for right now because it is unique and it is so different. So if it were to come down in some sense, obviously there would be losers on one end of that and there would be some upset people. But I wouldn’t personally think, “Well, that is going to cause the profitability of the equities that I hold to go down.” I frankly, don’t even know what people are using Bitcoin for right now other than speculation. I do know that there are some companies who do accept them as payment. But it seems fairly speculative to me right now, especially with these kind of thousand percent gains over a short periods of time.
Evelyn: He still wants to buy.
John: The second you said thousand percents gains, it just …
Luke: I should’ve said that a month ago when it hit $9,000, I said, “Well, that’s going to end soon.” And you could’ve doubled your money. That’s why I’m not speaking about it as recommendation for investment. It’s just … But the technology is incredibly interesting.
John: Maybe I don’t know people who own Bitcoin because they’re eating caviar and … Maybe that’s the reason.
Evelyn: Well, we said, “If you were going to go and gamble for a night and you were going to lay $1,000 on the table, why not just put it into Bitcoin because maybe it’s the same thing.”
Luke: Well, with gambling you certainly have to be willing to lose it, right?
Evelyn: Right. Exactly. And know when to stop.
John: So we, as a firm, we’ve seen a ton of transactions this year. I mean, just from every day operating transactions, contracts, licenses, things like that. But a ton of actually big transactions. MNA activity, sales. All across the board, international, domestically. It’s been a very, very active year. What are your thoughts on where we’re at as far as the acquisitions and what might be burning some of that on?
Luke: Yeah. You make a consistent observation that we hear in other parts of our footprint and from our clients and certainly what we see at the macro level. The first observation, it might sounds fairly simple, but there is a lot of money out there in the macro sense. In the sense that the Federal Reserve printed, electronically, but printed a lot of money to buy up treasuries and mortgage back securities in this big effort to keep interest rates down. But they created a lot of money. The European Central Bank has done the same. The Bank of Japan has done the same. There is a lot of money out here. At the same time that that has been going on, you have some meager returns on some historical asset classes, right? Just interest rates in a fairly safe investment like U.S. Treasuries or investment grade bonds. Don’t yield the same things that they used to. So what ends up happening there is money ends to chase and look for returns for obviously reasons, right? For investors. As you have more and more money chasing less and less asset classes that yield any kind of return, they start to look for other sources of return. So we do see things, perhaps like Bitcoin, right …
John: I was thinking it as you were saying it.
Evelyn: Money looking for a home.
Luke: Or a painting that sold for $450 million. But aside from those sort of extraordinary examples, you do have people moving into equities in way they haven’t before, looking for that return. You do have companies looking for if not cap ex., then were is another firm that I can acquire because of the efficiency, I can add value. That’s what the money is really looking for is a chance to earn, to add value and to increase the return for investors. So I think at the root source of it is really those two things. There is a lot of money out there that is seeking the return, and a lot of the traditional sources of return simply aren’t available.
Evelyn: So based on kind of what we’re talking about where I think you’re somewhat positive on the economy going forward. Would you think that for 2018 that kind of movement of money looking for a home will probably continue?
Luke: We do think so. we should say … I should say that our view about the economy continuing to expand is certainly true. We’re looking for about two and a quarter percent GDP growth. So a little bit of a deceleration from 2017. We’re not looking for the recession. I said there might be a correction for markets, but one thing about those high equity evaluations that I talked about are that they’re not very good predictors of short term returns. They can’t predict whether there’s going to be correction next year or the year after that. But over the longer term, when you have high valuations like this, they tend to lead to lower returns going forward. Our research that indicates with where valuations are right now, the aggregate large cap stock market, you’re really only looking at something like 5% return over the next five years or so. When you look forward, you’re going to have some meager returns there. What we are advising our investors is that there are some possibilities. There’s some other avenues for return briefly, just in some other instruments such as hedge funds or liquid alternatives and some other sources because in some ways you do have to get a little bit creative. We don’t think it’s just going to be put your money in the stock market and you’ll be fine. Certainly not in terms of [inaudible 00:31:51].
John: Welcome back to In Process. We’re here with Luke Tilley, the Chief Economist of Wilmington Trust. Luke, one of the things that you mentioned was that money tries to find itself a home. We also talked about these economic cycles, which usually some sort of imbalance leads to their demise. I guess I have a question, whether money just sort of gets tired after a while at all of trying to find a home, or whether at some point people just start piling in to one asset class, which leads to the imbalance because basically it so hard to find the right home.
Evelyn: Or it ends up going into businesses that actually aren’t … They’re too early stage or they’re really not going to support a return on investment.
John: As if it’s trying too hard to find itself a home.
Luke: Right. Yeah. I take what you’re saying. Does the money get tired? I don’t know. I guess that would be the investors getting tired because investors are looking for, you know, that investment where they can earn the return. What we’re always looking for is the bubble. Where’s the bubble? Where’s the economy overheating, or where are financial markets overheating? In 2005 and 2006, there was a lot of discussion about, “Well, is the housing market overheated.” We, not Wilmington Trust, but we as sort of industry, as a country, sort of talked ourselves out of that, even though in retrospect it was certainly true. So we spend a lot of time right now saying, “Well, where is the money built up and where has it sort of pushed values a little bit too high?” We’ve talked about equity market valuations. We don’t think that that is where it is. It certainly could be some sectors that you mentioned that could be due for a correction, but we don’t think that the overall equity market is too bit up. For a couple of reasons, one, earnings are still coming in. Companies are still making money. Two, if they do get this tax cut, then that immediately changes the price over earnings picture of the valuations.
So there are a few areas that raise a little bit of an eyebrow. Bitcoin, of course. Perhaps Di Vinci paintings. Commercial real estate in large metropolitan centers appears to have gotten a pretty good big over the last couple of years. We’re not calling an end to it by any stretch, but a lot of money has gone into those areas, but for good reason. The cities have been growing. But they’ve also benefited from a lot of money that’s been coming from outside. Los Angeles property market built up by a lot of Chinese money flowing in. Florida has seen a lot of money from South America. So those are the kind of things that we look for, for not necessarily money getting tired. I’ll just change it a little bit and say where there might be a possibility for money that’s looking for the way out, right? Because when an asset bubble does pop, it’s some dollars trying to get out the door, then a whole bunch of them trying to crowd out of the same exit. There’s just not enough room for everybody to get out at once. This is what we spend a lot of time thinking about. We can’t identify a large area where a large asset class that has that kind of characteristics, but that’s what we spend a lot of time thinking about. When we find them, we’ll be sure to tell our clients about it. We’ll be positioning around it. But we focus on where those bubbles might be and when might the economy turn. We don’t really see major examples of either of those two things right now.
Evelyn: So we’ve talked a little bit about the national debt and the impact that, you know, that it’s very large and potentially could be quite a lot larger. I know that when we’ve talked economics in the past, a lot of times we want to talk about kind of consumer debt also. Where has that gone? Are you seeing that consumers have more debt than kind of what would be recommended? Are they saving their money?
Luke: That’s an excellent question because consumer over in debt and this is really what caused the last problem, right? It was in the housing sector. No, we don’t think so. So if you look just at a chart of consumer debt, you would see that it moved down a little bit after 2008 and then resumed it’s upward margin. It might be a little bit disconcerting. But it comes with a couple caveats and certainly the biggest one is that it’s been financed at much lower interest rates. We’ve talked about the low interest rate environment and when interest rates are lower, that debt becomes more affordable. So you can do sort of a conversion and we have ways to look at the data. Basically consumers in the aggregate are facing fairly low debt levels in terms of how much do they owe on a monthly basis. Relative to their monthly income. Those are pretty low numbers right now. Going back as low as they’ve been since the early to mid-1980s or something like that.
But another caveat against that. Here’s the two handed economist again, right? Is the distribution might not be as favorable. We do see a widening of the wealth gap. So if there are parts of the income distribution that are struggling more with debt, that could be a little bit more problematic than just taking that macro view and saying in the aggregate that there’s no problem. So we do everything we can to look at the data both ways, but generally consumers look to be in pretty good shape right no.
Evelyn: So then you also talked about how unemployment is basically at an all-time low. I know a little earlier today, you were talking about well, we know that some of that might be people who have actually just taken themselves out of the job market or have been challenged by that. So any kind of connection between unemployment or removal from the market and debt levels?
Luke: Yeah, certainly there had been for quite some time. Just the math of the employment rate. When people stop looking, they no longer become unemployed after a certain amount of time. That was pulling down the unemployment rate for a while. But one of the most encouraging things that we have seen over the past year to two years have been a turnaround in that it’s called the labor force participation rate. How many people are able to work and then how many of them are actually engaging in the labor market? That has picked up quite a bit over the past year, particularly among females, not as much with men. But it’s been this encouraging turnaround. It’s actually in the main workforce ages between 25 and 54 called the sort of prime age workforce. That had been declining. That had been … When it was declining just after the recession, it was very discouraging. But it has really picked up in the recent years, as I said. I think that that’s very encouraging. It really paints another good picture of the labor market because that means people are seeing opportunities. They’re seeing some of these higher wages and are able to deal with some of those debts a little bit better.
Evelyn: So, Luke, we’ve talked about a lot of different areas. Let’s try to kind of bring it together for our kind of our listeners that are thinking about, you know, I’m setting my strategic goals for my business for next year or for my investing. Can you kind of give us a kind of a good cheat sheet on your thoughts kind of going forward? Optimism. Where they should be? A little more wisened perhaps.
Luke: Yeah. Certainly. We have our new publication coming out right about now actually. Every year at the beginning of the year we put out our Capital Markets Forecast. We try to center it around three themes that will be understandable for all investors. We actually, over the course of this discussion, touched on each one of them. Our first theme is very much about the economic cycle as we’ve discussed, and where we think the U.S. is in that cycle. We’re fairly positive, as I’ve said. We don’t think it’s time to run for the exit. So we’re positive about economic growth and that has the implications that I’ve said for remaining to some degree in risk assets, which means equities and some other things.
The second theme is about where are we in the relative cycle for the U.S., which is further along in the cycle. I said it doesn’t have an expiration date, but it’s also true that international economies are much earlier in their cycles along those markers that I was talking about. Whether it’s inflation or low unemployment rate. So we actually are … We have a preference for international markets over U.S. equities right now.
Then the third theme is something that I already touched on when we talked about where do you put your money in this challenging return environment, if you have these high valuations. It looks like it’ll be harder to get stronger equity market gains, and you have interest rates going up for fixed income. We do believe that there are opportunities for some of those alternative investments for liquid alts or for hedge funds and for some of our higher net worth clients in private markets. Those really offer the best opportunities. So that Capital Markets Forecast is where we sort of bring all of those ideas together. It’s available on our website.
Evelyn: Okay. Good. So let’s talk just a little bit about tax reform. We’ve got legislation that is very close. Just give us your thoughts on if this goes through, what positive things do you think we can see, and maybe what might be the challenges there?
Luke: Yeah. Certainly. I think it’s just about timing. It would be positive for economic growth in the near term because it would benefit consumers in the near term and I think companies would invest more in cap ex. that would increase the investment numbers, the investment and cap ex. numbers. But in the longer term we would be facing another sort of reevaluation of what is the long term debt and deficit picture for the U.S., which can be fairly daunting. It’s not that it can’t be overcome. But this would sort of just add another layer of debt to it, and it would create some more challenges there. We are optimistic that the U.S. economy can overcome those challenges, but it would be that much harder.
John: I have a question about earlier you mentioned that one of the big stories was this international growth and the export out to the other countries because they’ve been doing so well. How do we balance that with some of the more protectionist trade policies that we’ve seen being batted around, not just by the U.S. but by other countries as well. How does that work out in the long run you think?
Luke: I think that there are some very interesting issues there and we’re going to be dealing with those as we go forward. We cited in last year’s Capital Market Forecast that the possibility for major trade cutbacks and pulling out of those types of agreements posed a threat to trade for the exact reasons that you outlined. Exports and imports are very important. We haven’t seen that legislation yet. We’ve seen some changes on the margin, but that’s something that could hurt, I think, long term growth if we become very protectionist. Clearly there are some things that need to be done with our trade policies because a lot of times they’re not necessarily fair to our domestic producers. But we don’t think that the answers should be restrictive trade policy, but more importantly we just react. It’s not our job to opine on what the policies should be, but if we became a very restrictive trade policy nation then that would have those implications for longer term growth, mostly to the negative in our view.
John: Thanks, Luke. This has been tremendously interesting and useful. If you’d like to learn more about Wilmington trust, please visit WilmingtonTrust.com. We hope you enjoyed In Process today. If you’d like to download this episode, you can find our show on iTunes as In Process Podcast. If you’d like to be featured as a guest on our show, please email us at InProcess@Trusted-Counsel.com. Thanks for joining us.
Evelyn: Thanks for being here, Luke.
Luke: Thank you.
Speaker 1: This has been In Process, conversations about business in the 21st century with Evelyn Ashley and John Monahon. Presented by Trusted Counsel, a corporate and intellectual property law firm. For more information, visit Trusted-Counsel.com.