Doug:

Welcome to this client advisor webinar. Today, we’re going to discuss the capital markets during 2019 and the potential effects of a presidential election on the markets in 2020. Our goal with these quarterly broadcasts is to inform you about the progress of the financial markets in real time and also to answer your questions live. We appreciate you taking the time to join us today. My name is Doug Fabian, and I will be facilitating today’s program. I am the Science of Economic Freedom podcast host and part of the client communications team here at Mercer Advisors. Please note that the functions on your toolbar during this live broadcast will allow you to submit questions. It’ll send a text message to us, and we’ll do our best to facilitate as many questions as possible during the Q&A portion of today’s program. Our formal presentation will last approximately 40 minutes, leaving 15 minutes for Q&A. Joining me today is Don Calcagni, chief investment officer at Mercer Advisors, and Drew Kanaly, longtime client advisor and investment committee member. We wanted to begin today with a discussion about wealth management versus asset management. Today, we are certainly going to be talking about asset management, but I want you to understand clear differentiating factor between Mercer Advisors and many other firms in the marketplace, is our wealth management capabilities. Asset management is a part of wealth management, but right at the top of our service offering is financial planning. We believe that each and every client must have a comprehensive financial plan in order to be able to manage all of their wealth. Then, we believe that tax planning is such an important process of wealth management over time. Estate planning, key to your lifestyle and your legacy. Then lastly, when it is necessary, we offer corporate trustee services. We all want you, all of our clients at Mercer Advisors, to understand that wealth management is our primary focus for you throughout your lifetime. Today, we’re going to be talking about investment management. Here is our agenda today. First, we’re going to talk about the capital markets during 2019. Next, we’re going to discuss the election in 2020. Not from a political point of view, but from a historical point of view. What has history taught us, told us, about presidential election years and the markets? Next, we’re going to talk about what Mercer Advisor clients should be thinking and doing right now, and also we’re going to discuss what we are doing for clients. With that agenda and overview, let’s jump right in, and I’m going to turn things over to Don Calcagni. Don?

 

Don:

Thank you, Doug. I appreciate that. I think any time you do a recap of markets from the prior year, it’s always important to take a quick trip down memory lane. This time last year, the financial press would have us believe that the world was falling apart, financial markets were in for a very rough 2019, we thought 2019 was going to be a bad year, a bear market. Everyone thought this was in, that the bull market that had begun in the aftermath of the financial crisis was now over. I always love this Mark Twain quote. It says, “The report of my death was an exaggeration.” When we actually look at what 2019 looked like, what we see here is last year US financial markets, the S&P 500, was positive 31 and a half percent. When we look globally, we see that returns across the planet were very strong. In Europe and the emerging markets, in Asia and around the globe, financial markets were quite strong. Certainly the death of the bull market was greatly exaggerated this time last year. I do think it’s important, Doug, that we remind clients that 30% is not the new normal. I’m certainly not one of these fearmongers, but I would just caution our clients that stock markets don’t go up in a straight line.

 

Doug:

Don, would you comment on the pie chart on the left, and just how the United States continues to be the dominant force in terms of global market capitalization? Why is that?

 

Don:

Certainly. If you look at the left-hand side of the slide, you’ll see that the United States, our financial markets on what we call a capitalization basis, it makes up more than half of the world’s stock markets. That’s because, probably for the last 250 years or so, the United States has been the world’s primary financial workhorse. The United States is where companies come to go public. The United States has arguably still the world’s largest economy, followed close behind by that of China. What we’re showing you here is just the size of our stock market relative to other countries or regions of the world. Last year, obviously, stock markets did quite well. Very interestingly, bond markets did extraordinarily well. That was because, what happened last year is, earlier in the year interest, the central bank was cutting interest rates, and then towards the second half of the year we started to see interest rate cuts. They’re raising rates first half of the year, basically cutting rates the second half of the year, and that really pushed US bond markets up quite handsomely. When we look at the US aggregate bond market, this row right here if you can follow my mouse, was up 8.7% for the year. That is one of the best years ever for bonds. I just want to caution our clients, that was a very good year. I would not expect that going forward. By the way, that 8.7% return, that’s not an interest rate. That’s not yield. That’s just the total return on bonds in the market. That’s the return on the price of the bond but also the yield.

 

Doug:

Don, now we’re getting into some of the subject matter we want to discuss today. All of our clients certainly understand that 2019 was a great year, but as we look ahead, I believe that the financial press, all of the media is going to be focused on the 2020 election, and we thought it would be a good idea to take clients down memory lane, look at past presidential cycles. How did markets react? We are not going to predict who is going to become president. We are not going to predict what the markets are going to do this year, but we really want to give clients some clarity. Drew, I want to bring you into the conversation. During our preparation for this event, you had some interesting comments relative to 2020 and the election cycle. Drew?

 

Drew:

Thank you, Doug. I’d like to think that this webinar is brought to you by the number 20 and the letter E. The number 20 for a year so nice we’ve numbered it twice, and the letter E for what I think are the three big Es for 2020. Those Es are earnings in the economy, exogenous shocks, let’s use the Coronavirus as an example of that. Then, finally, the election. Gone from our conversation are concerns about inflation. Gone from our conversation are what the Fed might do. Gone from our conversation of last year is China trade. I will say that you probably will have trade rumblings this year as the president has telegraphed with the EU, but my thinking leans towards the markets have now been conditioned to these negotiations begin hard ball with tariffs and whatnot, and most likely will work themselves out. That’s how I look at 2020, using the three Es.

 

Doug:

Don, let’s take a look at a little bit of history and election cycles in the past.

 

Don:

Absolutely. I agree with Drew. The election is going to be a dominant theme in financial markets for the remainder of the year. The way I like to think about it, and the way I would explain it to our listeners, I call it one story two conclusions. The one story is, let’s first just look at the economy. These are facts, and certainly political idealists, both parties would have you believe their particular interpretation of the data, but let’s just take a look at the data first, and then from there we can try to draw some conclusions. First off, the fact is the economy continues to grow. One party would argue that maybe it’s growing too slowly, another party would argue that maybe it could be growing quicker if we had less regulations, lower taxes, or lower interest rates. The fact is, the economy does continue to grow. It is growing below its long-term average of just under 3%, but the economy does continue to grow. That’s a fact. That’s part of the story that I just want our listeners to understand. The economy is growing. Number two, the financial health of US households, it remains good on average. Certainly the parties and partisans will interpret this differently, and again I’m just stating a fact here, is that the average wealth, the average American household, is at an all-time high. That’s a good thing. I would argue that’s a good thing. Again, our parties will interpret that differently. By and large, US consumers are doing well. We have the lowest unemployment rate in probably the last 60 or 70 years. Again, both parties will interpret who is primarily responsible for that. Certainly one party that’s in power will want to take credit. The other party, who’s not in power, will argue that low unemployment rate is because of things they did potentially in the past, but again I’m just stating the facts. Unemployment’s at probably an all-time low, and the US households are in good financial health. Another, I’ll say uncomfortable, fact is the reality that our government is accruing about $1 trillion a year. That’s with a T, not a B. A trillion is one thousand billion. A billion is one thousand million. $1 trillion a year in new borrowing just for the US federal government to pay its bills. We can debate, and both parties do, over what the government should be spending on, and on the left hand side of our screen here we see that. This is how our government spends your money, our money. You’ll see here that over half of all federal spending goes towards social security, Medicare, and Medicaid. Whether that’s a good thing or a bad thing depends purely on your world view, your ideology. It is a fact that, this is how our government spends our money, and it is a fact that our government is borrowing $1 trillion a year right now just to make ends meet. When we look at our debt, the debt of the federal government, it is projected to continue to skyrocket in the years ahead. I would just encourage all of us as voters, as citizens, regardless of party affiliation, to please keep this in mind. We are all Americans first. The reality is, our government is borrowing $1 trillion a year to pay its bills. In terms of government spending, and again this is really subject to how you choose to interpret this, but I just wanted to share some facts with our listeners. Under the Obama administration, US federal spending, perhaps surprising to some, was actually pretty flat in dollar terms. Over here on the left-hand side, we’re showing you the trillions of dollars that made up the US federal budget in these specific years, and over here on the right we’re showing you the percentage of GDP, federal spending as a percentage of GDP. We’ll see that spending has actually gone up quite significantly under the Trump administration. Again, I’m not judging, I’m just highlighting some facts for our listeners to consider to take a look at, and ask ourselves, and we should challenge our political leaders. Is the government spending dollars on things that we collectively, as a citizenry, would agree that, that’s how we want to spend our money? Again, this is the one story. These are the facts that I think all of us as citizens should take a look at and just keep in mind. Another fact, and I hear this a lot, and we’re going to hear this more on the campaign trail this year. We often hear that US federal, US taxes, are at an all-time low. I would argue that claim is a bit of a bait and switch. It is true, and this is with the red line here, it’s showing us on the graph it is true that the marginal income, highest marginal income tax rate in the code has come down significantly since the late 1940s. Those are just the statutory rates. That’s what’s in the law. The reality is, we’ve also eliminated a significant amount of tax deductions over the past 60 years, 70 years, in the law. What the blue line at the bottom is showing you here on this chart is the effective tax for the past 60 or 70 years since 1946. What we find is that the actual effective tax as a percentage of the economy that the government has collected over that time period has not changed much. What that means is, in reality despite how uncomfortable it might be to admit this, is that US federal taxes have not really changed over the past 70 years as a percentage of GDP. What has changed is how we go about calculating how much we’re going to pay in tax, and that’s where the rates are part of that equation, when you sit down to do your taxes. Taxes have not really changed. That’s an important point.

 

Doug:

Ladies and gentlemen, I wanted to invite you to ask us questions. The question queue is open. If you would like to submit a question, please use your toolbar. It sends us a text message, and we’re going to be getting to the Q&A portion of our presentation shortly. We enjoy that part of the presentation. It’s where we can answer your questions live. We’d love to hear from you. Please submit your questions, and we’ll be getting to them shortly.

 

Don:

It’s important to keep in mind that, despite all that information, that’s the story, that’s the economy, is that both parties interpret that set of facts very differently. What we’re showing you here on this particular slide is confidence in the economy over time, broken down by political party. We’ll see that despite record deficits, despite record debt, and despite a large increase in US federal spending, republicans are actually very confident. Very high level of confidence in the economy. Democrats, their confidence in the economy is quite low, at 33%. Doug, I always find that interesting, that here we have this one set of facts. We have the GOP has often branded themselves, which we can debate as the party of fiscal conservatism. Democrats have often been branded at the party of big government, and here we are. We have a very large government, and we have very, very high federal spending. Perhaps ironically, the republicans are very confident in the economy. The democrats not so much, and so it’s just interesting. My message to our listeners is, just keep in mind that often how we interpret this data first and foremost as a function of our political beliefs and not the data, because the data doesn’t change, it is what it is. It’s just that we’re interpreting it very differently.

 

Doug:

Don, one of the things that we are all aware of just by turning on the media on any one night and depending upon what channel you’re watching, we’re also dealing with a country that is very polarized in terms of its opinions right now. As I’m looking at these charts, going back over the last 20 years, it seems that the disparity between the two parties is at a high point that we have not seen historically, and that’s also quite interesting. When you go back into 2009 to 2013, there isn’t that much of a disparity between the two parties, but now there is just this big gap in terms of the way people are interpreting the same facts.

 

Don:

That’s a great observation. We often hear that it was the rise of social media that has led to a very divided polity in the United States. We talk about Facebook, and everyone’s an expert on Facebook. That’s where you see everybody posting. What’s interesting is, if you go back to ’09 through 2014, to your point we were much closer together in terms of our collective thinking on how the economy was doing, on economic conditions. We had Facebook back then, and if we actually go back prior to ’08, where you didn’t really have Facebook back then, and yet we were still extremely divided. The thinking is that, when you have a financial crisis, and everybody is experiencing financial pain, obviously all of us are thinking, “Okay, the economy is crap,” and nobody is bullish on the economy. You saw that in ’08 and ’09, and 2010 and ’11, and ’12, and so on and so forth, right? If you look before the crisis, and if you look long enough after the crisis, I think what you’ll find is confidence in the economy is highly correlated by one, what party controls the White House and what your political beliefs are. George Bush was in the White House, obviously, in the first eight years of the century. Republicans were bullish on the economy. Democrats less so. When Obama came to power, you’ll see that the democrats actually were more bullish on the economy than republicans. Then, obviously, that flipped virtually overnight when President Trump was elected in November of 2016. The economy didn’t change overnight in 2016 when President Trump was elected, yet for some reason the two parties flipped in their views on the economy. Purely a political decision. The data didn’t change. Earnings didn’t change. Economic growth didn’t change. What just changed was who technically was in the White House.

 

Doug:

What about the markets, Don, in 2020? What does history tell us about how they may perform? Take us down memory lane here, to look at what’s happened in the past.

 

Don:

This is, I think, what our clients really want to know, is if so-and-so wins, or what does that mean for markets? Here we are. We’re in an election year. We’re also dealing with an impeachment. To Drew’s point, exogenous shocks, right? The coronavirus, but I think when we look at history, if we go back to 1928, we’ve had a number of election years obviously. When we actually look at the data, we see that the average return for the S&P in an election year is 11.3%. If we actually look at all the election years since 1928, there’s only been four years where we had negative US stock market returns. Obviously 2008, right? Let’s think about that for a moment. Let’s just stop. Was the market negative in 2008 because it was an election year? No. Obviously not. It was negative, because Lehman Brothers went bankrupt, and we had a financial system that was clogged with a bunch of bad debt. The subprime mortgage, for those of us who can remember. It’s important to keep in mind that election years by themselves are not a predictor of what’s going to happen in the market. Markets are a function of a lot of other things going on at the time. We go back to 2000. Bush beat Gore. When the market was down 9%, was the market down 9% because it was an election year? No. It was down 9% because we had a dotcom bubble, and we had companies trading at infinite multiples with no earnings. Again, if we look at the long span of history, there’s only been four negative years. By itself, there’s nothing about an election year that would give us any information that we should be trading on. My message to our listeners, to our clients, is that elections by themselves will not predict what’s going to happen in markets. We have to be careful. The data tells us that regardless of who wins, market do well over time. I know that’s not what our political leaders would want us to believe. They all want us to believe that their party or their candidate has all the answers for everything that ails us. If we look at the span of history, markets have done very well under a variety of presidents with very different world views. I would argue today President Kennedy would be a republican by any objective measure. These are just nominal party affiliations, this red and blue that you see on the screen, and the growth of wealth over time. Even if you look at the different policy proposals of these presidents, they vary quite widely, and throughout the last 80-90 years we have seen really, really good market returns. The data tells us that, regardless of who wins, regardless of the fact that it’s an election year, US capitalism is robust. US financial markets are robust. They work, and over time for long-term investors, you’re going to be just fine.

 

Drew:

Just to emphasize this, Don, I think everybody should really bear down on the last two slides. This is solid data. For a lot of people, especially slide 18, it just doesn’t fit your mind’s eye. Whatever your persuasion is politically, you would not believe this chart would look like this, but it does. The one that shows actually election years, I think, is the most shocking, because it has zero predictive value. Zero, when you really dig into what was going on economically in those time periods. Your big conclusion here is, data-wise, election years themselves have zero predictive power on the market, and over the long term no predictive power on who sits in the White House.

 

Don:

Completely agree. When we go back just 10 or 11 years ago, when it was Obama v. McCain, I remember at the time there was a front cover. Drew, you can keep me honest here. I think it might’ve been Time Magazine. It said, “We are all socialists now.” It’s very famous. Anyone can go to the Internet and Google it, and you’ll see this front cover. I remember how that struck me so powerfully at the time, that there was this accusation or interpretation that President Obama was going to drag the country hard left, that tax rates were going to spike, financial markets were doomed to a permanent death. When we go back to the fourth quarter of ’08, it was an ugly time. I remember seeing that front cover, we are all socialists now. I even thought to myself, “Oh, my gosh! What does this really mean for the health of American capitalism?” When I look at how US financial markets did under the Obama administration, here’s a presidency that was arguably very, very far to the left, US financial markets did exceptionally well. We can go back in history and apply that same litmus test to republican presidencies, where people thought, “Oh, these guys are just going to cut taxes and deregulate things too much, and it’s really going to hurt the economy or the markets.” Yet, we’ve seen markets do very well under Reagan and certainly Bush one. My point is, we have to be careful buying into this narrative or this story that we hear in the media or from the political parties that the other side is somehow inherently evil and is going to destroy the American way of life. I just encourage all of us to keep an open mind on that.

 

Doug:

Don, we’re at this point in the presentation where we want to be talking to our clients about what they should be thinking, but I wanted to begin by talking about what Mercer Advisors and the investment team are doing right now relative to our portfolios. What are we doing for our clients to navigate markets going into 2020?

 

Don:

That’s a great question, Doug. One, we’re always doing the same things we always do. We’re probably doing them with a bit more vigor, just because the opportunities are there, and we’re coming on the heels of a 30% equity market return last year. We’re doing a number of things. Number one is, we’re constantly rebalancing portfolios. I know that, for a lot of folks, that feels counterintuitive, that you sell things that have done well, and you buy things that have done less well. Sometimes you buy things that have done poorly, but that’s the essence of rebalancing. I just reviewed our rebalancing logs a few days ago, and we’re selling stocks, and we’re buying bonds. Stocks have done enormously well. You’ve got to take some of that off the table. We’re rebalancing. I would encourage all our listeners, talk to your advisors about that, how we’re rebalancing in their accounts, and across accounts, and things like that. The other thing we’re doing is, we’re encouraging clients to take those capital gains. If you have a portfolio that is lopsided, and you’re afraid to rebalance or sell a position that’s maybe very concentrated, we encourage you to do that. My believe system is, and this is my view, is that tax rates today, the nominal tax rates today are the lowest that you’re going to see probably for the rest of your lives. If you wouldn’t rebalance and pay realized capital gains, and pay those taxes now, you probably never will. What that means is, your portfolio is permanently lopsided, because you’ve been afraid to pay those taxes. Like we pointed out a few moments ago, federal deficits are an all-time high. That cannot continue indefinitely, and there’s going to come a time when I believe they’re going to raise tax rates, and especially on capital gain. Encouraging clients to harvest those capital gains. You know Doug, the other thing we’re doing is, we’re constantly going through and re-evaluating our managers. We just fired three managers. We’re in the process of moving out of those managers into two new managers. That affects not all of our clients but many of our clients. Those clients are in the process of being notified that we’re making those changes. We’re always looking for opportunities to save our clients’ money, fire managers, take risk off the table. Fees are a form of risk, the fees that we pay managers. If we have a manager that we pay 40 basis points to, that’s 0.4%, and we can find somebody who’s less expensive, we’re going to do that. We’re going to make that move for clients, so that they can book those savings.

 

Drew:

Yeah. One more point about that, if you really are following markets, and especially if you’re following actively managed funds, it’s increasingly narrow holdings, concentrated holdings in the marketplace explaining a lot of market behavior. This is precisely the time that you take profits in the stocks that have done particularly well, and rotate to those who’ve done less so. That’s what balancing and diversification’s all about, and if you’re a student of market history, they always follow this pattern, the energy stocks in the ’70s, the consumer nondurables in the ’80s, and the tech stocks in the ’90s, markets always narrow to a handful of, the money gravitates to the momentum eventually, and so you need to be rebalancing, especially in these times.

 

Don:

Absolutely.

 

Doug:

Don, I wanted to ask you about a couple of things. Number one, how fees have continued to fall relative to the investment vehicles that we use, and that’s one of the reasons why we’re making some decisions, but also the frictions of transaction fees, what has happened in the marketplace with Schwab and TD, and how those costs are coming down. What does that mean for our clients?

 

Don:

First off, that’s all great news for our clients. Anytime fees go down, that’s extra profits that just fall to their bottom line. That’s always a good thing, and you’re right. There’s so much competition in US financial markets for client dollars that Schwab waived basically their trading fees for everything except a handful of mutual funds. That was followed quickly by TD Ameritrade, and then Fidelity, and so that’s a great thing. That tells me capitalism works. Capitalism is about free market competition. The consumer is king. These companies are going to beat each other up for the privilege to hold your money. We see the same thing with respect to managers. This is one of the reasons why clients choose to hire Mercer Advisors, is because we have a particular expertise in looking under the hood and evaluating managers. One, to make sure that they are substitutes for each other. You can’t just fire a bond manager, because he’s more expensive than a stock manager, and then move all your money from bonds to stocks. You have to be able to look under the hood and understand. Are these managers substitutes for each other in terms of what they do and what they’re providing to our clients in terms of returns, and risk, and things like that? Yeah. To Drew’s point, the fees for active managers have been coming down, partly because we have index products, we have factor-based products or smart beta. There’s a bunch of buzzwords that we use for those, but fees have come down dramatically. Mercer Advisors, we are very vigilant in monitoring those fees. The best part of my job is going to a manager, Doug, and saying, “Hey, you’re twice as much as the next guy. Why should I leave our money with you?” If we don’t get a good answer, that manager gets fired, and for three managers recently we didn’t get a good answer. Those dollars are in the process of moving, and that’ll save clients probably about a quarter of a percentage point. Which may not sound like a lot, but over time, that’s pretty significant.

 

Doug:

Don, just final on what we are doing. What has history told us, just in academic theory relative to good practices and money management, how rebalancing helps clients’ performance over time?

 

Don:

It’s one of the things that, it’s probably perhaps a bit counterintuitive, but rebalancing actually increases return over time, and it actually reduces risk. It’s actually a free lunch. If you sit down, do the simple arithmetic on that, which maybe is not so simple to be fair, but if you sit down and do the math on that, you should be rebalancing as much as you can. Obviously, there are frictions. Because trading fees have basically gone away, that’s one major friction that’s no longer in the way. In the old days, you would be a bit slower to rebalance, because you had to pay a trading commission to TF Ameritrade, or Schwab, or Fidelity, or whoever, right? The reality is, for the most part, with the exception of mutual funds, that friction is gone. Now the only remaining friction is taxation. What that means is, all your tax-sheltered accounts — IRAs, Roth IRAs, 401(k)s, all that stuff should be rebalancing quarterly going forward. The math tells us, all the academic research tells us that rebalancing is a very, very good thing, and you should certainly take advantage of it.

 

Doug:

Let’s talk now to our clients about what they should be thinking in this election year. Volatility is something that has been relatively low of late. We may see an increase in volatility, but what’s the message that we want to be conveying to clients on what they should be doing, Don?

 

Don:

I think the number one thing, this is a theme that I know our clients hear from us often, but it bears repeating, and that is it’s critically important that we don’t cave to our emotions and become emotional investors. What that means is that you shouldn’t panic. Regardless of what’s happening in the markets, regardless of who wins the election, don’t panic. The other side of that coin is, I wouldn’t become too euphoric. If your preferred candidate wins, I would not go out and mortgage your house, margin your investment accounts, and go all in on one microcap tech stock. I wouldn’t get that bullish, right? It’s critically important to remain, to maintain a diversified portfolio. Doug, we see this all the time when we look at the data. The average investor, unfortunately, does very poorly when it comes to investing. We have reams of data going all the way back to the early 1980s. The average investor over the past 20 years has, actually about 30 years, actually earned only about 1.9% annually. That’s pretty poor, and the reason why the average investor… By the way, the average is the middle. If the average investor earned 1.9% for the last 30 years, what it means is 50% of the investors earned less than 1.9%. Whereas, if they just stayed in a diversified portfolio, even a 60/40 portfolio — 60/40 is 60% stocks, 40% bonds — they would’ve earned 5.2%. The important point here is, don’t panic. Don’t get emotional. Stay diversified. Keep your portfolio boring. I think Drew said this yesterday. I loved what he said, is that, “Vote at the ballot box, not with your portfolio.” That’s my advice for 2020. Your portfolio should remain boring. It should be globally diversified. It should be aligned with your financial plan. Vote at the ballot box. Number two, and I’ve already said this, stay diversified regardless of how you think about the economy. Regardless of how bullish or bearish you are on who’s going to win the election, maintain a diversified portfolio. This slide here is just showing us two diversified portfolios against the S&P over the past since October of ’07. We’ll see that a 60/40 portfolio, 60% stocks 40% bonds, actually fully recovered from the financial crisis by October of 2010. Basically, it fully recovered within two years. The S&P took longer. It took an additional two years almost, to fully recover. The moral of the story is, stay diversified. Again, don’t vote with your portfolio. Vote at the ballot box. Finally, ignore the noise. There is going, we are constantly bombarded with news that is trying to elicit an emotional response from us. Remember, the media does not sell wisdom. It sells advertising, and you, me, we are the product. Right? They are not there to help us. I’m not saying that the media is our enemy, but just keep in mind that they sell advertising. Their job is to make us emotional. Drew, I was reading Barron’s the other day, and it said there was a claim that 99% of readers make an investment decision after they read Barron’s. I thought, “How tragic that was!” That tells me Barron’s is doing a really good job eliciting emotional responses from their readership. I would encourage us. If you do read Barron’s, please be the one percent. Don’t make a change to your portfolio just because of something you read, something you heard, or something that you saw on television.

 

Doug:

Don, I think we’re down to the Q&A portion of our presentation. Let’s just review what we’ve talked about. If you can give us an overview of where the main message that we want to deliver to clients, where we are right now, and what people should be taking away, before we jump into the Q&A.

 

Don:

I think it’s important to keep in mind. The US economy, markets, they continue to grow over time despite changes in party control. Capitalism works. US financial markets work. It doesn’t mean they’re perfect, but they do work. I would also be careful of drawing these cause and effect conclusions from market history or economy history. People will look back and say, “Darn it! Things were good in the ’90s, when Bill Clinton was president, so I’m going to vote democrat.” Republicans will say the same thing when they wax all nostalgic about Ronald Reagan or whatever. I would just be very careful drawing those very simplistic cause and effect conclusions. Keep in mind that our political ideologies are really directing us to how we want to interpret the data. In terms of next steps, again, don’t panic. Avoid the euphoria. Avoid the paranoia. Stay diversified. Stick to the plan. Ignore the hype. The clients we have worked best with over our more than 35 years of operating history, they are the ones who have ignored what’s happening in politics, stay diversified. They’re the ones who actually succeed and do quite well over time. That’s our message to our clients, is stay diversified, ignore the hype, and vote at the ballot box not with your portfolio.

 

Doug:

Let’s jump into some Q&A, Don. I had this question from a number of listeners talking about the Fed, and the Fed being involved in the markets. What might the Fed’s next move be? The Fed in election years, and also a question about this repo market. Maybe you and Drew can comment on what you’re seeing with the Fed right now, and what’s been happening behind the scenes in terms of monetary policy.

 

Drew:

I’ll start out with that one. The Fed, I think, would like to just disappear. I think they would like to be very quiet, especially in the election year. I think they’re in a very difficult position of, they certainly can’t lower interest rates any more, because then they don’t have much capability should they actually need to in a real economic slowdown. I think they’re just going to be very, very benign this year. The repo question is a very interesting one. There’s three things to think about the repo market. If everybody’s not familiar, there’s been some overnight spikes in the rate of interest. Banks charge each other for lending overnight. It’s a very low-risk loan. It’s secured, but for some reason those rates have spiked and has caused a lot of observers to say, “Is this a signal of a financial imbalance, and something’s wrong with the system?” The three observations are this. Interestingly, if you’re a bank, and you      do a number of repos, it can actually trigger a required increase in your capital, a .5 percentage point increase in your capital, which doesn’t sound like much, but in today’s interest rate environment, a  capital raise like that would be very expensive. The next thing is, banks are required now, by regulation, to hold more cash on reserve at the Fed. That cash that they’re holding decreases the amount of cash in circulation. Cash in circulation, interestingly, is actually down by required regulation. The final is what’s called a leverage ratio, which disturbs low-risk investments or lending on the part of banks. There’s three things that regulators need to address between the Fed, treasuring, FDIC, the powers that be, these three things are presently crippling the repo market during certain time periods, and they’ve got to re-examine this, and hopefully they’ll do so, and that will clear up the repo market. My thinking goes to, the Fed wants to get out of the way of an election year, and this repo thing is a phenomena for regulation.

 

Don:

I agree that the Fed wants to, the Fed is really off the table this year. If the Fed knows what’s good for it politically, they would stay off the table. I don’t think we see big interest rate moves, at least none that are initiated by the Fed, so I would agree with that. Repo market, yeah. That spiked back in September. You could argue that, that was a coming together of some very unique events. Maybe, maybe not. It really happened right before September 15th. There was a massive demand by corporations to pay their estimated taxes for the year. It also came at a time when the US government was sucking a lot of cash out of the market to finance those trillion-dollar deficits. At any given point in time, in theory, the supply of money is fixed. Suddenly corporations needed a whole bunch of money to pay their taxes. US government needed a whole bunch of money to finance its deficit spending, and so you had this coming together of some unique event, but to Drew’s point, the regulators are trying to balance a lot of moving parts there.

 

Doug:

A number of questions on the debt and deficits. What would happen if the national debt exceeds the size of the US economy? What does this mean for the markets going forward? Drew and Don, let’s just talk a little bit about national debt, do a little compare and contrast. Obviously, Japan is the one with the worst national debt ratio in the world, but we still face some issues going forward. How might that affect the capital markets? Let’s start with you, Don.

 

Don:

I don’t think there’s anything magical or dramatic that would happen if the US national debt eclipsed the size of the US economy. The US economy’s about 21 trillion. We have about 23 trillion in debt, so I would argue in technical terms we’ve actually already eclipsed it slightly. There’s nothing magical about crossing the 100% threshold. To me, it’s the direction that is very problematic, in terms of how rapidly it’s growing. You rightly point out that Japan’s debt-to-GDP ratio is well north of 200%, and frankly Japan has done okay. Their financial markets have not been the greatest for the past 30 years, but by and large their economy has done okay. I don’t think there’s anything magical about it. What’s important is getting it under control, dialing it back. The reality is, the US government’s always going to have some debt. We’re never going to be debt-free. You want to be able to manage it. You want it to be something that we can handle in terms of our level of taxation. My concern with respect to the debt and the deficits is, the deficit is the new debt that we accrue in any given year. They are slightly different. The deficit is new debt. The debt is the sum of all the deficits from prior years that we have financed through debt. I think it’s critically important we get it under control. How can it impact markets? The reality is, like I said a moment ago, at any given point in time, in theory, there’s only a certain amount of capital that’s available to be borrowed. If the government shows up and borrows $1 trillion of it, what that means is that’s $1 trillion less for homeowners to borrow, for corporations to borrow, for people to borrow to go to college, things like that. What could happen over time is, we could see a very dramatic increase in interest rates, if we don’t get our debt under control. Drew, anything you want to add to that?

 

Drew:

The other school of thought it similar to what Don was saying, is as the government absorbs more capital, it actually blunts your potential growth rate in the private sector. It’s, according to some economists, that’s one reason why you’re seeing structural growth really struggling to exceed 3% at any one time, because of the distribution of capital between less efficient or less productive means. So much of the deficit is consumed in transfer payments. That’s a thought, there. The other thought is, it also hamstrings the Fed on raising interest rates, because the interest rate service, the debt service would go up so dramatically on such a large base. That also hamstrings the Fed going forward, and the final point is, we’ve been in this debt-to-GDP ratio before, World War II. What’s concerning, and I think what Don’s observations are so correct, is the trajectory of the projection going forward should we not act.

 

Don:

At a very practical level, I would add too, is every dollar that our government spends on item A, let’s say, what it means is they don’t have that dollar available to spend on other things. If we borrow $1 trillion to invest in infrastructure, that’s great if that’s what our citizenry decides, that’s the best way to do. It means it’s not $1 trillion that’s available to invest in healthcare. The point being is that, these are choices that we have to make. I will share that I do get concerned when I hear promises for lots of new spending, new social programs. I’m not judging whether or not we shouldn’t have those new programs. What I’m questioning is, where does the money come from to pay for those programs? If we’re just going to borrow it, to Drew’s point, that’s going to handicap our growth going forward. I do believe that the reason why the US economy is struggling to grow is because the US government is sucking so much capital out of the financial markets.

 

Doug:

Gentlemen, we had a couple of questions here about something that’s in the news right now. That’s the coronavirus and China. Obviously, we have gone through some scares like this in the past. Certainly, I have seen the media extrapolate some very scary numbers going forward. Can we just comment on an event like this and its impact on financial markets and the like? Don?

 

Don:

We have had, first off, it is a very scary development. I think it’s important to keep that in mind, and I think as the environment changes, the environment evolves, these things are going to continue to happen with a high degree of frequency. We had the SARS virus. We had the H1N1 bird flu. We’ve had the Ebola outbreaks. There’s definitely precedent for the rise of these new viruses. It’s interesting, though. The media does love to turn this into a field day. There have now been, I think, about 150 deaths globally, somewhere around that number, due to this new virus. In any given year, there’s about 15 to 20 thousand people who die just during the flu season. It’s, again, I’m not minimizing the deaths from the coronavirus. It’s still very tragic, but it’s important to keep in mind that, the reality is, viruses outbreaks, flu outbreaks, are definitely a reality of the human condition. It’s not going to go away. From an economic perspective, I think there is concern that it could blunt growth until we get it under control. If we’re going to cut back on travel to Asia, there’s tourist dollars that aren’t going to be spent. It’s going to hurt exports or imports from that part of the world. I do think it’s going to have an economic effect. I think long term it’ll just be a blip on the screen, but I do think it could have a short-term economic effect.

 

Drew:

Yeah, Don. The only thing I’d add is the obvious historical parallel recently is the SARS virus. That was 17 years ago, and the difference between then and now is the size of the Chinese economy. That observation got my attention, that if it turns to be a problem there, it still has an economic ramification, but even at that, unless it turns into a very, very serious thing, it should be transitory over time. Financial markets, if you look back at the SARS, they bottomed out and recovered long before the cases actually declined. It bottomed out and corrected as soon as the rate of increase began to decline. We’ll see how this one plays out, but the big difference is the size of the Chinese economy this time around.

 

Doug:

One of the things that we wanted to do, ladies and gentlemen, with today’s webinar is, we wanted to make sure that we ended on time, and be under an hour. We’ve got a few closing comments that we want to make just relative to some other services that we’re providing. Don, if you wouldn’t mind going over and let us talk a little bit about the insights page. If you have not been to merceradvisors.com of late, we certainly want to let you know that there is many resources out there for you to be able to access. This is a picture of our home screen. One of the things that’s on the toolbar of the home screen is our insights page. The insights page is passage into a lot of editorial commentary that we have. This is where we post these webinars, and we’ll be posting this webinar. Certainly, if you came in during, or had to leave early, or couldn’t make it today, the insights page is where you’re going to be able to find the webinar, previous webinars that we have done. This is also where we keep the podcast archives, this is where we are posting all of the current articles. We just recently did some articles on the Secure Act, which is new legislation that was passed by Congress as we transitioned between 2019 and 2020. I’m sure many of your clients, your advisors are going to be talking to you about the Secure Act. It does affect many people who are transitioning into retirement. It does impact people’s estate plans, and this is what, again, I began the webinar with a discussion about the difference between asset management and wealth management. At Mercer Advisors, we are very focused on wealth management. We want to continue to educate our clients. There’s a lot of content specifically for women at the insights page. We would encourage all of our clients to get out there, take a look around, share with your family and friends some of the content that we have delivered, and we believe that this will help you be more informed, more educated about what’s happening in the marketplace, and this also gives you better information and questions to be able to take to your client advisor. The insights page at merceradvisors.com is a resource that I would encourage all clients to be visiting on a regular basis. I also want to mention the Science of Economic Freedom podcast. One of the things that happened as we transitioned between the year is we went a little dark with our podcasts. We are ramping up a number of topics that we’ll be doing on the short term. We have over 60 podcasts that are available. One of the most recent podcasts we did was economic freedom for women. We did a podcast on socially responsible investing. We encourage clients who would like more information, a steady stream of content relative to what we’re thinking and doing, and how we’re helping clients and educating people, the Science of Economic Freedom podcast is another tool for you. Don, Drew, I want to thank both of you for being a part of this webinar today, and ask if you have any closing comments.

 

Don:

Great. Now, thank you, Doug. It’s always a privilege and a pleasure to speak with our clients, and I think my parting words of wisdom hopefully for our clients for this year would be vote at the ballot box not with your portfolio, and stay diversified. With that, thank you very much.

 

Doug:

Drew, any closing comments?

 

Drew:

I don’t recall making that comment about vote with your ballot box not your portfolio, but I’m going to take 100% credit for it and have it trademarked, call it my intellectual property in terms immediately.

 

[Laughter]

 

Doug:

Great, Drew. Ladies and gentlemen, this concludes today’s Mercer Advisors client webinar. Thank you very much for joining us today.

 

 

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