NEW YORK FOREIGN PRESS CENTER, 799 UNITED NATIONS PLAZA, 10TH FLOOR (Virtual)
MODERATOR: Welcome, everyone. Good afternoon and welcome to the first of many briefings the New York Foreign Press Center is hosting as part of our Wall Street series. As many of you know, we invite experts, many of whom are chief economists and heads of research at U.S. banks and banking companies, to share their views on the U.S. and the global economy.
First I’d like to introduce today’s briefer and then I’ll go over the ground rules. Today’s briefer is Mr. Barry Bannister. He’s a managing director at Stifel, leading the firm’s equity, macro, and sector strategy research. And over the course of his 30-year career as an equity research analyst Mr. Bannister has been recognized multiple times as the top stock picker and earnings estimator by The Wall Street Journal, Financial Times, Forbes, and StarMine.
Today, Mr. Bannister will provide Stifel’s equity market outlook for 2021 and beyond and review key factors to watch this year, including monetary policy, the economy, trade, and corporate earnings. We appreciate Mr. Bannister for giving his time today for this briefing.
This briefing is on the record. The views expressed by briefers not affiliated with the U.S. Government are their own and don’t necessarily reflect those of the U.S. Government. Participation in Foreign Press Center programming does not imply endorsement, approval, or recommendation of their views. We will post the transcript of this briefing later today on our website, fpc.state.gov. If you publish a story as a result of this briefing, we’d appreciate a copy.
Mr. Bannister has indicated a willingness to take questions throughout his presentation, so from time to time he’ll take a break and ask if anyone has a question. So please don’t hesitate to begin formulating your questions from the onset. If you have a question, you can go to the participant field and virtually raise your hand or you can submit it in writing in the chat box. And as I call on those of you who wish to ask your own question, please remember to unmute yourself.
And with that, I’ll pass it over to Mr. Bannister. Thanks again. Over to you.
MR BANNISTER: Thank you, Daphne. I’m going to share the screen here. You should be able to see the slide deck, and I will go through a few of the key points. We are – we were very positive on the market. We missed the top in COVID back in February of 2020, having been positive before that – the market was very strong – but only about two days before the bottom, on March 19th – the bottom was March 23rd on a Monday – the – we turned very positive. We had a 15 percent in less than six weeks positive view. And we hit it, and then we raised the target again and again and again. And finally by the summer of 2020 we saw a pause in the low 3,000s for the broader S&P 500 index. When the election occurred, I realized that there would be a very good chance of fiscal stimulus to complement the Federal Reserve’s existing monetary stimulus, and we raised our target a full 500 points from around 3,250 to 3,800. It was a six-month target, and we hit it in a period of three months.
So now I’m very cautious. I think around 3,800 – the S&P 500 broader index of the United States large capitalization stocks has reached a plateau, possibly a top, a multi-year top. The only way higher is a bubble. A bubble is a very, very rare thing, only occurring in the last two years of the 1990s and the last two years of the 1920s. That could occur, but at this point we don’t see it.
So let me go through a few key charts that I think you’ll find interesting. First, this chart – and I’m using my pointer – is the broader S&P 500 index, which, as you can see from 2016 to 2018 starting, was very strong. Then there was a sell-off as the Federal Reserve signaled tightening. The Fed eased some of its wording and we had a rally, and then of course the Fed overdid it in the fourth quarter 2018 – massive drop. Chairman Powell of the Fed did what’s called the Powell pivot: He eased policy and stopped the rate hikes that were bleeding and hurting the U.S. stock market and the economy. It was fully offsetting the benefits of the Trump tax cuts.
So the market rallied back, then COVID hit, dropped the most – fastest drop. I believe it was the fastest drop – I can give you the days if you email me – the fastest drop of 20 and 35 percent in history. So it was just a matter of a month. And then of course we turned positive just a couple days before that and we’ve had a very big rally. But as I said, in the summer it’s been going sideways. Recently it broke out as we had raised the target again, but I don’t think it does more than sideways now.
Now, what’s been driving this market is important to the entire world, and that is money supply. So here is a depiction of something called money supply. What is money? Money is demand deposits in checking accounts at banks. It’s currency in circulation. That’s M1. Above that, you have a broader measure of money with savings accounts and small-time deposits or certificates of deposits at a bank or retail money market. And above that, you have things like corporate cash, institutional money funds, Eurodollars, repos with non-banks and very large time deposits.
Thank you, J. Powell – we had a $4,000 billion surge, very unusual surge in the supply of money. As a consequence, we find that if you look at money globally – and this is all countries’ money. This is China’s money. This is Europe’s money, Japan’s money, British money, et cetera. When you convert it into dollars and look at the growth rate of all that broad money, it tends to oscillate. And in the last dozen years it’s now at one of the highest levels.
The market likes excess money. Money that’s in excess goes into financial assets, not the economy, and that’s what we’ve been doing. The problem is we are now at 20 percent and it looks like we’re topping on money growth. And the market cares about the growth, not the level – the growth of things like liquidity in money. So if money slows, typically the market slows. You see an average gain since the financial crisis of 2007-8 of 3 percent a year. Not a very good market. So that’s one of our reasons for thinking there’s a top.
The other is COVID is still with us. It’s seasonal. It’s endemic. Virus efficacy and uptake is – for a vaccine is extremely important. Fear by nature tends to come on fast and dissipate slowly. We become afraid quickly and less afraid slowly. And so we don’t know yet if this is going to come back seasonally next summer and then the following winter – and the final stragglers go ahead and take the vaccine. But this is a big surge, and I think that’s had an effect on psychology.
And in a historic sense, if you do what’s called a population adjustment, meaning you gross up the deaths by the growth in the American population since the time of the pandemic, the socalled 1918-19 flu pandemic was about 2 million people in today’s terms. COVID’s about 421,000 Americans. It’s already above the Asian flu of ’57-’58, the Hong Kong flu in ’68-’69, and of course much bigger than the 2009-10 swine flu that Obama faced with Biden. So the problem with this is that unlike a flu, it tends to last more than a season. It could come back over and over. And because of that we have a great deal of market volatility related to perceptions of the virus.
If you look at earnings after we have something called yield curve inversion, which is when the short-term rates rise above long-term rates, it’s very unusual for earnings to grow very strongly, not just a year after but two and a half years after you invert the curve. So indexing earnings at every recession since 1969 – we looked at the earnings after that curve inversion first occurred on a 50-day average – and you find that about nine months, eight months after the inversion, which most recently was June 2019 – June 20th – that the earnings are fine, as they were through February of 2020. Unbeknownst to us, the market saw this virus coming in a sense. It saw the recession coming because the yield curve always predicts recession if you look at the 50-day average. And sure enough, earnings fell in 2020.
Now, the – our estimate of recovery is towards the high end of history. Other recoveries from recessions didn’t go that fast, but the street – meaning Wall Street consensus, the average of other analysts – is up 37 percent this year. I do not think that’s possible. We think 17 percent. And until the street comes down closer to our estimate, we think that the fall in the pricetoearnings ratio offsets the rise of earnings and you level out the market.
This is a complicated chart, and let me just say real quickly that by pressing down on what’s called the real yield, or the 10-year yield after inflation since Powell pivoted, as I referenced earlier, back in January 2019 and realized that the rate hike regimen had been too much, too soon, the price-to-earnings multiple responds to cheap money and is effectively doubled. And that’s very good for growth stocks, but it puts you in a very precarious position.
Any nuanced change, anything, one word out of the fed that seems misplaced or isn’t quite right, the market reacts very negatively because it’s at a very high valuation. How high? Well, let me show you a few charts real quick.
We use something called a modified CAPE. Dr. Shiller at Yale does this thing called the CAPE ratio he invented. It’s the Cyclically-averaged or Adjusted Price-to-Earnings Ratio. It’s the ratio of price to earnings. Imagine you have a stock with a hundred-dollar price, five dollars of earnings per share. That’s – 100 over 5 is what, a 20 multiple of earnings. And because CAPE looks at a 10-year average of inflation-adjusted earnings, it normalizes earnings power over a full cycle.
So for the last 10 years since 2011, in today’s money terms, inflation adjusted, the earnings of the market have been 125. Interestingly, that’s close to 2020 earnings, way below 2019 pre-pandemic. So dividing the current price by the average earnings, we find the multiple of the market is 31 times, very high.
Now, let’s look at that CAPE ratio, that PE on trailing 10-year earnings over 100 years monthly since 1920. This is a century since 1920. It follows a trend. It’s called a – or an exponential trend. But where we are today, the valuation in this moment, is where we were in 1998 or 1966 or 1936 or the late 1928 timeframe, mid ’28. Now, that ’28-29 was a bubble, it burst. Thirty-six was a policy error, fed tightening plus fiscal policy tightening, and we fell hard.
Sixty-six is probably more similar to today. You have what’s called guns and butter. You have a war against climate change; you have a war against the virus, very expensive; and you also have a lot of social spending, social programs. We had the same thing with the Vietnam War and Lyndon Johnson’s Great Society in the 1960s. So in effect, I think it’s very similar in that we’re looking at a top. Now, we could have a bubble like 1998, ’99, but you all remember how painful 2000, 2001, ’02 was. You don’t want a bubble unless you’re smart and get out at the very top because very quickly, you give it all back. It’s highly disruptive and I do not think – and I do not think the fed wants that. So you’ll see Chairman Powell probably make some comments about excessive excitement on Wall Street.
Another way – this just shows what I was saying before. There’s your bubbles and there’s your tops. Now, another way to think of it is stocks versus commodities. So if I have a commodity index – let’s just make up a number – it is 380 and the stock market is 3,800, then 300 – 3,800 stock market divided by a $380 commodity index is 10. So what we did is we showed that since 1910 – this is stocks relative to commodities – it’s simply paper assets versus hard assets following this cycle.
Now, back in 2000, I made a call that we would have a 15-year commodities cycle, and you can see a screen shot of the report, and it was a good report. I mean, oil went from 11 to 145. The S&P was flat, as we expected, during that entire period. The problem is we are back to one of those highs. We are at a stock commodity ratio that is as high as we were at all prior periods. The only way higher, as I say, is a bubble like 1928, ’29, or a bubble like 1998, ’99. You’re picking – cherry-picking four years out of 110 years if you’re buying stocks. This is a stock market that is topping out unless you have a bubble, and bubbles only happened four years of the last 110. So it’s very hard to make a bull case on being an index investor in the U.S. large cap stock market. You can see here those bubble tops as I referred to with arrows.
Now, the market – I’m going to pause here and see if there’s any questions just on the broader market, and Daphne is the moderator, and then I’ll come back to this slide, which is another section.
MODERATOR: So journalists who have questions are welcome to raise their hands in the participant fields or to write your question in the chat box, and I will call on you.
MODERATOR: I think that maybe folks are waiting for you to finish your presentation before they have —
MR BANNISTER: Okay.
MODERATOR: Actually, I take that back, as Manik Mehta has a question. Manik, if you’re on the line, please unmute yourself and then go ahead.
MR BANNISTER: Probably muted still.
MODERATOR: You know what? We’ll come back to Manik. I see there is another question.
MR BANNISTER: Zhihang Du.
MODERATOR: Ms. Du, go ahead.
QUESTION: Hi, this is Zhihang from Caixin from China, and concerning the surge of GameStop and AMC today, do you think that’s a bubble? And would that affect the performance of the market in the next few months?
MR BANNISTER: Yes, well, clearly what has happened is we have seen the Federal Reserve, as I say, inject $4,000 billion. This is quite a bit of money. We have a $21 trillion economy, so $4,000 billion is a lot of money.
When you have people who are idle, perhaps getting paid government-subsidized unemployment insurance and sitting on excessive liquidity because their social life has been condensed, they take up stock investing, particularly with sports investing, sports betting under pressure. So yes, I would say we have a manic market with retail investors who have time on their hands and plenty of cash, and that can drive very short-term pops in the market.
I don’t think it’s the basis, as you ask, about a long-term bubble. We know what those look like. These bubbles that lasted from the summer of ’97 to December of ’99 or from the summer of 1928 to the summer of ’29, they tend to have more, shall we say, broader institutional appeal and more people with very big money believe in them. So this is more of a sign of speculation than it is a sign of an impending bubble.
QUESTION: Thank you.
MODERATOR: And there is another question coming in from Weier. Weier, please, go ahead.
QUESTION: Yes, can you hear me?
MR BANNISTER: I do.
MODERATOR: Yes, we can.
QUESTION: Yeah. I had a follow-up question on the – in terms of the GameStop and AMC Entertainment, their recent surge. We’ve been seeing since this pandemic a surge of retail trading from, like – platforms like RobinHood. Do you think this will change the landscape of the total – like, the U.S. equity market if, like, we are going to see more and more retailer tradings as a important participant of this market and how this will change the way that – the market performance when we’re getting out of this pandemic? Thank you.
MR BANNISTER: Yes, I touched on that with – on the prior question. I mean, if you look at AMC, that was more a case of they obtained financing to avoid bankruptcy, so a highly leveraged enterprise bounced up because of that, and U.S. movie theater attendance is very weak.
The GameStop is the retail market, and yes it’s true that small amounts of money over many, many people is a lot of money, and so there can be a battle in there, plus you have the average time that people own stocks in the United States, including electronic trading, is less than a minute. So this is not the basis of investing. It’s just the basis of short-term speculation, which increases volatility. Volatility has a cost, as does ignoring fundamentals. When you buy a stock, it’s not just a piece of paper; it’s a shared ownership of a company, and everything has its price but sometimes you find irrational buyers who pay more.
History is littered, as you can see, and if you study history as I have, the late 1990s where I was there – I was an analyst for, by that time, almost 20 years. It was a bit of a manic market, but the stocks that went up, such as AOL, Cisco, Dell, Nortel, and WorldCom, most of those are gone now. Think of it. Worldcom is gone. AOL, gone. Nortel, gone. Dell went private and then parts of it went public. So yes, it’s pure out speculative behavior. It’s fun when it makes money. It’ll be devastating to people when they lose money. But it does have an effect on the overall market, and I’m aware of it.
QUESTION: Do you think their regulators will step in – up if things getting more and more severe? And if you would compare this to the tech bubble in 1999, what are they in in common and what has been changed? Thank you.
MR BANNISTER: Well, the late-1990s bubble did get to the point where you had companies that essentially had no product at all, and they came public with just an idea and put “dot com” on the end of the name and made a lot of money until it burst, and then they went out of business. The equivalent today would probably be some of these specs. These are companies floated purely with cash on the balance sheet for the purpose of taking over as yet unknown private companies, and Bitcoin, which is – it has some validity but it also has some major usage drawbacks, and not least of which is that government would not surrender its monetary monopoly without a severe fight.
So I think that what you’re seeing more is a pure out speculative hysteria caused by excessive liquidity on a global basis and a far-too-idle population that’s not working because of pandemic fear and lockdowns. These things pass.
QUESTION: Thank you.
MR BANNISTER: Now —
MODERATOR: Mr. —
MR BANNISTER: Yeah.
MODERATOR: We have two questions in the chatroom. Would you be willing to answer those before going forward?
MR BANNISTER: Sure.
MODERATOR: Okay. I apologize for interrupting you.
MR BANNISTER: Oh, no problem.
MODERATOR: So this is one question coming in from Manik Mehta. He’s a syndicated journalist in Southeast Asia. The question is: “The government has been sending stimulus checks to invigorate consumer spending. However, commodity prices have risen by a huge margin. Inflationary trends are rising. Where do you think this is going to lead? Also, do you think that the Biden administration should withdraw the steel tariffs imposed by the previous administration?”
MR BANNISTER: I can’t speak to the last question of steel particularly. I know that the tariff usage by the U.S. was a negotiating tactic. There are pluses and minuses on tariffs. It is a tax, but it does force consumers to buy more domestic goods, albeit sometimes less quantity at a higher price. But it’s a question of where you concentrate the domestic income, and I do think that Biden’s Buy America program will lead to a continuation of a fairly aggressive U.S. first trade policy. And that’s because to win elections, you need to be a populist, and you can’t be a populist if you’re purely a globalist. So American politics has become what we call populist.
Now, why does that matter? You asked about commodities. I want to stress that as I showed here that stocks versus commodities are very high, so if you’re buying paper assets and ignoring oil and copper and nickel and gold, it might be a mistake. It was a mistake here, here, here, here, and maybe here.
So let me go back and show you an interesting chart, if I may. What we know about commodity prices, and I think it’s really interesting – you’re going to like this – we have a lot of history. Okay. So this is commodities since the year 1795, around the time of the American Revolution. And what I show is the growth rate. So it’s the growth rate of commodity prices on the index. So the index could grow. Double in 10 years is a 7.2 percent growth rate, just mathematically. So you can see that commodities grow, fall, grow, fall, grow, fall, and it usually bottoms with what is a depression. So we had our first depression and there we had our second depression, then the Great Depression, and I would classify what we’ve been in since the global financial crisis as a depression-like scenario.
But those depressions, as you just asked about trade policy, lead to what’s called populism. We had Jacksonian democracy populism, Progressive Era populism, New Deal populism, and now we have populism in its current form. When you have populism, it typically within a generation leads to global strife. So we had Napoleonic Wars and the War of 1812, the U.S. Civil War, World War I, World War II, the Cold War, the rise of China, the global financial crisis, and something is coming around 2030 to 2040.
So that’s our sequence of events. We just have to live within this framework, and we do think commodities are bottoming. Why does this matter? Well, if you look at commodities’ bottom, if that’s your thesis, if you think that’s going to happen, then check out this page. This is our commodity price chart, and this is value versus growth. What is value? What is growth? Well, I’ll tell you what it is. The red line typically goes up if commodities go up from these extraordinarily low levels. It would go – lean you towards these groups – financial stocks, industrial companies, utilities, basic materials, energy, real estate. Because that’s the stocks that are in the value category, and they have been under pressure, as we showed earlier. On the other hand, growth is all technology, a lot of the internet names, and the retailers like Amazon and Tesla and autos.
So you can keep buying these, which are highly elevated, unusually so, or you can start to hunt for value in the blue. The problem with long-term market returns is that it requires patience and it requires selectivity. To answer the earlier questions, GameStop and AMC and Reddit, the issue is the light that shines twice as brightly burns half as long. We’re going to find that people are going to lose money, and they’re going to get wiped out, and they won’t be back. So hopefully they’ll learn from that, but I think it’s an important lesson for all time that we should consider that.
Now, there’s only one other point I wanted to make, and I think it’s a really relevant point, is you asked about commodity prices. I’m not going to belabor and spend a lot of time on this because I think it’s too much. I mean, there’s the dollar angle and what it means for growth stocks if the dollar weakens. But what I wanted to show you, and I think you’ll find this interesting – and again, I don’t know. You may not be interested in anything beyond five minutes ago, the quote on a stock, or maybe you have an interest in what drives the market. But I think this is fascinating.
Okay, here’s our commodity prices, which are our North Star; they’re our guidepost for a lot of events. Currencies can be manipulated by governments. The U.S. has done it, China’s done it, everyone does it. Inflation measures can be lies, but commodities never lie and they tend to be priced at whatever the price it would require to get a producer to give it to you. So we have commodity prices here since 1760, a quarter of a thousand years, a quarter of a millennium. Every month – so there’s your peaks. Again, usually around some conflict. Even November ’56 with the Suez crisis; or November 1980, the peak of the Cold War when Reagan beat Carter in the U.S. presidential election; or the rise of China, which the growth rate peaked in June of ’08.
If you look at these seven cycles and convert it to a growth rate, you find that in the 10 years leading up to the peak – these are the peaks – the 10 years leading up to the peak is bullish growth rate, the 10 years after is a bust, five years’ consolidation, and then a new cycle starts. We have been in consolidation mode for four years. So commodities should be rising about now, and indeed they are. So if you normalize that cycle with something called volatility adjustment, you see the green cycle now versus the average R-squared weighted of all past cycles for 200-plus years, and we are bottoming.
If commodities bottom – once again, that’s our forecast – then we’re going to find things like the 10-year yield is going to rise. We’re going to find things like value stocks are going to rise. Pardon me.
And so value is where to go. I know that the latest fad and fashion is exciting for print, but it’s better now to be cautious, and in fact, as I said – I don’t think I mentioned this, but I wrote a note today – I’ll send it to you if you email me directly. My email is on the cover page. So if you click that name right there, I can send it to you. But we did a report today, we had said – last night, actually, was the report; it was published last night, the market’s down now – we said the market was going to go down. And we said it would have a correction in the first quarter. We said that the way to preserve your money would be to be in purely defensive stocks – utilities, real – consumer staples like food, electric utilities, health care stocks, and – like Abbott Laboratories – or telephone companies, like Verizon. Pure defensive stocks, because they are at one of only four lows, relative to the market, four times in 70 years. And every time they reach this level, we had a bear market. In 70 years, four times.
So it’s very – this is a very important time to be cautious, and that’s what this note was about. And I can send it to you if you click that email and ask me for it. But that’s generally our conclusion right now.
If you’ll allow me a moment about the political situation in the U.S., because that’s obviously important, Biden has proposed a tremendous amount of spending. I do not think he will succeed in getting very much of that, but we will definitely spend a little more than we should. So then that brings the question of what happens when a country spends a lot of money on debt.
So this is the debt of the entire United States – the government sector, the business sector, and the household sector – as a percentage of the economy since 1962. There was a big wave in the ’80s and to the ’90s, another big wave in the household sector, and now we have this government wave. This is how much nominal GDP you get from $1 of added debt. So back in the early ’60s, the John Kennedy era, you had 80 cents of GDP per dollar. The next wave you add 50 cents. The next wave, 30 cents. The next wave will be 20. And by 2035, you’re looking at default. You’re looking at inflation as a choice to ameliorate a debt problem.
It is approximately the same time that the Baby Boomers – my generation, which was born at a peak year, 1958 – reach 80 years old and half of them are dead and half are dying. So when the Baby Boomers fade from the scene, the U.S. will have so much debt that it generates no return on the economy, and they’ll have to choose not to actually default – that’s not what countries do – but there’ll be a huge amount of global inflation. Which is why Bitcoin, one of the reasons it’s been up, which is why gold is up.
So that’s what you’re left with, and that’s really all that we have to look forward to over the next 20 years if you’re an investor. That, and fairly weak market returns. Our models are very good, and they forecast better at 10-year forward than in 10 days forward, obviously. But we have some very good indicators that indicate that the S&P 500 large capitalization stock market index return is only going to be about 3, maybe 4 percent per year, including 2 percent from dividends, the next 10 years. That compares to about 16 percent a year for the 10 years ended 2020. So imagine lowering your returns by a factor of four.
That is the future. And we feel very confident in it. So what we as investors have to do is pick the winners. If you thought commodities were going to rise, you thought that we would get economic growth, plus some Biden spending, plus Fed easing would help, then what you would buy, as I said before, is the value – the financials, the energy, the industrials, the basic materials. Because relative to growth stocks in the last four years, they fell 50 percent, and they look like they’re making a third try. First try failed, second try failed, third try – that’s maybe the magic one. So if we get that, we rally.
So at this point, I’ll just take questions. And some of them may or may not be slide-addressable, but I can do it verbally.
MODERATOR: There’s another question coming in from Jimmy Liu. I believe he works for Xinhua press – Xinhua Media. The question is: “Hi. What are the prospects of growth rotation out of the U.S. in 2021? Which markets could be beneficiaries?”
MR BANNISTER: That’s a great question, Ken. The growth rotation, the rotation out of growth into what’s called value, typically means international as well as small capitalization. So international value is exciting, and China is an exciting market. Singapore is exciting. I think Korea long-term is very exciting. Asia, developed Asia is – or developing Asia is a very interesting investment because they have reasonable valuations in many cases, and good prospects for returns to rise. If commodities rise, obviously Latin America and Africa, you would find money opportunities there, but the markets are less developed.
But yes, I – personally, I’m – I own EM*Asia funds, and they’ve done extraordinarily well recently. I have commodity-sensitive holdings, and I have U.S. financial holdings based on more of a value call. I’m trying to get back into energy, but the alternative energy is expensive, and the conventional energy is cheap, and it’s hard to separate the two at the index level.
MODERATOR: Okay. We’ll go to the next question. It’s coming in from Ken Moriyasu of NIKKEI. Ken, can you unmute yourself and ask your question?
QUESTION: Yes, hello. Can you hear me?
MODERATOR: Yes, we can.
QUESTION: (Inaudible.) I was very interested, sir, about the relationship with war. You said that the commodity – I think it’s on page 31 and 32 – the situation of the commodities indicates a coming war, and you said the next conflict or something could be between 2030 and 2040. Could you tell us a little bit more about how that works? And also, with the Biden administration coming in, are you watching any hotspots, like Taiwan for instance? Is Wall Street looking at that based on these charts? Thank you.
MR BANNISTER: Yeah. I mean, to a degree there’s a certain amount of repetitious behavior. It’s beyond any horizon where I would make a recommendation now, because we’re talking about something that if it happens, it probably doesn’t happen for another 10 to 20 years. But it’s always a long march into these things, and we have deglobalization, we have great powers rivalry, we have conflicting interests, we see a great many problems around the world. And I don’t know if you’ve ever heard of a Kondratiev wave, around a 55-year cycle, but it’s interesting that the growth peaks for commodities – which occurred in 1813, 1864, 1920, 1980, and potentially around 2035, 2040 – they all created – they were all at conflict highs. So it could be a conflict; it doesn’t necessarily have to be hot. And hopefully it won’t happen.
But countries, when they turn inward, tend to become rivals, and I would say there’s been an inward move. China’s often called the hermit kingdom. The – when they burned their large boats 600 years ago, they gave up on the hope to be a global factor, and they just really focused inwards. So they tend to take care of their own interests and they tend not to do that outward focus.
So when I look at it, there’s that issue. But I also think that this war on climate change is going to prove to be enormously expensive, because the energy is by definition duplicated – meaning if I have a wind farm, I have to back it up with conventional energy if the wind stops blowing. And by duplicating that capacity, the capital cost as capital charges rise – we’re at cheap capital now, but it won’t always be that way. But duplicating energy sources is going to prove to be extraordinarily expensive. And so we’re going to have the kind of inflation you have in a war by fighting a war on climate. So that’s another factor, and probably a little more likely since that seems to be policy.
QUESTION: Thank you very much.
MODERATOR: I’m going to read another question that’s in the chat room. It comes in from Ines Zoettl, Capital Magazine of Germany. She’s asking, “What do you think of BlackRock’s climate policy? And what do you think about Biden’s pick of Gary Gensler as SEC chairman?”
MR BANNISTER: I never really understood BlackRock getting so heavily involved in policy decisions. Maybe their chairman has political aspirations; I don’t know. But it does not seem to me that that’s the duty of investors. Investors’ duty is not to make policy but rather to anticipate and react to it. If you can’t anticipate, react. But at the very least, I don’t understand why they’re involved in that.
And as far as you said Biden’s choice of what? I’m sorry, Daphne.
MODERATOR: Gary Gensler for SEC Chairman.
MR BANNISTER: Mr. Gensler is fine. He – I have watched several Democratic and Republican administrations come through over the years, and I think he’s a very reasonable man. I think some of the horror stories that have been told about him are not fair. He just wants a functioning, safe market. And I think he’s just fine. I think he’s a good person.
MODERATOR: So I don’t see any more questions. I know that we had paused your presentation. If we wanted to go back to it or are we – perhaps we’re almost at the end anyway.
MR BANNISTER: Ms. Du has a question.
MODERATOR: Oh, I apologize for that. Go ahead.
QUESTION: Thank you. Thank you very much. I have a follow-up question on China concerning the legacy of the Trump. So you might know that Trump has banned people to own Chinese military-related companies’ stock in the U.S. and that has kicked off a process to de-list Chinese companies in the U.S. stock market. And on the other hand, the Congress has just passed a bill to ask Chinese companies list in the U.S. market to comply with the auditing requirements of the U.S., and if they don’t, they will be de-listed too. So judging from those policy from the Trump administration and the potential more populist-leaning policy from the Biden administration, how would you see the U.S.-China decoupling in the field of stock markets specifically? Thank you.
MR BANNISTER: Well, Mr. Trump has left office, and I think Mr. Biden and Mr. Gensler are not terribly interested in a hostile policy for the purpose of political purposes. I think that their policies are shaped more by practical considerations. The congressional act is practical to do an audit properly. And my undergraduate majors were accounting and finance – two of them – and the master’s was in finance, but I never really forgot the accounting, right? Accounting. I know what auditing is like. I know all about it. And to do a proper audit you need full access. Their can’t be a closed room. So I think that the lack of ability to have a full audit that meets U.S. standards is going to definitely stick, and it will affect cross-border investment in that way for sure.
QUESTION: Thank you.
MODERATOR: I see the next question is from Kanwal Abidi. Please, go ahead and unmute yourself.
MR BANNISTER: Kanwal might be muted.
MODERATOR: We’re having a hard time hearing you. Can you try asking again? Or Kanwal, you might want to type your question into the chat room as we cannot hear you, and I’d be happy to read it.
MR BANNISTER: Let me say this also with our participants: That report that came out last night or yesterday, you can use any of the charts you’d like if you want to just clip them out and use them or direct quotes from the report. Just cut them and paste them and use them. So I think you’ll find that report, better than this one, to be very punchy, very quick, very understandable. It’s just one point after another, and it talks about why we saw some downside in the market. I don’t know that the downside is going to continue every minute of the day, but we are down 80 – 93 points on the U.S. S&P 500, 2.44 percent just today. So the timing of the note was good and it’s certainly a timely note, so if you would like a copy of that, you can use anything in you’d like. Please feel free to email that address on the cover and I will answer right away.
MODERATOR: Great. I think Kanwal was asking a question: “In your opinion, what will happen to NAFTA, which was converted into USMCA?”
MR BANNISTER: Well, NAFTA 2, or USMCA, it’s really was just a modification of the existing agreement. I will give kudos to the administration. I thought they did a very good job of getting the deal done. If you look at the CAFTA, which preceded NAFTA, it took seven years from CAFTA to NAFTA. To get the entire deal done was seven years. Trump did do it in a year, so that is Herculean. That’s a great achievement. But there weren’t any really major changes.
I thought that Biden’s shutting down of the Keystone Pipeline was a huge negative. He not only slapped in the face the middle of the country that really needed that cheap oil and gasoline for their standard of living, but also Canada, our closest, nearest ally, very much their part of the Midwest which is called Alberta and central part of Canada. They very much needed that pipeline for the oil sands to produce oil and ship it to a market. So for that not to have gone forward I thought was a diplomatic faux pas, and they did it anyway.
So I hope the relationship is good. I don’t think there’s been quite enough disappointment expressed out of Ottawa, but I don’t think their prime minister stands up for the interests of the people of Alberta.
MODERATOR: The next question will go to Gerben. Gerben, please unmute yourself and identify your outlet, please.
QUESTION: Yes, the Dutch Financial Daily in the Netherlands. Mr. Bannister, I have a question. There has been a lot of warnings lately, also from you. Today, the IMF, Jeremy Granthem’s taken (inaudible) for the fact that the financial markets are out of touch from the real economy. I think you just mentioned that you would expect from Mr. Powell a warning, like an irrational exuberance warning like the one of Greenspan in the end of the ’90s. Well, is a stock market correction something that we should be worried about? If you look at what – how much – well, if you look at the increase in the market, is that something that actually could come back and hurt the real economy, or is that – would that be like a healthy correction? And if so, if that happens, while the Federal Reserve might warn, but what weapons do – does the financial reserve have to actually stall the drop in the stock markets? So what is left in the instrumentarium?
MR BANNISTER: Yeah, the page I had referenced earlier I thought was interesting, on 10, just shows quite clearly that if you look at the – what’s called the real yield, the yield after inflation, which has a very big bearing on valuation – remember, your real risk-free return is negative in the United States. It’s -1 after inflation the next 10 years in U.S. treasuries. And as a consequence of being negative, you are pushed into risk, which is stocks, and that pushes up your valuation, your price-to-earnings ratio.
So as the Fed under Bernanke – QE1, 2, and 3 drove down the real yield, they found that they couldn’t keep it down there and it bounced back up to a little more normal level, and when that happened, the Fed’s policy setting, which is more – it’s unable to keep that rate down – caused PEs to fall. So since Powell went dovish in January 2019, the real yield – the 10-year yield of Treasury paper after inflation – has gone from positive 1-1 to minus 1-1, and the price-to-earnings ratio duly went from 17 times to 29 and a half times so that any correction would just be, I think, a healthy shakeout realizing that – I don’t know if you’ve ever been to a beach, but if you hold a beachball under water, you can only do it so long before it bursts up. And I think the Fed repression of real yields is the beachball under the water. So there would be a little uptick in the real yield and a downtick in price-to-earnings multiples – completely healthy.
So that – that was part of our call today or yesterday when we called a top in the first quarter, and so it’s doing that now. What was the other part of the question, Daphne?
MODERATOR: The other part of the question came from Kanwal Abidi, and he’s asking, “In one of the slides, there is a rise after World War” – he doesn’t specify – “there is – there is the rise of China. My question is: After the global financial crisis and COVID, what are you seeing rise now?”
MR BANNISTER: Yeah, I mentioned that. The war on – the war on climate is going to be – I think will prove very, very, very expensive. If you look at energy production, it’s an economy-of-scale business. So I have to drill quite a bit of wells and produce quite a bit of oil to cover my fixed costs. The other is refining. If you need gasoline or diesel or jet fuel or bunker fuel, what you find is that you can’t economically run a refinery if electric cars destroyed all the demand for gasoline or diesel or petrol. So the cost per unit has to go up if you take away that base demand.
So I am – I am concerned that the dollar could fall and the price of commodities rise based on that very expensive war on the climate policies combined with the geopolitical tensions we referenced earlier. I don’t think China has any designs on Hong – or on Taiwan explicitly. I think that’s just alarmism, but I do think that realistically it’s a fraught relationship. It’s a difficult relationship with the rest of the West. And it’ll be interesting to see how that and Russia play out over the years, but I think it’ll be very expensive for both sides with defense spending and whatnot.
And again, the decline of the globalization – the decline of the globalization as a percentage of the total world, of world trade, the decline is not necessarily good for growth. It’s difficult. It makes growth harder to come by. It tends to raise prices and cause inflation. So when you look at all the factors that are coming, that’s why we included that section; there is a certain inevitability to these cycles. I don’t know how you get out of it. One quarter of a millennium – a thousand years – of cycles that look like the same picture, that’s a lot to be said.
And so we feel like commodities are bottoming now. They’ll slowly rise the next 10 years, and then in the next decade into the ’30s they’ll go very, very sharply up as they had in all past cycles. So the ’20s gets you started. The ’30s takes you to the top. And that’s how we look at the commodity, the inflation. The price-to-earnings multiple would fall. The interest rates would rise – the yields, I mean, on the bonds. It’s going to be a very challenging market for investors. That’s why we’ve done so much work on sectors and industries.
MODERATOR: It looks like we have another question coming in from Jimmy. Jimmy, do you want to ask your question yourself this time?
QUESTION: Yes, just a quick question. How much do – do you expect the correction will – will have? Could we have a more than 10 percent correction (inaudible)?
MR BANNISTER: I think five is very easy. Ten percent is also very easy. A lot of news flow will depend – for example, the economic growth seems to be moderating. And what we find in these periods where the defensive stocks – these are consumer staples like food companies and tobacco companies, the healthcare companies like drug companies and hospital supply, the utilities like electric utilities, and the telephone companies – that when they’re cheap versus the market, which they are now – only four times relative to the market have they hit this level on a trend basis – that when that occurs it’s typically been a recession or a double dip.
So the risk is what would cause a double dip. The Fed doesn’t want to make a misstep. You could have delays on fiscal policy. You could have a resurgence of the B117 virus mutation. You could have a failed vaccine. I know the world is counting on the Johnson & Johnson vaccine working, so we very much need that one because it’s cheaper to make and easier to distribute. So all kinds of things could happen.
And it’s – the problem with an elevated market – a market with the Reddits and the GameStops – the problem with an elevated market is it’s like standing on top of a ladder. All that has to happen is for the wind to blow, and you’ll beak your leg. And that’s where we are today.
MODERATOR: Are there any final, more questions?
MR BANNISTER: All right. Well, before you go, please email me for that copy of that report from yesterday. I thought it was very timely, and it’s also very readable, very interesting. So you can use that one any way you want. I think you’ll enjoy it.
MODERATOR: I’m also happy to get it from you and share it with the journalists who participated today, Mr. Bannister.
MR BANNISTER: I’ll send it to you.
MODERATOR: Perfect. I’ll do that then. And I think that concludes today’s briefing. I want to thank you so much for your time. Really appreciate it and all of the information you’ve shared with us today. As I had mentioned at the head of this briefing, this was the first of several briefings in this Wall Street series that we have planned over the next few weeks, so stay tuned for invitations to other briefings.
Today’s briefing was on the record, and I will share the transcript with those who participated today. And of course it’ll be posted on our website at fpc.state.gov as soon as it’s available. And with that, I hope everyone has a good afternoon and thank you again. Bye-bye.