Jose: If you think 10 years back, 10, 15 years ago when Europe debt crisis, when everyone is talking about Europe, it was, oh, the South is terrible, the North is great. I look today and Italian yields are significantly cheaper than the British and the French. Has the story flipped? How did this the southern Europe learn something and is that now flowing through to other countries?
The self-help story.
Christian: Talk about Spain as an example. So, they have had a 3% growth over the last couple of years to maybe 1% in northern Europe. And a lot of it is higher levels of immigration, cheaper energy access, a fairly dynamic economy, and a lot of growth industries, including renewables. So, I think they've been able to kind of pivot their policy and have strong levers of growth where other countries are falling behind, whether it be on immigration, fiscal policy, not having access to cheap energy.
So, there's a bunch of factors, but they kind of all build up together to create some solid foundations for growth.
Jose: Interesting. Interesting.
Alex: So, I would add a couple of things to this discussion because I think it's really easy to look at Europe and say like it's a collection of countries, but they're actually a highly integrated, like we'll call it single economy, where either trade or investments are basically frictionless across borders. And, you know, when Christian you and you're talking about that, that is like global architecture that the U.S. built.
I think one of the most important aspects of it that led to actually interest rates globally coming down was that you basically had free capital market borders where like you could if you were sitting in Japan or you were sitting in Europe and you didn't like the, you know, investment return prospects at home, you could for very, very little costs like negligible cost, go and get that exposure in the U.S. in emerging markets wherever part of the thing when you become more like self-help oriented or as the U.S. is looking to kind of internalize the cost of those capital, borders starts to increase as well.
So now how money flows across the world will start to have meaningful costs, which changes your, you know, your return forecast, if you will. Now, in Europe, we're not seeing that happen within the bloc. Right. So, when you're talking about, for example, the PIGS, you know, starting to do better, the South doing better, that's really coming because the north is starting to ramp up its investment makes a huge difference.
But if I take this trend sort of from a bird's eye view, thinking about the 2010’s where monetary policy was extremely easy or what we call accommodative negative interest rates, you know, QE of every single kind that you can imagine. And for a prolonged period of time, central banks were begging, begging governments to borrow money and invest, but they weren't doing that.
So, you had low growth, low inflation. Now, central banks have ramped up interest rates and say, guys, stop and nobody's stopping. In fact, the taps are just getting turned on more. So, what you realize is that the fiscal side dominates inflation and growth expectations, both positive and negative, in a much more meaningful way than monetary policy does.
Jose: I love that you bring that because I think this or it looks like this is the era of fiscal dominance and in some sense ultimately muscular fiscal policy is really what pretty much every nation is kind of embarking on.
Alex: But I guess the point is that when you look back to the 2010's, what was missing is that governments weren't flexing that fiscal discipline. Yes. So, what you realize is that actually it is fiscal all the time, no matter what monetary policy is doing.
Jose: Is it safe to say that QE and negative interest rates is an experiment that is probably going to be looked at very unfavorably?
Alex: Personally, I don't think so. I think it's a I will call it a tool that could come up at any point in time in the future when it will be needed. Because if you think about even something like yield curve control, it might surprise most people to know that the Fed had already done that. Right. post-World War Two by suppressing real rates, that is how they managed to pay back the mountain of debt and rebuild Europe and rebuild Japan.
And, you know, Marshall Plan, interest rate, the Marshall Plan costs money. But what about the interstate highway system in the U.S. and all the airport infrastructure and all that all that good stuff was made possible because they suppressed real rates that kept them artificially low.
Jose: I kept wondering the same question to like, why wouldn't a government, when rates were so low, just issue billions of dollars of debt for 50 years and lock it in and invest in infrastructure and now.
Alex: They wish they had done that at that time.
Jose: I would assume that was the case, but there was reticence. And are you seeing that shift now where fiscal is really can we like at least for a foreseeable future? It doesn't look like anyone is into monetary policy to drive going forward.
Christian: I think when we're talking about the zero rates and QE, like that's a response to like an extreme economic shock. So we saw the same thing after COVID. So, if we were to have another economic shock, I'm sure those tools would be brought out and I'm sure they'd be quite effective coupled with fiscal policy. So, I'd see that as like CPR for a patient that's under severe duress.
And I think it would come back in that scenario, and it would be extremely effective. Even seen coming out of the COVID shock when we had rates at zero, that was extremely similar for the housing sector and all the industries attached to that. So, and a lot of corporate corporates to refinance. So, it's extremely powerful and just used in specific instances.
Alex: And you know what's fascinating about this, because I think it's also something that we need to keep in mind, especially when we look at the return potential, whether it's in equities or credit within bonds. I've been on a lot of like, you know, meetings and speaking to investors globally about sovereign risk and the more recent past in the last couple of months, especially, you know, given the fiscal muscle that you're talking about that's being flexed globally and everybody is wondering, well, you know, our government bonds, no longer risk free, that they've always been considered the risk free rate because technically they shouldn't default.
They could just print cash and give it back to you.
Jose: Starts right.
Alex: There. It starts right there. Right. That's the implied to every other aspect of you. Right. And what's fascinating is, like policymakers like if you're a chief economist said the central bank today, you're never really going to say what you think or classify things as fair or unfair because you sound a little petulant, but it's funny to hear how ex policymakers are talking about it.
And then one fascinating example is actually from the former chief economist from the ECB, Peter Pryde. He actually, when asked the question about sovereign risk, especially for Germany, given how much money they're spending, he said it's interesting how everybody forgets that in the pandemic and covert governments are the ones that bailed out the corporate sector. So corporate balance sheets look good today because of what we did.
But it has to make you wonder that if push comes to shove, if investors are going to start punishing countries and countries' government bonds, what's going to happen to corporate tax rates? Suddenly we won't be in a race to the bottom on that. Maybe we're going to start inching those back up and you're going to see that as a global theme.
And that's especially the case if this sort of, you know, becoming more self-reliant, you know, the environment that we're in now is actually going to, you know, continue. It wasn't just a 2025 theme. I think you're going to find that investor in Japan that had no alternatives is suddenly not going to be there when there is some kind of sovereign debt crisis in your country.
And you're going to have to figure out how to pay back, you know, the debt. You're saying.
Jose: Full cuts.
Alex: There's going to be painful cuts. They'll be higher taxes.
Christian: But we're kind of seeing that today, I'd say even like for a little bit.
Alex: Little bit.
Christian: But there is a difference between countries that are spending on high multipliers. Let's improve growth like, say, Infrastructure Canada, but definitely Germany. And that's been fairly reacted by positively.
Jose: Versus.
Christian: Versus France, France or, you know, much more so much weaker fiscal situation.
Jose: Yeah, yeah. What do you spend on also matters.
Alex: 100%. Yeah, that's true whether you're government or whether you're a corporation.
Jose: To that question then the wild card in global GDP or particularly at least let's call the US GDP to some degree is the productivity to some degree. What do you guys think about that?
Alex: To me, that's like the plug. It's not always all one equation.
Jose: Yeah, something like.
Alex: That. How do we balance all the two sides of the equation? And if something's missing, we just call that productivity. Yeah. The thing is, it's so hard to measure it that we just call it productivity as if it's something that we can control. And I don't I personally am really skeptical that it is, although I still love to criticize, you know, the Canadian economy and say that it's been the least productive versus all its other peers over the last decade, I have to be honest and like step back and look.
Well, actually, Canada has also had the highest population growth rate over that period versus its developed market peers. And you know what I mean? Like, so when you actually start being honest about how an economy either has grown or has changed over a period of time, what you realize is like productivity is something that we just use as a plug rather than like a measurable, manageable metric.
Christian: Yeah, I like that. I really like that you brought up the population aspect there because the long-term growth equation is just population plus productivity. And I think I'm quite optimistic on the productivity front and I and everything there. But when we look at policies for major economies around the world, the population policy is changing pretty aggressively. Yes, I think one of the biggest changes under the Trump administration has been their immigration policy, where you have substantially less immigrants coming to the country and also a high number of people leaving the country, work permits being canceled.
And even in Canada, we've had a huge step function change in how many immigrants we're taking in and certain European countries as well as well. Yeah, and there's other countries like China or Korea where the population is already just naturally declining because most developed economies have sub replacement birthrates. So, we need that productivity to keep up versus, I think the population side of the equation is not going to be as beneficial as also as historically, because.
Jose: How do you just all of a sudden turn the engines of 1.5 replacement birthrate.
Christian: To 2.1? Yeah.
Jose: How do you just turn that? It doesn't work.
Alex: Robots' productivity. Yeah, yeah, yeah. That's what we're calling. Yeah. I call like uber placement.
Jose
I guess. So, I mean, could you count robots into GDP? No, I'm just saying that.
Alex: Can they consume. Mm. I like.
Jose: The bit.
Christian: Exactly.
Jose: They can take energy.
Alex: So sorry.
Jose: Right. Like I consume an apple but it's energy. Yeah. It's just a form of energy that's going in.
Alex: Healthy calories.
Jose: Organic energy that is healthy. But say a robot I want to plug it into and that is a robot that's potentially a Canadians citizen as well.
Alex: Yes.
Christian: Yeah.
Jose: As interesting and as producing work, let's say that robots are collecting trash, paying income taxes.
Alex: I can't keep up with this other. And but yes.
Jose: Hypothetically, would that count to GDP? That could. Right.
Alex: Like, well, technically, a corporation has like the same type of like rights as individuals in the United States. So, like, why can't a robot.
Jose: Like a robot? Yes, maybe that is the solution for productivity. And we feel like.
Alex: Yeah, we're going to be put out to pasture.
Jose: So, this is another thing that.
Alex: Ecuador is.
Jose: Equity's No, I love it because it took it under so many tangents. Right at the end of the day, there is a big structural change that is going on. I think globally it's pretty evident. A lot of things that were the norm from, let's say, 1980s to 20, like it's almost an investing generation, got used to a certain world.
Jose: Yeah, but that world kind of changed. We are in a different world. So as portfolio managers, how are you thinking about your processes? What is the difference of managing money previously versus today?
Alex: I'll start because I think it's the easiest for me given the big regime shift that we've had in interest rates. The simplest way of thinking about bonds is that there are two sources of return. There's the income return, which is really just the yield on the bond. And then there's the price return, which matters a lot, like if the markets are volatile, if you have a lot of duration on the bond like it's going to be up and down a lot more because income return was very negligible.
Alex: pre-COVID, you basically were a risk manager, right? As a bond, as a bond PM And whereas now we're not in that mindset anymore, we can tolerate more risk just because that income insulates a lot more. So, I would say that's really the big shift that I've noticed among, you know just say bond managers at large pre- and post-COVID
Jose: A nutshell and for you it's a big change.
Christian: Yeah, I think it's a very big change because again, if you think about will be shifting between those quadrants much more rapidly than they were. There are different asset classes that will work in those different regimes. And so, there's a broader set of tools that you need in your asset allocation. I think the portfolio of just a very basic 60/40, all North American equities, all Canadian bonds, good to go, may not be as effective in different regimes, I think including other asset classes.
Christian: Being a little more dynamic is very important to our audience.
Jose: A sense of context. Okay. What is an if 6040 was the Holy Grail pre this, what is how the world shifted in your opinion?
Christian: Yeah, I think it's shifted because it's more likely you'll get regimes now where inflation is higher.
Jose: Which tend to be like today. What is it like. Yeah. 6535 something else with.
Alex: 10% gold.
Jose: Yeah. Well, what does that add to what.
Christian: We've done to diversify our portfolios was odd in commodities, commodities including gold, but the whole swath of commodities, because that's the only thing that will work in periods of high and rising inflation and equities work when inflation's a little bit hot like three. But above that it's not, I think. And then you have interesting commodities, like I think gold's a great example where because we're no longer in the same geopolitical world we were in before, what is your stable source of value?
Christian: What will happen to your reserve assets that you hold if you're a central bank, if maybe you go afoul of a certain government or another, maybe you want to diversify into something like gold because that has historically, for thousands of years been a source of value that people can trust. And so that's why we've seen gold outperform this area.
Christian: Central banks have bought and then other individuals as well. So that's on the commodity side, real assets also have a lot of inflation protection and solid income. So, it could be infrastructure, it could be select real estate. They also have quite low volatility generally as well. But beyond that, see, there's a lot of like liquid alternatives like that are quite attractive hedge funds like strategies that give you low volatility but hopefully high absolute return levels.
Christian: So, it's a kind of bond replacement. And then beyond that to maybe how you structure your portfolio should change. So, this is a great example for Canadian investors. It always made sense to keep your US dollar unhedged on your equity side because it was a natural diversifier.
Jose: I'm going to ask you this question anyway, but let's dive into this. Yeah.
Christian: Yeah. So historically, for at least the prior decade, if you had U.S. equities, but you're a Canadian investor, when you were actually sold off, capital tended to flock into U.S. treasuries, U.S. assets and the U.S. dollar outperformed especially versus Canadian dollar, which is seen as a more risky currency.
Commodity currency. Exactly.
Christian: So that was like natural diversification. Your equities might be down 20%, but your contract is up. So, for an investor, it doesn't look bad. What we saw this year, especially on Liberation Day. Yeah, they both U.S. dollars sold off with equity. So that was a big scare for everyone around the world who's invested in US equities, which is absolutely everyone.
Christian: Hey, maybe we should consider hedging in the future. And we've seen some headlines from Canadian pensions as well, because if it's not going to provide you with that diversification or maybe your domestic currency will do all for its own idiosyncratic reasons, you have to be a little bit more dynamic there. So, the whole currency equation is one that you could have just not paid any attention to for the prior decade.
Christian: But I think now it's quite relevant.
Jose: So, going forward from the currency standpoint, how should investors approach this USD CAD pairing? Because it depends on both countries, you know, we could do a lot of things policy-wise that could make our currency stronger, or they could do stuff that could make there's weak or strong or whichever way. Let's break down. But let's start with Canada.
What could we do to make the CAD? Because it's always been a commodity currency, but let's say we do so.
Christian: The commodity correlations have been kind of nonexistent for the last several years. Yeah, mostly because we're no longer mostly investing in the oil markets. Maybe that's, which is back, right. So, I think that's interesting.
Alex: Or not just oil, right? Like all.
Jose: Online entities. Yeah.
Christian: I think the biggest changes we've seen under the new administration first was Bill C-5. Yeah. Which allowed for the fast tracking of infrastructure projects and centralization of those decisions. And we're supposed to now see a rollout of major infrastructure projects.
Jose: What's the difference between previous posts?
Christian: It would take an extremely long time. And when you talk to some Canadian politicians, they'll say the old administration wanted to get them to no and the current administration wants to get to yes. So, I think that's a big change. A lot of investors, I think, are still skeptical of this change. But to me, it's kind of a 0 to 1 moment.
Christian: A policymaker, before I tell you, I don't really want to do this, and others say I'm going to make it happen. Usually, you want to bet on the side of the policymaker. So, I think it's quite positive for Canada. And if we build a lot of these nation building projects like ports, highways, pipelines, and natural LNG terminals, growth is going to start to pick up because they're going to be a lot of allies.
Jose: And sometimes I feel like we're a nation that is playing poker with aces and then we're just like throwing the cards away like.
Alex: Yes, yeah, I saw. I don't have anything to add to what Kristin said, but fun anecdote for you. So, I've been to the U.S. quite a bit. Yes. You know, business still happens like cross-border. So, I decided to use like a U.S. computer just to ensure that there's no sort of bias or whatever in my line of questioning.
And I asked Chad tweeted, like looking a decade or two out, taking into account things like climate change, which is still very much real and it's creating a ton of problems, like for that self-reliance concept for every single country around the world, economic opportunity, level of education, level of like resources and diversification, etc. like what country is sort of best positioned for that?
Canada came out number one, like, whew, good to be Canadian. But now the problem is like historically we've been probably getting in our own way. And Christian's point like, can we change that?
Jose: Well, equity market is saying that we might be on to something if you think it's a leading indicator.
Christian: But I think that that's even under the radar, in my opinion. Like and if you ask most people on the street with an investment account, if we know that Canada outperformed U.S. this year, most people are not going to guess that.
Jose: I've been telling you that our market has been like a ninja all year and it's the best kept secret. No one, I'm being honest, seems to be talking about it either.
Christian: Yeah, I think the interesting Canadian assets is very low. I always ask like, you know, us researchers they come through or other people in that we talk to and know whether I get apathy, or I like to get laughed out of the room. So, I think the Canada story is still early days.
Jose: This concludes part two of our Q3 market wrap up. If you've found this helpful, make sure to check out part three.
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