Inflation at 5%, 10-year treasury yields at 1.5%, how is that sustainable? In the post-COVID investment environment of explosive growth coinciding with inflation concerns, it seems implausible that interest rates could remain this low.
However, for my entire career, investors have decried, “Interest rates are just about to rise, so watch out!”. But they haven’t. Interest rates have been declining for 40 years.
In this podcast, we interview Tony Crescenzi, Portfolio Manager and Investment Committee Member of PIMCO investments. What better person could we have found to ponder this perplexing conundrum?
Buckle up or grab the dog and go for a walk; this is not to be missed.
Geremy: Welcome to the podcast Deconstructing Alpha. This is a podcast where we respect the art and science of active management. And in the world of sound bites and clicks and internet searches, we miss long form journalism, but we don't actually have any time to read anymore. So, we're gonna Podcast. Today, I'm joined by Shannen Carroll.
Shannen: How are you Geremy?
Geremy: I'm excellent. So Shannen, where are we today?
Shannen: We're actually recording for the first time together in sheridan.
Geremy: I know, we're actually in person. And this feels kind of intimidating to me because we're in this really cool studio.
Shannen: Yeah, it's awesome.
Geremy: So we're recording from an old restored train station in Sheridan, Wyoming. And we're in the Gobe Wyo Studios, which has done a great job with this podcast, and we're actually in the studio and do you feel kind of like a hipster? Do you feel kind of like you're in some form of a TV commercial?
Shannen: I do feel pretty cool. But I'm disappointed you're not wearing any flare today, just a really nice suit.
Geremy: For our listeners. I'm wearing a suit for the for the first time since COVID. And I had to go and find it in my closet, and, I'm in full regalia. So no flare, I've got normal socks on normal shoes, and a normal belt.
Shannen: And if anybody knows Geremy, that's not normal.
Geremy: But I did get my hair cut to. Thank you very much. So Shannen's gonna sit in with me here. And as we go through this interview, and she's going to summarize key points at the end, where we're going to have a fun little conversation about the podcast. And please stay at the end for also for Shannen's important compliance disclaimers, but I don't think you're gonna have much trouble staying on to the end of day because I think we have a pretty special guest today.
Shannen: Yeah, it was a great interview.
Geremy: Thank you. So who is our guest?
Shannen: Our guest is Tony Crescenzi. He's a portfolio manager and investment committee member for PIMCO.
Geremy: So at first, when when when PIMCO agreed to be on the podcast, I thought, well, this would be great. If we get a portfolio manager from Pimco, this would just be phenomenal. I mean, because they're such such a large investment firm. But then we ended up getting one of their investment committee members. So PIMCO as, you know, as most investment firms, as an organization, have an investment committee and to be on the Investment Committee is probably the most senior role of being a portfolio manager. So I'm pretty excited about our guest.
Shannen: Yeah, I can't wait to hear.
Geremy: So Shannen, on our last podcast, we discussed inflation. And which was pretty cool, because we had this experience of a near decade, you know, nearly a whole decade of almost deflationary forces. And now we're experiencing inflation. And of course, inflation has a lot to do with interest rates as well. And so one of the conundrums that we have, right now in the economy is that inflation looks like it's running at about 5% year over year, but the 10 year treasury bond is still only at 1.3%. And in Europe, interest rates still are near zero or negative. And in Japan as well. So it seems like we're operating in this extremely low interest rate environment where there is inflation, which generally they don't go together. So we're gonna ask, we're gonna, we're gonna try to get to one question here today. So I'm where the uniqueness of this podcast is, it probably still be 40 plus minutes long. But we're going to try to answer one question.
Shannen: What's that question, Geremy?
Geremy: So I want to know, from the people that might know why our interest rates so low, because it seems very odd that interest rates would be, you know, near 1%, for high quality bonds. While inflation is 5%. It seems like a situation that really can't go on for very long, like something has to give. So I think, hopefully, Tony Crescenzi is just about absolutely the one person that we could have gotten to talk about why our interest rates so low. So let's hope we get to answering that question because I know how I can meander and we all love to talk about this stuff. And so, Shannen, if you could do this if at the end of this podcast, if we don't answer that question. Let's answer let's ask it again. Perfect. Try to formulate a good answer. I can do that. Alright, so let's get to it. As a reminder, please stay on the podcast till the end for the important compliance notes and for our fun conversation about the podcast with Shannen. And ladies and gentlemen. Without further ado, Tony Crescenzi the portfolio manager and more importantly, investment committee member of PIMCO investments.
Geremy: Welcome to the podcast Tony. I really appreciate you being here.
Tony: Thank you so much Geremy, its great to be here.
Geremy: I really appreciate you being here. This is fantastic. You know, we, there's so much going on in the world today. I just made a presentation is sort of typical strategist presentation. And it was. It was like 40 slides long, you know. So I think that there's so, so much for us to talk about. And this is like a really good time for us to be talking about a lot of these subjects. And so I really appreciate you being on here. So where are you calling in from?
Tony: I'm in New York City today. And were born and raised and lived in Newport Beach, which is where PIMCO has its home office for eight years. So I've been I've been back here for a few years. But it feels a little odd that I've been in years so often, because even though I've been back in New York for several years, I haven't really been back since I had previously, for COVID, travelled weekly, somewhere around the world. And so it's a bit odd to spend so much time in New York first time since 2009. I would say the past year, I've spent this much time in New York, but enjoying that, of course, New York, it's a wonderful place, as most would would know.
Geremy: Yeah. I love New York, it's a fantastic place, my wife and I are going to take our first official vacation to New York, to pay our respects to New York, post COVID. Right. So, so along those lines. You know, for a lot of the country, this question might be getting a bit old, but you know, what is the COVID situation like in New York? Are you in your actual office? Are you are you still working from home?
Tony: Yeah, I'm in and out of the office today I'm not in the office, I'm in the office the rest of the week, but when I am and it's on 50th and Broadway. So near the heart of New York Times Square, it's different from what the pre COVID era, we see a lot of shut businesses, retail shops, particularly, there aren't groups of people. This is something we see everywhere. In fact, I've traveled last week to Italy, in Florence, Italy. And I know from having been there many times that typically as in New York, there are groups of people touring. And but you didn't see that people with a flag raised and just large groups everywhere. And it's not happening. Yeah. So it's still a different period right now than it used to be.
Geremy: Yeah, it sounds like you know, a lot of the, you know, here in Atlanta, everything's sort of really open. But again, it's open, but different. People aren't going to work. And the schedules are real differ. There's no rush hour rush hours, like at two o'clock here.
Tony: Atlanta. Yeah, yeah, Atlanta has a bit of traffic here and there.
Geremy: But it's no longer you know, it's so random when it is. So it is, that's kind of, I guess, a great way to characterize the, sort of the posts, it's, you know, the world is open and free. It sounds like it feels like but it's different, you know, and hopefully, we'll get some lasting benefits here. I certainly, like some of the new lifestyle, and probably not some of the other so.
Tony: It's also more digital than it used to be everyone knows about these themes. It's, yeah, more inclusive, it's turning more green, that there will be some silver linings on this terrible story.
Geremy: Yeah, I think they will. I think there's, well, I mean, I think there's gonna be a new appreciation for live work. I think we're all going to embrace digital culture. I think it's probably part of the reason why we're now doing, you know, a podcast, I think a lot of different formats of information are now more generally accepted. We all knew they were there, but nobody really used them, you know. And so, so let's get to your role at PIMCO. So PIMCO is a, how much money. So how much money is PIMCO manage?
Tony: Well, we'll have new data out soon on that. But in the last look, at the end of March, it was around $2.2 trillion. Pretty large sum for sure. I am an executive vice president at Pimco, I work as part of the Investment Committee a nine member body that meets daily to steer the firm's 2 trillion plus in assets with guidelines, themes, etc. Part of that group includes the Group CIO Dan Iverson, and other chief investment officers from different segments of the bond market. I also manage money, I manage money in what's called the total return realm. Total Return Realm is an area where you could say I'm a generalist and simply have expertise in different areas and depend upon specialists within PIMCO to guide me in various segments of the bond market, which could include, for example, municipal bonds and corporate bonds and mortgage securities, interest rates, etc. Global bonds. And so as a generalist, I get my hands in a lot of different areas, but the biggest role I play as part of the Investment Committee, and helping steer the firm's assets, the final thing I'll say is I'm an author published six books on markets, including one this year. And so I'd like to write I do a lot of writing internally for clients and do a lot of communicating with clients on television. And now and then, on stage, certainly not lately, but that sort of thing at large events for advisors.
Geremy: Okay, so, you know, I could probably make some jokes here about why you're talking to me. It sounds like you're you have quite a role at Pimco, which sounds like it might be the largest bond investment firm in the world. And I really, I really appreciate you being here. And I really want to make the most of this time together. And so hopefully I do this this interview justice, right. So today, but let's keep you know, there's so many, like I started this call with, there's so many different themes going on today. It's like, I'm just inundated with different, you know, points of investment strategy. I am an investment strategist. So I cover, you know, the sort of more global role in our investment group, and in cover many different areas. And one of them, obviously, is fixed income and interest rates. And one of the big themes that is going on in the market is inflation and interest rates. Right. And so, I would like to use this time just to answer one question, right, and it might take us a while to get there. But the question I want to answer is, why are interest rates so low?
Tony: Its a long story. Yeah. And it's an excellent one. People often wonder about it, because it's like a slow boiling frog. We didn't really see it happening as it was happening. Yeah, over 40 years. It started with the Paul Volcker, the central bank head in 1980s. In toughening Feds policy stance to try to bring down inflation expectations from the high inflation period of the 1970s. And over numerous decades inflation rate was guided lower, the chief reason was because of falling inflation expectation, and it had a lot to do with the central bank and central bank today is still working at that, but trying to push it up right now may have gone too far downward. But the big cause in the end, I'd say the few for one central banks have been large buyers of securities, and without the purchases of bonds by central banks trillions of dollars worth in the US, for example, they sent industries, you'd probably be a bit higher, there's something called a term premium, which is the extra risk that investors demand the extra deal that extra investors demand for the risk of holding bonds, but they don't demand as much in profit because of the purchases by central banks. And that suppression of yields US 10 year might be as much as a percentage point. So today about 140, who knows that you might be in the twos otherwise. Second thing is, is demographics. The population is aging. The last 10 years, the US labor force has grown at a 0.5% pay very slow growth. Aging people like me, I'm a baby boomer born and 64. Some of the last baby boom period was 1946-64. A lot of me retiring 300,000 Americans per month turn 65. And this reduces the amount of people entering the labor force, which reduces the growth rate of the economy. So if you take the simple math equation, Geremy you take the growth rate and the amount of people working 0.5 and it's projected to be 0.4 the next 30 years. 0.5 and add in productivity, how productive the workforce is. That's been about one and a half, we get growth potential of two that's lower than the old days of three. Yeah, typically low growth rates mean, low inflation. Let me give you one really strong example of this story. It's in Japan where interest rates are zero and have been zero for many years. Its population today is 125 million, because of low birth rates, aging population. The projection is that by 2050, the population will shrink to under one 100 million, so 25 million decline. So how fast can Japan grow in 30 years time? Not much. That mean, low interest rates. So those are major forces.
Geremy: That's driving percent decline in the Japanese economy. Sorry, population.
Tony: Yeah, there's lots of things in place that just won't get used. And yeah. And that reduces the demand. And we know that low demand for things means low prices and low inflation and low interest rates.
Geremy: Yeah, so that really kind of gets to, you know, if we just sort of I love how you started with Paul Volcker, I kind of think our current era that we live in, started in 1980, I often sit called, you know, break the, the history of our economy into eras and, I think the era that we're in right now, while we're there might be two eras. So the first era would be from 1980, to say, 2008. And, I characterize that era as being where the baby boomers were entering the workforce where they had dual incomes. It where the Fed had a strong hand, and where, you know, the entire economy was really, I mean, it was really firing on all cylinders, because you had falling interest rates you had increasing in financial technology, you had increasing in the general population of workers, at least up until 1997. And, often that's characterized as sort of the best era. But then we get to 2008, which sort of also coincides with the beginning of the big rush of people retiring, the baby boomers retiring. And so post 2008 to 2019. Does that feel to you like a certain sort of a different era?
Tony: You are really right about that, let's break it up, Geremy, because like 2011, when the first baby boomer born, 1946, turns 65. So the wave really starts to move. But you could argue that it began somewhat is 2008, especially now, the new information because it accelerated some of the retirements just in the same way that the past year some of the retirements have accelerated, in fact, the labor force participation rate, the amount of people that decide they want to work, looking for a job has been flat for a year, one would have thought with all the job openings, there would be an influx, but yeah, the retirement story is so potent, young influence.
Geremy: Yeah, so yeah, sorry to cut you off there. But like I often say, you know, this is 2008 to 2019 was the slow and low environment. And it was slow and low, slow growth, low interest rates, low inflation, it was slow and low because of demographics, globalization and technology. Right. That's kind of the and high debt levels, which kind of mute everything. And those seem to be structural permanent factors influencing inflation and growth. Right. Does that sound about right to you?
Tony: Yes. So potent because of the effects? Close potential. So there's no question. And also, there's another force throw in that is that pre 2008, banks were more freely lent money to individuals. And so when 2008 rolled around, if they took a shellacking and there were new regulations imposed upon the banking sector, banks said, No, we're gonna be a little bit more careful about lending than we used to be really burned a lot of loan losses in the crisis. So we're not going to lend like we used to, in fact, there's a contraction logo. Now think about this, you have money in your pocket paper, fiat system, as they call it, paper system. fake money, in a sense, it's not hard asset like gold. And so the amount of money that exists in our pockets matters. And so only banks can create more of that money that's in our pockets a Fed who put lots of money into the banking system bank and have let's say, an extra trillion dollars. But the banks decide, we don't really have loans today to make let me hold the money, the Fed isn't earning much today, five basis 15 basis points on the money, they decide that as better than taking a chance with it. So there isn't the money doesn't get released into the economy. So that's part of this year that you refer to as this credit.
Geremy: And so a lot of that money was so I've heard it you know, you mentioned the population times productivity, sort of leading to GDP is just kind of a shortcut formula that a lot of people use. You know, a different formula would be the money supply times money velocity, and I guess during the 08-19, you had an increase in the money supply because the Fed was continuously supporting the economies all over the world central banks were supporting economies through the slowest recovery. And so you had a continual increase in the money supply but no increase in money velocity, which I've heard termed as the money that was printed or manufactured or, you know, floated into the economy was trapped in asset prices. Does that sound right?
Tony: I love that word. I'm just gonna just write myself a note. I wrote an article about 10 years ago. Yeah, called the Yucca Mountain, Yucca Mountain is a nuclear repository actually never got you utilized. But it was meant to be a place where we put nuclear waste. I said they probably wouldn't be meaningful inflation. I remember, Alan Greenspan, who was an advisor to PIMCO came into our offices in Newport Beach, and spoke to the Investment Committee. And he said he thought the inflation rate would increase to made perhaps double digits because of all the printing money printing the fenders, and we were arguing something different. And I had this article called Yucca Mountain. And it said, you know, these inflation toxins are in stored away at the Fed locked up. And unless they seep out, they can't cause meaningful inflation. So the concept of the money being trapped. Yeah, that's absolutely correct. And it hasn't gotten has not gotten out, it's still stored up locked up in the Yucca Mountain.
Geremy: And it's interesting you sitting on Alan Greenspan hinted that all you if you have this expansionary monetary policy all over the world for so long, certainly, we would have some form of inflation and rising interest rates. And, my I've heard that argument. So I'm, 52. And I started when I was 24 I think in this industry, I've heard that argument my entire career. And my entire career, inflation has fallen, and interest rates have stayed low right. And, also for our listeners, when you store assets, you store money in bonds, you are raising bond prices and lowering interest rates. So that's probably part of the reason that interest rates have been so low, for so long. And so then we have COVID right. And I kind of joke around here, you know, COVID is the only economic catastrophe that ever caused the bull market, right. I don't think there's any history book that can ever characterize what happened to markets because of COVID. So I think we had a very unique experience last year, right.
Tony: To present and, you know, and the date accelerated what began in 2008, this idea that central banks could inject themselves into markets and become a player, not just the referee of markets, and it's an era one could say that Ben Bernankey, who is an advisor at PIMCO opened up, and it's probably appropriate Federal Reserve and other central banks have argued, hey, we're a bridge to you, the fiscal authorities, you take the baton, eventually, we're going to release enable the growth to occur with all this extra money, according the system. And only lately have fiscal authorities, governments decided to take the reins and we see large fiscal bills. And there are new ones on the way we in fact PIMCO project, another two and a half trillion dollars of bills between now and the end of the year, financed by probably one to one and a half trillion of taxes, but a net trillion of additional spending. And we talk about these trillions as if they're, normal.
Geremy: So we're at this current state, that where, where it looks like we were living in a slow and low world, which needed to be primed by central banks continuously, then COVID happened. And then Central Bank's response around the world was something like eight times the response from 2008 is, I guess what I've heard, they became more comfortable. Yeah. They said, well, let's just do more of this. And so then you have then hundreds of billions turn into trillions. And so I often joke another thing I joke about that people don't even think it's funny. I think it's funny is that nobody told me that a trillion was 1000 billion I think it's a big number. And we throw these trillions around and so now you've got we have this state of humongous central bank actions, not just constant central bank actions. And you mentioned fiscal policies in the government is running this 15% deficit to GDP or something in the last 12 months, which sounds staggering, right. Yeah.
Tony: I, wonder where it ends sometimes. Yeah, I wrote one book, one of my six books that 10 years ago was called Beyond not lean to talk the book at all. But the concept beyond the Keynesian endpoint, what is a Keynesian endpoint? It's where, first of all, John Maynard Keynes said, way back in the Depression, hey, if, there's a lapse in spending by people and businesses, government should step in and spend in business and governments with that way of operating for a long time. But we saw in the 2010s, some nations reached the Keynesian endpoint. Greece did it couldn't borrow from the markets, markets said no, we don't think you have good credit, we're not going to we don't think you're going to pay us back, we could find your money elsewhere, the Keynesian endpoint, eventually, the central bank helped bail them out. But there were losses by holders of debt of Greece. And so there is always that possibility. But the real story is that there's so much indebtedness, and this was a story in the 2010s. That it prevents policymakers, fiscal authorities from using money wisely. Now, what I mean is money was used wisely, one could say in the past year, individuals and households needed money, businesses did too. But most of the money went toward consumption and not investment. So by wisely, I mean, a new idea, a new round of spending, and we're about to get that it's just not going to be a lot spread out over 10 years, what's a trillion net, over 10 years, pretty much zero, in terms of close to zero in terms of long term impact and spending on something like Eisenhower's defense and interstate highway system in the 50s and 60s. 50,000 miles of roadway that we in America all still use lots of productivity from that. And we don't so that the indebtedness, what I'm trying to say is, people say, when's it gonna hit the fan, so to speak, which I always say it already has, because it's preventing us from doing things that could be very good in the long term.
Geremy: Yeah, if you think about the staggering amount of money that we spent, I mean, let's not get get into I don't want to start talking about where the government should or shouldn't spend their money. But, Yeah, cuz, you know, we could probably go down that rabbit hole for an hour or so. But so you know, so it sounds like everything's backstopped. Right. It sounds like, hey, if I'm an investor, doesn't matter what I'm buying, it will work out, because if something doesn't work out, I'll get just get bailed out here. And I think that sounds like, you know, the reason I think that, you know, I've had to, you know, Why is everybody so bullish? Why was there such a staggering response in the marketplace, and to the point now that we have all these accoutrements in the marketplace, like meme stocks, and Bitcoin and all these, you know, tech stocks, and all this, like froth that feels like 1999. And so the two responses I've heard as well, every in my entire lifetime, the markets have recovered very quickly. So they're just each decline recovers quicker, because everybody knows buy low. Right. And then the second thing is, well, the Federal just bail us out. And but it ignores this third point that you mentioned is how do we ever get out of this? This is just how it's supposed to operate. Needless to say, we're very bullish market. And you're probably seeing that also in the bond market.
Tony: Yeah, I'd say, you know, adding to all that you said, some cash flow, what a bond investor cares most about is cash flow, meaning getting some interest and getting the invested money back. The bond investor cares about the equity investor. The equity investor cares about profits, which is cash flow and dividends. And there's so much money has been put in the system that the cash flow story looks good. So for example, the s&p 500 earnings projection for this year, I think is around 30%. And for next year, 10, and year after also around 10. Right, that's good cash flow, and I can show you charts and you've seen them Geremy, the profits versus growth in the stock was the change the percent change in profits versus percent change in equity prices and similar, so mad so those things and also finally, for the bond investor, reduced risk of default, a triple B rated bond which is the lowest of the investment grade, so it goes triple A double A single A and triple B Double B would be considered a junk bond. But triple B rated, which is the biggest part of the corporate $10 trillion corporate bond market, it's the default rate in the last number of decades is 0.1%. According to Moody's, meaning, there's a 99.9% chance that you'll get your money back investing in a company that's rated by the major rating agencies, triple B, in 2008 2009, the default rate reached 0.6. It's not that high. In a historical perspective, if money stays invested in triple B bonds, right, but the what the market did in 2008, and 2020, in March, was push up yields so much that it seemed to suggest a much higher risk of default, than has been the case historically. And with all the money in the system, investors eventually decided, this is where we are today. Well, company XYZ looks pretty good. Now, cash flows pretty good. Lots of money flowing through from stimulus checks and other things. So yeah, I can get my money back. So I'm going to stay in these bonds.
Geremy: Yeah, it looks like just a continuation, just a more amplified version of, well, we'll just increase the debt in the system and increase the money supply in the system, and asset prices will just go up. And if asset prices go up, and everybody is better off. So here we are. So we sort of went through this era from 2008 until COVID. And then we had COVID, which is, you know, we've I think the response that occurred in capital markets is probably the best response anybody could have asked for. It's an incredible a great response. And, so here we are, and I think investors kind of, you know, the big question, you know, when we look at it in a historical perspective like that. Is this a new era, the post COVID era, is that a new era? Or is this just like an explosion that will peter out, and we'll return to the 2008 to 2020 era.
Tont: There's potential for to be a new era in the 2020s have been reimagined by you and I, businesses, governments workforce, broadly speaking, it's going to be more digital than it would otherwise have been. And that can bring along with it more growth. Because we're being we're able to operate more efficiently. Secondly, more inclusive, there is an effort by government and by corporations. To get back to this point in a second is to create greater inclusion, even the central bank, the Fed August 27 last year, a new framework for conducting monetary policy says that it seeks maximum employment that is, quote, broad and inclusive, unquote. The first time, the central bank said, we're going to do something about the lack of inclusiveness, we want it to broaden out to women and minorities. We won't care about the jobless rate itself. So what the Fed said, basically, if it reaches three and a half percent, it's not good enough. What we want is it to be broad, inclusive, and finally, more green, right out about that. Now, one inclusive part is not just the government sector, not just the fed the private sector last year before the crisis. in Davos, Switzerland, the World Economic Forum, the yearly Economic Forum, there's something delivered called a new Davos manifesto, it overturned a doctrine from Milton Friedman, delivered in 1970, in an essay to the New York Times, where he said the social responsibility of a business is to increase its profits. He specifically said in an era of shareholder capitalism, and certainly investors written that for a while, but now the new year is stakeholder capitalism, every company to preserve the edge brand wants to seem to be doing the right thing. So this could mean what will mean more investments in green areas, and companies be willing to pay higher prices in order to decarbonize and secondly, companies will be more willing to pay people higher wages in order to seem to be doing the right thing. And that front as a stakeholder, have the room to do that, because profits as a share of GDP are pretty high. So it may be then this next decade better than we could have imagined before it began because there is this focus in this ESG realm, and it's serious by companies and people and it's a major change.
Geremy: You're the third person in a row that I've interviewed that have said exactly that. And that's new to me, right because you know it started you know, we, as a strategist, we study history for relationships and inferences about what the future might unfold. If you think about history, history is just a whole bunch of things that have never happened before tied together. And we get to look at it in hindsight, right. So when you look forward, often it is things that have haven't happened are things you haven't thought about that are extremely relevant. And so you're, mentioning that the future could be more efficient because of digitalization, inclusiveness, and, more, you know, not the infrastructure, not the word word, but more spending in the green area. And, this might sound like a dent, to the shareholder primacy of what we have been living in, for the last, say, 20 or 30 years, which is, you know, not corporate profits above everything. But, you know, the, one of the one of the, you know, reasons that the US or one of the reasons is pointed why the US is more profitable than other countries is the shareholder primacy that we have. Over, you know, where other nations require companies to do more. And so that's extremely interesting. So I'm really glad you brought that up, because it just reminds me of how important that must be. And it's something I don't know that much about, but certainly, you know, anytime you have a trauma or catastrophe in the economy, it speeds the future up. Right, you get more technology, you get, you know, the whatever changes you think are on the horizon happen more rapidly, which is a really great point. So let's switch gears here. So the big story this year, at least in capital markets is inflation. Right. So, inflation has been benign for 40 years, as I said, my entire career, everybody has always said, well, inflation is coming. Right. And, my analogy is, oh, so we're gonna turn the the Evergreen tanker around in the Suez Canal. We're gonna do it right now. And then so, I guess the big question is, is obviously inflation's here, CPI has gone from somewhere near one and a half percent and can't get it off the floor. And deflationary pressures, where central banks have to stimulate just to keep inflation above zero. And now we have inflation in the last 12 months of 5% on the CPI u. So, if we turn the corner.
Tony: I'm like you and I, you know, our collective experiences effects how what we expect of the inflationary so you and I have experienced higher inflation rates, even in 1989, CPI, Consumer Price Index got as high as 6%. So there were periods in 80s, where some doubts about it, even though it's been downward trending. But it's been quite benign for a long time, but there is a possibility that the inflationary will accelerate. If one does a search under Google Trends, and you see the word inflation, you see that more people are thinking about it. Does that matter? Yes. Because in the all the research that exists by economists, and return Janet Yellen into the mix, you isn't she visited us in Newport Beach almost two years ago, and I remember having having dinner with her and a group of other PIMCO employees. And I brought up a paper she wrote 2015, called inflation dynamics, where she concluded and she's very thorough about things. In fact, Ben Bernanke is current advisor, and he says, she'd be the type of person that she would show up to an airport three hours early, and not because she's traveling internationally, you need to do that these days, but it's quite prepared. So she would look at the inflation story, what drives it, what makes the inflation rate go up? And she concludes, as others did, the 40 footnotes, that's inflation expectations, what people think about it, how they feel. And now the Fed has been getting in the way, because every time that people start to feel that the inflation rate was accelerating, the Fed said, No, we're gonna get in the way that we see it too. We're gonna preempt it, you're gonna do a pre-emptive rate hike, we're gonna start moving on rates. That's what it did in 2015, for example, and then kept moving on with policy. But now it's saying, You know what, we're not going to do that anymore. We're going to have a outcome based strategy. We're going to let me see inflation. Wait, so it's actually here and I can just shoot when you see the whites of his eyes as the saying goes, but then that's worked because we see inflation expectations accelerating but in recent weeks that story is the Fed seem to get a squeamish, inflation rate got higher and people talking about inflation, you see it in Google Trends. And they blink, I like to say the Fed wrote its August, new framework last year in disappearing ink, in the sense that it told us it would wait. And it didn't tell us though, that it would start to sound more hawkish when people started to feel the inflationary was going up and up. And instead of waiting until it stayed higher, now this higher, you mentioned Geremy the inflation rate is higher. But it said we wanted that to be in place for a little while before we start talking about going back. Now it hasn't raised rates, we're not expecting it to raise rates for two years, but it's starting to talk about it. And just that talk can affect it. So we're the Republic. So the bottom line is, it is has a chance to be higher than past because lots of money printing. And because of the new framework where the Fed says we're going to let the inflation rate be a little higher. And creating that faster inflation expectation is the foundation of letting there be more but don't expect too much more, because the Fed can stop it in an instant with its words.
Geremy: Yeah, so the framework I have for this current round is current levels of inflation is A I think it has a lot to do with asset prices being high. I think asset prices have had a phenomenal run both stocks, bonds, commodities, everything, and so and real estate, and so, you know, people feel wealthy, and they feel spendy. Right. So there's a lot of demand from consumers. I think that businesses are a little bit flat footed here with this increased demand. And they've been spending a lot of time buying back their shares and not building factories. And so and so they're a little flat footed, and so there's a boost to the capex level. And then the Fed still easy. Right. And, inflation is contagious, it certainly trips over. Right. So once it starts, I think it has legs. I don't think that, you know, unless the stock market falls. I don't think this is going to stop. And so, so what you know, how should you know, as a strategist, I know that in our you know, our investors own stocks for growth, they own fixed income for, you know, consistency and safety, they own cash for storage, and they own commodities for inflation. So what does an investor supposed to do if the Fed is not going to do anything about this, and it looks like there's a little bit of legs here. So what should investors do?
Tony: Well, one should be invested to have some inflation protection and to benefit, so what does that mean? Certain types of bonds, inflation protected bonds can provide it. I mean, we're not talking about runaway inflation. We saw in the past month, a demonstration of how potent words are Ben Bernanke in his recent book, said that monetary policy is 2% Action 98% communication, so the Feds words can have a lot of impact the Feds words of the past month did, it stop the rise in inflation expectations, the market was priced for the CPI. By market, I mean, the tips market inflation securities market for 260s, CPI over 10 years, that was supposed to be the average. And then it crashed down in the 220s, after the Fed spoke and said, You know, I'm pleased to hear might want to raise rates sooner. So what I'm saying is, it probably will accelerate a little more the inflationary and Fed doesn't want the CPI expectation in the 220s. Because that would mean it's inflation based when it falls would be under two, it's below its goal of two and wants it to be over two for a little while. So you can gain the protection in various assets, private credit assets, for example, because in private credit, you get high interest rates on the assets behind them probably can do well in terms of price movement. Also, in real estate, we're still big believers in the real estate market course you got to be selective about it. But that's an area that looks good to us for various reasons. And the equity markets tend to do well, too, when there's some inflation not enough to push the interest rate higher, and on bonds. I mentioned Inflation Protected bonds. But what about the other ones, I mean, one would say Well, as you mentioned earlier, fields go up. That means prices are going down the inverse of what you said earlier, and so it seems like a risk but we would say that the market is already priced for some of this story. We see the market price for the Fed to push us policy rated to over 2% In the next few years and get some income along the way and protection we think in the 60-40 model. Still farewell. And that's been the case this year 8% Plus returns, we think, and you saw it recently. And when the Fed seemed to be toughening up, longer term securities did well when the stock market fell. So we think that protection would still be there. It's not a time to be market timing, diversification benefits of bonds, even if they seem to be low returning, they still have that protective element that's quite important. Like deciding today, I'm going to get my car feeling good today. I'm not gonna have an accident. I don't need insurance for today. And tomorrow. I'm gonna shed it. I don't need it. Yeah, I say, the wrong mindset. We believe in the model that still high quality bonds will provide protection.
Geremy: Yeah. So it feels to me like so you know, I deal with in the investment advisory community, and we're sort of very in touch with the client base. And, it still feels this magical combination of 60-40. You mentioned 60-40, this magical combination of 60% stocks and 40% bonds, which obviously have had a tailwind since 1980. because interest rates have fallen. Right. And so, you know, there's there's a lot of talk out there, they're like, Well, if the entire complex of yields is below inflation, do I want 40% bonds? And I hear that question a lot. And, of course, there's probably many reasons to, to hold bonds, but I think, you know, they don't have so much of an investment quality to them, if you're below inflation. But there is still that safety, quality. Right. And because, I mean, let's face it, the stock market has done phenomenally well. It has very high valuations. And what are you going to do with the main driver of your growth doesn't perform well, right. You still need the protection. So that's a, that's a really good, that's a really good point. So is it really like so if inflation hangs around 5%, you think the Fed won't do anything for two years?
Tony: Well, in order to what the Fed says, cause it ain't anchor inflation expectations at a higher level since they've gone down. Now imagine, first of all, why is that important? Why is it important to have a higher inflation expectation, then a lower one? Well, when, when individuals households, and governments have lots of debt, think of having mortgage. So you certainly wish that the home price went up more to help you make the debt seem smaller. Goes for income, and so it says, rather, seems like the optimal level, for whatever reason, price stability is around 2%. The Fed wants to let that set in. It hasn't been long enough. You and I've talked about the era that we've worked in these multi decades, and it's been the falling explanation expectation ever fine. So the Fed wants to say, you know, that's enough already. And we've got to do something tilted back the other way a little bit. Yeah, let's let the economy dwell. And finally, when we think of the job story, there's still a shortfall there 7 million relative to the peak, 22 million jobs were lost, and Fed wants to ensure that the people get back to work fully. And add to that, to add to that, typically, job growth is about 1% per year in keeping with growth in the population, and so a little bit less than that. And so the job shortfalls 7 million plus about a million for the past year that we would have had otherwise as the population grows. So it's got a ways to go it's got those two things. It's that's its dual mandate is inflation, unemployment. And it wants to anchor both.
Geremy: And the employment thing, as we mentioned earlier in the call, I think is very important, because it's not necessarily to me, it's not necessarily the unemployment rate. It is the labor force participation rate. And with 3 million people a year going into retirement, you were losing workers fast. In which the least on paper sounds deflationary. So I don't know, I don't, you know, I it's probably a whole, you know, we're actually probably butting up against time here, because I've been having fun with these questions. And, hopefully, we're still sort of on track to answer our question. Right. So let's try to I guess, summarize. Right. And so I'll put this in, you know, so I guess more direct terms. Last quarter, the second quarter of 2021. The long term treasury bond gained 6%. And inflation was 5%. Interest rates on the 10 year are 1.4. And, interest rates actually bell in the face of inflation and rising commodity prices. Does that sound right to you, is it a blip? Is it you know, it's hard to characterize what exactly is happening in that very short term.
Tony: What's happening in part is the bond market, to some extent, might be using, as often has the wrong analog, it's using the 2010s analog, which is to say, inflation never didn't never materialize. There's all this fear and lots of commercials back in 2009- 10 by gold, because the Feds printing lots of money. Now, Bitcoin. That was it to be more efficient and didn't happen. And so the markets not all that fearful, and that we've seen the influence of demographics on growth worldwide. And it's so potent that people still just sit down. Finally, Investors are saying, well, what, what is what are government's fiscal authorities doing with that money? What kind of spending are they engaging in? Is there anything transformative happening? Yeah, and the answer unequivocally is no, it's just a lot of consumption being driven. Nothing that last, if I have a stimulus check and can buy food and clothing, that's great, we need it. But that will do nothing for growth three years from now. And so the bond investor says three years from now, boy, this money is going to won't be circulating anymore, there'll be no benefit to the kind of growth generated, so let's not worry about inflation. So it kind of makes sense in that terms. But again, back to the analog thing real quick is that it's it the 2010s didn't turn out to be any inflation, for various reasons that the different now I mentioned that ESG factor, more willingness to spend to decarbonize more willingness to pay people money, more willingness to create more inclusivity, which means more growth. And we're seeing a little bit more spending in the infrastructure realm and human capital and in other forms of capital, we might get faster growth. And we have a central bank mindset, that's a little different to say, let's not preempt this, let's let it run a little. So there's a chance that picked up. So that could mean somewhat faster inflation, somewhat higher rates, but not not very high, just a bit higher, gradually higher.
Geremy: Yeah, that's about kind of the way I would sum it up, I think, I spoke a lot about the 2008-2020. Because or 2019 because to me, there's so many structural elements to the low inflation and low interest rate environment that don't haven't seem to have changed here, right. And so we have this burst of inflation, we have this burst of growth, and largely, I think a lot of that has to do with the stock market's up. Right. And that's sort of causing people to feel spendy. And then on the flip side of that, businesses are sort of flat footed and, COVID is causing these rolling supply interruptions. Those sound so that so the reasons for inflation sound transient to me. And the persistent reasons for deflation still sound like they're in place, it still sounds like technology is going to work against us. Globalization is going to work against us demographics are going to work against us and debt is going to work against us. And as you said, the answer is the same old answer, we're just going to pour gasoline on the fire just more debt. Right. And, hope the asset prices go up and we'll grow our way out of this through asset prices. So, in my mind, I think it's there's a lot of, I guess, persistent deflationary pressures, butting up against short term transitory inflationary pressures. And then I guess a final point that I would, you know, maybe we can discuss a little bit is that it's really hard, it's gonna be really hard. The Keynesian endpoint, it's gonna be really hard for the central banks around the world to stop, in Japan they have had 1% or below interest rates for 26 years and they're on the forefront of the of the deflationary structural pressures of which we have and then the last time the Fed tried to raise rates in 2018, there was such an abrupt response from the stock market, right.
Tony: So that we have something to compare against people often go back to the Japan experience and that is a good comparison. The difference is that we at least have some labor force growth they have non negative, so there may be one major factor.
Geremy: Yeah. Alright. So, we've talking about a lot Tony. And this has been really fun for me. I had to helps me organize my thoughts about around strategy. And hopefully listeners have organized their thoughts a little bit about what we've talked about here about low interest rates, possibilities of inflation and how the Fed gets out of this. Is there any single point you want to leave us with? One final thing that you're scratching on are itching to tell us?
Tony: Yeah, I'd say we spoke to it a little for the ESG story, is another twist to it that the young, the youngest age cohort cares about it a lot. It'll drive those areas of ESG, but also drive the movement of money. Also, advisors should be thinking about it, because there's about $30 trillion that will get passed down to the young. And they're going to say, well, I want invest in this company or this type of investment, mutual funds or what have you. Because it's, it's got a good ESG score or something like that, whatever games they want to use. And that money in a fiat paper system. As we said earlier, it moves markets. And so prices will be moving in certain ways because of the youngest generation deciding it wants to invest in ways that are thoughtful, so think of that. But final that relates to that is this ESG story and the rebooting of the 2020s is could be an optimistic story and turning out to be in markets. Let's see that last. But this is it's looking okay.
Geremy: So sort of like the idea that every bull market has a theme, right. Like in the in the late 90s It was .coms. And there was the biotech stuff in the mid 2000s. And then certainly was the transition to the digital economy here after COVID. And the growth theme. And so maybe what setting up as a new era here is, you know, if we're going to speed up the future, we've all known ESG was going to be important. But maybe this is the beginnings of that. The big foundation of it.
Tony: Yes it is no doubt my mind, based on the will of companies, households, and now government in the private sector is engaged, people are engaged in this societal shift. There's no doubt you could see various ways and a great thing.
Geremy: It sounds like a great thing to me. I love progress. So fantastic call. I really appreciate you doing this. Again, I guess I could ask you why did you spend this time with me, but I'm very thankful. I'm sure you have a lot of important things to do. We will all be watching as this drama, this sort of how do we get out of this drama unfolds. And there's probably so much to talk about here. And this is where I'm going to hopefully invite you back one day, and I would love to have us again one day.
Tony: Well, thanks so much.
Geremy: Thanks again, and carry on and have a great day.
Shannen: Geremy I'm really diggin that new music.
Geremy: I know. I can't believe how good that sounds. I think it sounds awesome. So that song came to us from Scott Iverson, who works here at Frontier and he's a southwest representative for frontier portfolios and, he's one of many musicians, we have here at Frontier. And so I asked him to do like a little snippet for the podcast. And that's what he came up with all on his own. It just really sounds fantastic. It's and if you remember from the dude ranch a couple of years ago, Scott Iverson did. He also did the song called TLT.
Shannen: Yes, and there was a one last year for our 25th anniversary.
Geremy: You also had a song for that. And so I think Scott and maybe a couple of the other musicians at Frontier should get together and make an album of investments songs.
Shannen: I think that's a great idea. They'd make hundreds people can use them for their podcasts like we just did
Geremy: And their audience would be a very select group of investment people that also like music.
Shannen: I think it's a great idea. So Geremy, that was a great interview. I think that I'll always look at interest rates a little differently now. You went in depth with that.
Geremy: Yeah. And I know we, we set out to answer one question, and we went sort of in several places. But I think again, investing is not a soundbite investing is hard. It sounds easy, but it's hard. And there's so many layers to every small decision in investing.
Shannen: Yeah, so PIMCO and 2.2 trillion is a little more than we manage
Geremy: Oh, we're getting there. Just a few more trillion. And so one of the funny things I say about a trillion because we say, a trillion all the time now, just steal a trillion and government's stimulus, the Fed bought a trillion dollars worth of bonds, or, some investment company manages a trillion dollars. And I forget that just for our listeners, as a reminder of how much a trillion is a trillion is 1000 billion. So that's, that's a lot of money.
Shannen: Yeah, something that I thought was noteworthy is that their investment team meets every day. So that's kind of cool to hear how active they are and not reactive.
Geremy: Yeah, exactly. And I think it's, again, I think, once people are investing in a portfolio, they think, well, I invest in a portfolio, somebody goes out and selects all my securities, and then everybody just hangs out. Right. But investing is a day to day operation. And investing is not about big decisions. It's about a lot of the micro and small decisions that you make day to day.
Shannen: Yeah, they make a big difference. So I didn't realize that the labor force growth was at a point five pace and is projected to be at a point four pace the next 30 years.
Geremy: So one of the themes of why interest rates are so low, is demographics. You know, I think you know, people are state this and quoted a lot of places, but there hasn't been like an, you know, I haven't seen like an extensive, you know, connection between demographics and inflation and interest rates. But it is an important component. And, you know, the first world populations are aging. And so the younger generation isn't having as many kids as the older generation. And so it, it's not that populations are necessarily shrinking, it's just that the workforce is shrinking in the last year in this last COVID year, upwards of 3 million people retired here in the US. So that's just 3 million people no longer working. And so the what they call the labor force participation rate is falling.
Shannen: Well, and as you know, you can't have as many kids these days, because they cost so much money.
Geremy: And they they do and I think that's they do cost a lot of money. I have a couple. But I think that is a deterrent to why young families aren't willing to have, you know, as many kids as prior generations.
Shannen: Absolutely. And the growth rate isn't just affecting the United States. It's happening all over the world. I mean, look at Japan and 0% interest rates and projected 20% decline in population over the next 30 years.
Geremy: Okay, so that was pretty staggering to me. And so the, I think the lowest birth rates are I mean, I don't know exactly, but one of the lowest birth rate areas is Japan. And you know, they have very large cities. So space is a problem, the cost of children's a problem. And people are very focused on work in this modern type economy. And so it's, you know, not as many births and their population is ahead of ours on aging. And so they're living longer. But their bulk of people that are retired is more than ours. So sooner or later, something's got to give over there.
Shannen: Yep, absolutely. So what do you think about banks lending money, so that it seems like they lend it more freely before 2008? Do you think banks should be lending more or less? Or how does that affect the economy?
Geremy: Yeah. So interest rates and lending are tied together, right. So the lower interest rates go, it might, you know, banks might not be inclined to lend as much money. So I think we've gone through a cycle, though, on the lending, you know, we had prior to 2008, that was very easy lending 2008 was sort of a correction to the lending process. And then we had sort of like a lockdown on lending and money was being stored, right. So banks would, you know, would be able to borrow from the Fed at zero, and then it'd be able to store it in the bond market and they'd be able to make that spread. And so they weren't lending as much. And now lending tends to, you know, the, obviously the Fed is trying to induce lending, that's part of the stimulus. But I only I believe now, the lending rates and the, free and ease of borrowing Money is starting to look like pre 2008 again.
Shannen: Awesome. So to wrap it up, did we sufficiently answer the question? Why are interest rates so low?
Geremy: Now, I'm not sure we did. I think we touched on all the reasons why it's so low. And one of the, you know, one of the themes was definitely demographics. And, but that doesn't sort of necessarily explain the current difference between inflation and interest rates, you know, when you have the entire fixed income complex offering yields below inflation, or almost the entire complex, it'd be hard to find a bond with 5% yields these days. And it feels like that interest rates should be higher to normalize to that inflation. And so there is a more short term element I think that's going on. And so here's how I'll try to encapsulate that. So I think there's three things that are currently affecting why interest rates seem so low in the face of the current environment. And so I think the first thing is money supply. I think when you increase it, we talked a lot about money supply increasing, and then the money velocity shrinking. And so when that happens, people are the money supply is increasing, but people aren't spending the money. They're storing it. And so where do they store they stored in asset prices. And so I think, as the Fed and central banks all over the world induce the economy through money supply, it's just increasing the money supply, and that money needs to be stored. So there's a lot of demand for bonds. So there's a lot of money that's been created, and it needs to be stored somewhere. So there's a lot of demand all over the first world for bonds. And that's why you have interest rates low here, because as you buy more bonds, the interest rates drop. And in Europe, it's, you know, even worse, they have interest rates, or, you know, many nations in Europe have negative interest rates, there's so much money that needs to be stored. And so that's the first thing I think, as you increase the money supply, there's more demand for storage. The second is, is I believe that most investors think this current round of inflation is transient, and not persistent. And that that supply shocks that are occurring, and the demand burst that's occurring, will fade, right. And, then the third thing is hedge value, which is if you if you are an investor, and you do have a lot of money to invest, not all investors feel the need to invest every single dollar in stocks, some of that money needs to be stored in something that's relatively safe. And maybe some of that money should be stored in things that are can offset their, stock risks. So while inflows to stocks are, you know, unbelievable this year, there's just massive inflows into the stock market. At the same time, people aren't gonna invest 100% of their dollars in stocks. So some of that money is going into bonds.
Shannen: Well, that was another great conversation, Geremy. And it was so awesome to be together this time.
Geremy; Yeah, I know. This is great. I've really enjoyed being in the studio and sitting next to you. This is really fun. I feel incredibly lucky and incredibly thankful for our guests today. And so hopefully, I don't know. Hopefully, we can keep the talent pool up. So again, another thank you for Tony Crescenzi for joining us on on the podcast. But until next time
Shannen: Have a great day.
Geremy: Thank you very much everybody.
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