In the opening episode of "Unearthed," hosts John Reade and Joe Cavatoni celebrate the launch of their new podcast, focusing on macroeconomic trends and their impact on the investment landscape. Joined by Lori Heinel, the Global Chief Investment Officer at State Street Global Advisors, the group discuss the current market conditions, the role of central banks in addressing inflation and the potential implications of the upcoming U.S. election on investor sentiment. Heinel also shares insights on portfolio diversification strategies and the evolving trends in ETFs, including those for gold, highlighting their significance in today's economic climate.
In the opening episode of "Unearthed," hosts John Reade and Joe Cavatoni celebrate the launch of their new podcast, focusing on macroeconomic trends and their impact on the investment landscape. Joined by Lori Heinel, the Global Chief Investment Officer at State Street Global Advisors, the group discuss the current market conditions, the role of central banks in addressing inflation and the potential implications of the upcoming U.S. election on investor sentiment. Heinel also shares insights on portfolio diversification strategies and the evolving trends in ETFs, including those for gold, highlighting their significance in today's economic climate.
Additional Resources:
Notable Quotes:
“Economies around the globe were suddenly confronted with the prospect that inflation might be higher for a longer period of time, and that was going to require a lot of attention from central bankers.” -Lori Heinel
“Despite the fact that we have had massive tightening, consumers have remained healthy.” -Lori Heinel
“[China] did not have the robust covid bounce that many of us thought they would have. They had some bounce but it was not nearly as robust as many had expected. ” -Lori Heinel
“I don’t think that the election shapes the economy, I think its that the economy shapes the election.” -Lori Heinel
“No matter how much planning you do, the thing that ultimately happens, surprises you.” -Lori Heinel
“We think treasures north of four percent…look compelling especially against the structural view that we have that we are going to revert back to more trend growth in the US which would be around that two percent level.” -Lori Heinel
About World Gold Council
We are a membership organisation that champions the role gold plays as a strategic asset, shaping the future of a responsible and accessible gold supply chain. Our team of experts builds understanding of the use case and possibilities of gold through trusted research, analysis, commentary, and insights. We drive industry progress, shaping policy and setting the standards for a perpetual and sustainable gold market.
You can follow the World Gold Council on Twitter at @goldcouncil and LinkedIn.
Terms & Conditions | World Gold Council
Lori Heinel (00:00):
Interestingly, despite the fact that we've had massive tightening, consumers have remained healthy and that has voided the economy and enabled central bankers including the Fed, to try to engineer this soft landing.
John Reade (00:18):
Welcome to our first episode of Unearthed.
Joe Cavatoni (00:21):
Well, John, we did it. We finally got here. Shall we introduce ourselves?
John Reade (00:26):
My name's John Reade. I'm the market strategist at the World Gold Council, responsible for Europe and Asia.
Joe Cavatoni (00:33):
And I'm John's co-host, Joe Cavatoni, market strategist for the Americas at the World Gold Council.
John Reade (00:39):
Our focus for this episode is on macroeconomic trends, a great place to start this show. Our guest today is Lori Heinel, global chief investment officer at State Street Global Advisors. Thank you for joining us, Lori.
Lori Heinel (00:53):
Thanks for having me.
Joe Cavatoni (00:55):
So Lori, a lot's been going on.
Lori Heinel (00:58):
Oh, really? Hadn't noticed.
Joe Cavatoni (01:01):
Why don't we start by letting you help us level set a little bit and basically for our listeners, let's get some summarization of what we've got in front of us. There's so many factors at play. Help us start getting organized around how we should be thinking about things.
Lori Heinel (01:15):
Well, as you know, there has been a lot in play over the past many months, and I would say that the starting point is really that coming out of COVID, we had these massive bouts of inflationary pressures and we could debate whether those inflationary pressures came about because of COVID or whether they were going to happen anyway. But the bottom line was that suddenly the western world in particular, but economies around the globe were suddenly confronted with the prospect that inflation might be higher for a longer period of time and that that was going to require a lot of attention from central bankers. So I would say that what we've seen transpiring over the last 18 months or so is this battle between central bankers who are trying to navigate a post-COVID world where inflation remains a bit hot, but economic activity is not as robust as it was in just the immediate after-effects of COVID. So how do they delicately balance getting inflation under control and not choking off what growth we do have in the global economy?
John Reade (02:19):
I mean, I have to say, when you think about how much interest rates have gone up around the world, I've been surprised by the resilience of some of the major economies, particularly the United States. Did that take you by surprise, Lori?
Lori Heinel (02:31):
Well, it certainly has in the sense that typically when you have interest rate increases of some 400 basis points at this stage in time, that's a pretty sharp calibrator on economic activity because of course it drives borrowing costs higher, it drives the willingness for companies to invest in capital projects. The hurdle rates become a lot higher for those kinds of things. But I think what has been different this time, and part of why those stark rate increases haven't choked off growth is that there was a lot of resilience in the system, again, coming out of COVID and the US is a great example where during the sort of immediacy of that moment, we saw a lot of fiscal stimulus. So when people were losing their jobs, there were payments being made to those individuals that help them to get through that immediate downturn. We've seen very strong labor markets as again, we've seen consumer demand, we've seen business demand for goods and services. So interestingly, despite the fact that we've had massive tightening, consumers have remained healthy and that has buoyed the economy and enabled central bankers including the Fed to try to engineer this soft landing.
Joe Cavatoni (03:43):
So are we just expecting this to happen in a way where the effects of this rate increase are going to come harder at some point here in the next couple of months? Are we looking at six months? What should we be expecting in terms of when those rate increases hit the market and in particular on the corporate level, are corporates in a position to sustain themselves with these rates this high?
Lori Heinel (04:06):
So our view is that the central bankers and the Fed in particular has already done enough. Our view is that they should not be raising rates from here despite the fact that they continue to sound a very hawkish tone. We actually think that they should give it a bit of time and as you noted, let those rate increases that they've already manufactured, kind of run through the cycle. What we've seen is that consumers, while they're impacted in a number of ways, the core way that one would think there would be an impact is in housing costs. Well, most people aren't really moving, so they're still getting the benefit of those lower mortgage rates. So that's not necessarily constraining consumer capacity to spend, but as you note, the more serious challenge is going to be corporations who perhaps are going to have to refinance themselves. And we see a pretty big wall of that refinancing coming at the end of 24 and into 2025. And so if rates are still at the levels that they are today, that could be quite punishing for a lot of those companies.
John Reade (05:05):
And the soft landing? I mean we've been speaking about a soft landing now for more than a year and there's been a considerable amount of skepticism about the fed's ability to pull it off. As time passes though it seems to be looking more likely. Would you agree with that?
Lori Heinel (05:19):
Well, we were early to the view that they could engineer a soft landing, so we started to talk about that being the most likely outcome late in the spring or into the beginning of the early summer. I would actually argue we're starting to become a lot more concerned. So as this soft landing scenario has started to mainstream, our concern is that because the rhetoric coming out of the Fed is still quite hawkish and there seems to be at least some cohort there that are likely to want to increase rates, that that will be too much and we might actually be jeopardizing the soft landing they've worked so hard to engineer.
Joe Cavatoni (05:54):
So that's a really interesting point and you can't help but think that this is only more complicated than it's ever been before. So you've got a political geopolitical, a fiscal monetary policy, all of these factors that are just weighing in. There really isn't a clear narrative, but I think what you're saying is we might not necessarily get that soft landing. Are we reading that right?
Lori Heinel (06:18):
You are. And again, our core call is still that we could get there and I would say our base case is still that we have a soft landing, but we have decreasing confidence in that being the result. And again, the longer the central banks keep rates high, the more that you get those impacts that you were referencing earlier where it starts to trickle through to the real economy because consumers do have to refinance and that means that they're refinancing at higher rates. Companies have to refinance, that means that they're refinancing at higher rates. Governments have to refinance and that means that they're refinancing at higher rates. So the combination of this higher for longer is really what could be devastating to the global economy.
John Reade (07:01):
I think under most circumstances it seems likely that the Fed will, wherever it ends up in the short term, probably be cutting interest rates in the second half or maybe towards the end of next year. Would you agree with that?
Lori Heinel (07:14):
Well, certainly their dot plots suggest that despite the fact that they are still contemplating raising rates at this stage, that they'll be in a position to potentially start to cut rates. And here again, our view is a little bit contrarian. We actually think that they're going to have to cut a lot more sharply than what the markets or the central bankers themselves are suggesting. In part because we do think there's growing risk that the economy is going to slow pretty meaningfully here in the U.S. In fact, we've penciled in about 1.1% growth in 2024, which is precariously close to that recessionary level.
Joe Cavatoni (07:50):
We often talk in particular in the gold market about the Fed, the monetary policy in the US. How substantial is it and how are you looking at the other central banks and their behavior right now in this grand scheme of things in terms of calling this next phase in our economy?
Lori Heinel (08:08):
Well, I think one of the other things that's been quite tricky here is that not all economies are in sync. Certainly we've been talking a lot about the US over the last few minutes and what the fed's been doing, and they were ahead of the curve in trying to raise rates very rapidly to tame the inflation beast. You also still have the Eurozone where inflation continues to run a bit hot and we're quite nervous about the winter and what energy prices might mean and how that's going to translate into inflationary pressures. Now again, that may not be core inflation, but it still hits consumers in the pocketbook and potentially gives them less capacity to spend on other things. Then you look at other places like Japan where rates remain very, very, very low and they seem to be not quite worried about inflationary pressures in the same way. So it is an unsynchronized environment that we're operating in today, which just makes navigating it that much more challenging
John Reade (09:06):
One market, of course, where we don't have inflation, but there certainly are economic challenges is China. Do you have any strong views on what's going on there?
Lori Heinel (09:15):
Yeah, we do, and I'll just caveat this by saying up until a few years ago we were quite positive on China because of course, despite the fact that we all knew that China's growth trajectory was slowing, it was still growing much more rapidly than most other major economies around the world. I think there are a couple of things that are different now. Certainly COVID hit them hard and maybe at the wrong time. So if you think about just the personal element of COVID, one cohort that got hit hard were the elderly. In some sense, China's the elderly on the global economy, their population is aging very rapidly, and this COVID scenario put them in a tough spot just when they're trying to get their economic vibrancy going and trying to really claim that place on the world stage. So China's got a lot of overhang. They did not have the robust post COVID bounce that many of us thought they would have. They had some bounce, but it was not nearly as robust as many had expected. They also were dealing with the overhang of the property market and trying to navigate a gentle way out of that without creating a lot of moral hazard. And then they're also dealing with the geopolitical tensions which weigh heavily on them. So we've been much more cautious on China in the recent months.
Joe Cavatoni (10:36):
Yeah, the geopolitical factor, the US-China relation, very complicated, and actually we're moving into 2024 and election year in the US which will be a fun thing to watch, to say the least. In terms of how that election develops. How does that weigh in on what you are thinking, how you're assessing the outlook? Does it? And actually, what are your clients saying about that and what are they asking about it?
Lori Heinel (11:02):
Well, the election in the US is of interest to everybody. So every client that I talk to, whether it's somebody in the US or somebody outside the US is very much interested in how that's going to transpire and who are likely to be the candidates and all that good stuff. Curiously enough though, I don't think it's the election that's going to drive markets over the next year, frankly. I think it's going to be this continued dynamic of what's going on with central bank policy, how is the inflation picture coming under control or not, and how much damage is getting done to the real economy as central bankers continue to battle the inflation fight. Now, if our core call is right and inflation continues to come down, maybe not in a direct line but comes back down into that sort of sub 3% level and central bankers can kind of take their foot off the gas and perhaps even start to cut rates, well, you could be setting yourself up for a really decent time next year, and that would of course benefit the incumbents generally if the US economy navigates that soft landing. Conversely, if we have a situation where more damage is done, we hit a sharp slowdown, probably coincident with when the election is actually happening in the US, then that could lead to a different outcome. So I don't think it's that the election shapes the economy. I think it's that the economy shapes the election.
John Reade (12:28):
Interesting. Yeah, that's a really interesting point and it's hard enough to call elections without this degree of economic uncertainty. I hesitate to use the word unprecedented because we seem to use it too much, but it is one of the more complicated situations I can remember through my career. So, with that in mind, what are you saying to clients in terms of asset allocation strategy at the moment?
Lori Heinel (12:50):
Well, there are lots of things that we're communicating to our clients. I think the first thing that we've noted is it's better to stay a little close to home right now because this thing could break in either direction pretty sharply. So unlike in past environments where you might say, boy, it really looks good to load up the bus in bonds, we're getting four and a half percent on treasuries, why wouldn't you go ahead and put a lot of money there? Given that cash is 5% or so, it's not really worth it to make that kind of bet in here. Similarly, there are scenarios that one could construct that would lead us to actually be much more bullish on equities. You've got earnings seem to be pretty resilient in here looking for S&P to generate 10, 11 percent growth from a consensus basis. Well, that's an environment where you'd say, geez, maybe I want to load up the bus on equities. But here again, given the kind of outlook that I've described, that doesn't feel like a high-conviction move either. So there are a couple of things, one is stay a bit close to home. So if you've got a 60/40 portfolio spread your bets, take a little bit of positive allocation in some places where you think that you've got good risk-reward. We have looked for diversifiers, so gold continues to play a very prominent place in our portfolio. We've got about a 3% allocation, which might sound small, but strategically we typically don't allocate to gold. So that is actually a nice little hedge against both extremes, frankly, you know, a high inflationary environment or a deflationary environment. And so that would be a place we'd look opportunistically to add some capital. And then we want to have a little bit of attention to what's under the cover. So within equities, looking for those high quality companies that aren't levered and aren't going to have to refinance into a high interest rate environment.
John Reade (14:37):
Are there any particular sectors within the equity market that you would avoid in the US?
Lori Heinel (14:42):
Well, I think it's less about avoidance and perhaps more about being a little opportunistic, right? So earlier this year we were positive on energy because we still thought that the global economy was going to look pretty good. And then as we got into the year and we started to see some slowdown and China not being as robust in its reopening, we pared back on our allocation to energy. And then more recently over the last couple months, we've started to skew that back positive again. So less about getting wholesale out and keep in mind that as a large index manager, we tend to follow major indices for a large proportion of our assets, but more about looking for those opportunities around margin.
Joe Cavatoni (15:22):
Do you take into consideration in these discussions kind of event risk? You know one of the things we've seen a lot of over the last call it three years have been moments where unpredicted shocks to the system risk assets moving in all kinds of directions. How do you address that? Is that still on your mind? Do you see anything that's out there in the horizon leaving the election aside. Government shutdown, ongoing concern around banks and ratings of banks, and we had an unprecedented fail over the course of a weekend with Silicon Valley Bank? Is that still factoring into all this discussion right now?
Lori Heinel (15:59):
Event risk always looms large. And if there's one thing I've learned throughout my career, it's that no matter how much planning you do, the thing that ultimately happens surprises you. But they do rise. So if you think about Silicon Valley Bank, this was another kind of liquidity crunch. Now it manifested in a very different way, but ultimately it was the inability for certain institutions to finance themselves, right, which is a liquidity crunch. So I think the way that we think about an event risk is to try to decompose them into what are the actual macro or micro, in some cases, implications at the portfolio level that you can actually trade around. So yes, I can say I'm worried about cybersecurity attacks. Okay, that's an event risk. If something really terrible happens to the energy infrastructure in the US because of cybersecurity, that's massive, but how you actually invest against that is a little trickier to try to divide. So I'd say we try to look for those things. And SVB was a great example. Silicon Valley Bank was a great example because it was about liquidity and trying to get under the covers to see who else might have similar kinds of underlying vulnerabilities. And then you also have those shock absorbers and your portfolio. And we talked about gold earlier through the context of a genericized kind of diversification bet, but it also tends to be a good diversifier against these kind of event risks that we often see.
Joe Cavatoni (17:29):
As an aside for our listeners, we recorded this episode before the Israeli Hamas conflict erupted on seventh October. While the situation is rapidly evolving, generally during times of geopolitical volatility, we see increased demand for gold as a defensive asset.
John Reade (17:50):
As a big ETF manager, you must pay a lot of attention to the flows within the ETFs that you manage. What trends are you following at the moment, Lori, and what do you think would interest listeners?
Lori Heinel (17:59):
I think there are a couple of things. I mean, certainly as a broader asset manager, we've been quite intrigued by the active ETF space, right, and trying to make sure that we can participate there. And you probably know we do that through some of our partners that we work with to take active capabilities to our clients. I think there's also this kind of thematic, and thematic has all kinds of different dimensions to it. It could be things in certain spaces like robotics or green energy or things of that nature. It could also be sort of niche asset classes; commodities, precious metals, you know, things of that nature. And I do think that investors are interested in some of these kinds of thematics in part because they behave very differently in different kinds of economic environments. So if you do scenario analysis, most of us kind of grew up with mean variance optimization, looking like the distribution of returns. But what we know is that not every environment looks the same. And if you look at a stagflationary 1970s environment, which I don't think we're going to go into, but if we did go into that, the kinds of things that would win in that environment are very idiosyncratic. So I think thematics and ETFs is kind of interesting because it gives investors ways to play these niche opportunities that are going to behave very different depending upon what your worldview is.
Joe Cavatoni (19:25):
You know, Lori, transparent active ETFs might be the fastest-growing category in the ETF space right now at a compounded annual growth rate of about 47%. And it's a 408 billion market and a very young market. I mean this is something that's a recent phenomenon of five years?
Lori Heinel (19:41):
I'm sure your listeners and others will also pick up on is in many cases it's really moving structure, right? Moving from a conventional sort of mutual fund structure into an ETF structure. So some of that growth is conversion of assets, right, but there is, as you note, a very healthy growth in that segment as well. I would be remiss if I didn't also comment on fixed income, which again has been an asset class that has really burgeoned in the ETF markets over the last couple of years.
Joe Cavatoni (20:10):
Yeah, we want to talk about fixed income just for a minute here. Where are you looking on the curve? What are you thinking right now? How are you picking your spot at this point in fixed-income land?
Lori Heinel (20:19):
Yeah, so very carefully. I'd say the first thing, and this I think will resonate given the environment that I described earlier, we're kind of barbelled right now. Rather than having a sort of Barclays egg fixed income exposure, we're holding a fair amount of cash. So we actually have one of the more sizable cash positions in our strategic portfolios that we've had in a long time at nearly 10%. And then we're also playing the rates market. I don't think we can call the bottom. It's entirely possible yields trend a bit higher from here in treasuries at least, but we think treasuries north of 4% or depending upon your day, north of 4.5%, look compelling, especially against the structural view that we have that we are going to revert back to more trend growth in the US which would be around that 2% level.
Joe Cavatoni (21:09):
So shifting gears a little bit, Lori, maybe you could share some of your views on the privates market. So you're talking private equity and private debt. We often hear that in a lot of the discussions we have with our clients when they talk to us about alternatives and assets like gold, they bring up privates as an alternative. What are your thoughts there?
Lori Heinel (21:29):
Well, certainly there's been a lot of enthusiasm for private assets over the past couple of decades as a lot of institutional investors saw that as a way to get, you know, liquidity premium or perhaps alpha as they found managers who are particularly skilled in the space. I think it's a little different today, though. We've done a fair amount of research that suggests that when you actually look at the leverage that they deploy, and you look at the available asset pool, returns are likely to disappoint going forward. So, we actually think investors should be quite cautious in deploying assets there. And oh, by the way, the liquidity in those markets is quite small. So the other dimension here is oftentimes plan sponsors and other asset owners sort of fail to take account of what the illiquidity might mean in crunch events.
Joe Cavatoni (22:19):
That's it, liquidity when you need it, and that's when you need to measure it the most.
John Reade (22:23):
So I think you've laid out your assessment of the economy and the investment landscape really well, Lori, and I'd like to thank you for that. Now we're going to throw you by asking for a fun fact that you think our listeners might be interested in, we can end off the show with.
Lori Heinel (22:37):
Well, I had a fantastic vacation just a few short weeks back where I actually went to South Africa. And I'm sure your listeners know that that is the current home of five of the largest gold mines. I did not visit a gold mine, but I did buy a piece of gold jewelry.
John Reade (22:55):
Well, the industry thanks you for your support. Coincidentally, I'm recording this podcast today from a hotel room in Vienna where we've just had our central bank offsite. It's an environment where we invite central banks from around the world in a closed-door meeting to discuss gold. It's been co-hosted with the Austrian National Bank, their central bank, but also the Austrian mint. And I had the pleasure of visiting their gold vault today, and more than half of the gold in that vault actually came from South Africa. Lots of Rand Refinery bars there. So, there is always a linkage back to gold.
Joe Cavatoni (23:26):
Though I don't have a linkage to South Africa, other than I can say that I know the deepest gold mine in the world is in South Africa. And if I'm not mistaken, John, you've been to it. But I can actually counter that by saying I've been to the highest gold mine in the world, which sits in Tibet, and I visited China Gold site, and it was an extraordinary experience. We went up to go down, and I had a lot of fun doing it, but it was definitely taxing on the body to be at that altitude and then go down a gold mine. So that would be my fun fact.
John Reade (23:59):
Well, that's excellent. Well, thank you very much, Lori, for your contribution today. It's been a pleasure talking to you. I'm sure we'll do this again because this market's going to move around a lot in terms of performance and expectations over the next few quarters, I'm sure.
Joe Cavatoni (24:12):
All right, well that's our show for today. Thank you Lori, again for joining us, and thanks to all of our listeners.