BlackRock managing director and CIO of model-based fixed income strategies, Thomas B. Parker, CFA, describes the three major super-cycles coming to a close and the investment opportunities that exist therein. Also, listen as he provides a very contrarian view about the role of central banks in the current interest rate environment.
The Take 15 Series is a series of short interviews with leading practitioners on timely topics focused on the investment profession.
[MUSIC PLAYING] Jason Voss, CFA: Hi, I'm Jason Voss, CFA, Content Director for CFA Institute. Joining me today for a Take 15 interview is Tom Parker. He is Managing Director at BlackRock and their Chief Investment Officer of Model-Based Fixed Income. Welcome.
Thomas B. Parker, CFA: Thank you.
Jason Voss, CFA: So talk to me about these three super-cycles that I know that you've earmarked as-- if they're not already having ended-- are coming to an end soon.
Thomas B. Parker, CFA: Yeah. So the big one is the debt super-cycle, which started in the '80s. It really was a reaction to kind of slowing potential growth that we were seeing in the US. And so in a sense, just like a company will lever up an ROA to get to higher ROE, we started seeing leverage find its way throughout the companies and especially in the consumers to maintain a certain lifestyle as potential growth got lower.
The great financial crisis really brought that to an end-- not that leverage isn't still increasing-- but kind of the pace of it and its ability to kind of magnify returns. So throughout the west, we've basically seen the end of debt super-cycle.
Now we're still seeing one in China, which just brings up the second super-cycle, which was really the kind of China EM commodity super-cycle. And commodities and EM were really just a derivative of China. But what you saw is China was growing at a huge rate. And they actually grew through the great financial crisis because they did a fair amount of stimulus. And one of the few countries that had that debt capacity to do stimulus was during the financial crisis.
But then about 2011, that kind of ran dry and we've been seeing them secularly just decline in their GDP and their NGDP growth has really come down quite a bit. In fact, NGDP went from 20% in 2011 to about 5% last year. So a pretty big collapse in growth in China, which has had ramifications throughout asset classes.
Jason Voss, CFA: Right. So what's the third super-cycle?
Thomas B. Parker, CFA: Oh, the demographic super-cycle, which-- there certainly were a lot of benefits as the baby boomers aged. Originally, the inflation problem in the '70s was about too many young workers with low productivity skills. So the inflation cycle that we saw there was very related to demographics. But then as they aged they became more productive. We got a huge productivity increase for awhile-- savings, et cetera, et cetera.
But now we have the aging of that and all that has done is it's done a couple of things to potential growth. Honestly, part of potential growth is working age population growth. And that has really slowed a lot as each year, more and more people retire.
The other thing is that older people tend to save so the savings ratio is starting to rise, which is bringing down consumption.
Jason Voss, CFA: Sure.
Thomas B. Parker, CFA: And then in reaction to this you have companies spending less on CapEx because they see that they overbuilt in the prior decades. Think of the retail. Retail is very over-stored relative to the demand that we're seeing now.
Jason Voss, CFA: And to say nothing of e-commerce, right?
Thomas B. Parker, CFA: Yeah exactly. They're fighting to two big things. They over-stored and they have a new competitor that they never had before.
Jason Voss, CFA: Sure. The demographic thing-- is that a global phenomenon or is it just USA?
Thomas B. Parker, CFA: Yeah. Definitely. Japan. Europe. In fact, Europe and Japan, obviously, have a much worse demographic problem than the US. The US is actually through the worst of it. It just doesn't come back for a while until kind of the echo boom kind of finds its way. But certainly, the largest demographic right now actually is millennials. It's actually bigger than the baby boom. The problem is there in those early non-productive years--
Jason Voss, CFA: Formative, almost.
Thomas B. Parker, CFA: Yeah, formative years and so forth. So yeah.
Jason Voss, CFA: So not that anybody would have a favorite super-cycle, but if you could point the finger at one of those big three as being the big driver for future returns, which one are you most concerned about?
Thomas B. Parker, CFA: It's the demographic. It's the cycle that dominates all of those cycles. And one of the things that's just not on everybody's radar is that China isn't in that phase right now, but they're going to enter that phase due to the one child policy. And so they start to hit a really big decline in working age population in a five year horizon. And they're also the only country going through debt super-cycle right now. So we have a lot of worries about Chinese growth as we move our way through that.
Jason Voss, CFA: So you chose demographics. Is that because of the sort of pre-determined almost-- like it's a fixed element in everybody's model? Or is it that it isn't in anybody's model?
Thomas B. Parker, CFA: Yeah, I think the problem is it's so slow moving and kind of so obvious that it gets ignored when it actually explains a ton about buying behavior. And so a lot of things will be attributed-- you know, for example, there's a lot of supply-side rhetoric about the Reagan Revolution, but it was primarily a demographic.
You just had this huge group of baby boomers moving into their formative house-buying years. But it had been delayed by two recessions that Volcker essentially started to kill inflation.
Jason Voss, CFA: Right, sure.
Thomas B. Parker, CFA: And so you had this just unprecedented level of pent-up demand due to two recessions and unbelievably high interest rates. And so as soon as those interest rates started falling in the '80s, you got this amazing super-cycle of home buying.
Jason Voss, CFA: Yeah.
Thomas B. Parker, CFA: And everybody could say, well, that was supply side. And you go, no, it's classic Keynesian at the end of the day and so forth. And so the kind of supply side myth is still really built on that Reagan-- that it was because he deregulated, he did this. Whereas you go, no, he hit a democratic super-cycle.
And that's often the case. And we talk a lot about fast rivers at BlackRock. And it's better to be-- is it good to be a good paddler or is it a good to have the best canoe technology or is it better to find a fast river.
Jason Voss, CFA: All right. That's a great metaphor, yeah.
Thomas B. Parker, CFA: The fast river is the key to all of these things. And a lot of great investment careers have been made by finding fast river.
Jason Voss, CFA: Wow, that's a great metaphor. I will remember that one. So I know that you also talk about three phases of central bank policy. For the audience, if you could, talk about that too.
Thomas B. Parker, CFA: Yeah. And so this has been a really important thing because it's always existed but the second phase, which I'll talk about, really hasn't existed for any period of time. So when you think of a liquidity cycle, there's a first phase. And that first phase-- the forward security marker line-- so future returns relative to future volatility-- shifts down and it flattens.
And if you think about that process, it means beta does really really well, but dispersion and volatility fall. And so there's certain kinds of outcomes that we saw from 2009 to 2013-- is huge equity rallies, huge high yield rallies-- those kinds of things.
Jason Voss, CFA: Sure.
Thomas B. Parker, CFA: There's a phase three that we've seen before in history which is called the tightening cycle. And it's when the economy is overheated and the central bank has to pull back from that and the exact opposite happens. The security market line shifts up, it's steepens, beta does terribly during that time, volatility rises, dispersion rises. And so you get very different outcomes.
This transition period in between, which historically has never been more than a month or so, has been in this cycle-- we've seen three really long periods. So the taper tantrum from May to September of 2013. The first six months of 2015. The first six months of 2016. We're seeing these. We know we're nearer to the end of the liquidity provision that we've seen. But we don't know when that will end.
And so the trades that worked during that phase one where the exact opposite trades work in phase three-- you can imagine small changes in, is the Fed going to raise this month or next month-- actually have huge changes in asset prices. They're much bigger than normal. And we've lived through that now for three different periods.
Jason Voss, CFA: So I know that many people are critical of the Fed and other central banks. And you're a little bit less critical. If you could talk about that and then another point too-- is it your belief that maybe the central banks have had to be so active because there's just fiscal gridlock in two of the big three economies-- the EU and the US?
Thomas B. Parker, CFA: Yeah. So to the first point is-- there's this idea that interest rates are being suppressed by the central bank. That it's financial repression. And that somehow if the central banks weren't doing what they're doing, the interest rates would be a lot higher.
Jason Voss, CFA: Sure. That is definitely the consensus.
Thomas B. Parker, CFA: Right. That is definitely the consensus. But if you actually look at it and say, build a model of what predicts interest rates, how do you explain interest rates-- 90% of it would be about what the level of NGDP is, both here and globally. Because rates are all relative. So global matters too.
And why were rates falling for every decade for the last three decades prior to ZIRP, NIRP-- you know, all the central bank activity. And now they're just falling again. But all of this fall is explained by central banks. And what were the previous falls explained by.
And what we've seen is that both global NGDP and US NGDP has been a lot lower than people expected. We're running about two and a half right now. And you can actually build a model that doesn't include any central base that would say, hey, interest rates in that kind of 1.5% to 2% range are actually pretty fair. And you haven't used any central bank explanation for what's going on.
And so yeah, the short end is definitely being suppressed. There's just obviously no question about it. But it's just not really clear that the longer end, which is the more economically important end, is being suppressed.
Jason Voss, CFA: Right.
Thomas B. Parker, CFA: And it's more of the Fed just reacting to these changes.
Jason Voss, CFA: And do you think some of the choices of the central banks have been sort of almost pushed into a corner where they have to act because there's no fiscal stimulus?
Thomas B. Parker, CFA: Yeah, it's pretty clear that that fiscal stimulus combined with monetary stimulus is the right policy prescription. They work better together than they do separately. And sometimes you can have one and the other going the other way.
So you know, Reagan put on this huge stimulus and Volcker was going the other way. He was tightening monetary policy. That works if the stimulus is big enough you know and the monetary policy is not accommodative but not completely going the other way.
But the central banks-- as they say-- I think there's a book coming out-- they're the only game in town. They are the only game in town. They know that the only game in town. I think the biggest criticism I have of the central banks is they've been overactive. They keep trying to innovate. They're reacting to very short term changes in the economy. And I think they're doing it because they have this pressure on them that they are the only game in town.
I think they would have done a lot better during of taking a much more medium term view of economic activity and reacting to that.
Jason Voss, CFA: Right.
Thomas B. Parker, CFA: Because that probably would have let them, at the beginning of 2014, to start raising rates. It would probably be a lot less damaging at that point than it would be now and going forward because it's just much more of late cycle in the economy now.
Jason Voss, CFA: So all of those ingredients that we've laid out so far could make for a delicious beef bourguignon soup or something like kind of a not so tasty chicken soup for the sick. Where do you see things going? And where are the opportunities to have a beef bourguignon and a chicken soup for the sick?
Thomas B. Parker, CFA: Again, I think you could get to a point here where you just have it's lower growth, but there's also lower risk associated with it. In a sense, there's less chance of overheating. And the amount overheating really is what leads to the size of the downturn. And that overheating can be in a real economy or that overheating can be in the financial economy. And obviously in 2008, it was much more about overheating in the financial economy than it was about the real economy.
But you can get either of those things. And the amount of that overheating will kind of determine the depth of any recession that happens. And so you can make a pretty strong argument. There's this argument that the Fed doesn't have enough bullets because you've needed to lower rates 5% in previous times of recession.
But you go, well, those were big recessions caused by an awful lot of overheating that we can identify now-- housing, S&L. You know, each of these recessions has had its own source of overheating, but it definitely has been there.
If you don't get that overheating, it's pretty easy to imagine kind of short and shallow recessions, which, actually-- everybody talks about the lost years in Japan, but from '90 to '97, they've never really had a recession. They just had this kind of up and down growth.
Jason Voss, CFA: Right.
Thomas B. Parker, CFA: But they didn't overheat. And so they didn't go into a recession. And it really took the Asian financial crisis, which obviously was huge, to really finally put them in a recession. So you might get a lot less ups, less downs. And that's a pretty good carry environment, fixed income environment. You can make money in that. You don't make 10%, but you can make steady money with probably less downside.
Jason Voss, CFA: Right, sure. Well thank you very much for being here today. Really appreciate it.
If you enjoyed this interview, look for more Take 15s on www.cfainstitute.org. Thanks for being here.
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