Tim

Hello and welcome to the RBC Global Asset Management’s Navigator podcast. My name is Tim Leary and I'm a senior portfolio manager with the blue Bay Fixed Income team at RBC Global Asset Management. It's my pleasure to be joined to be joined today by Frances Donald, chief economist with RBC. On today's episode of The Navigator, we're going to discuss the current thinking around markets, sentiment, volatility, inflation, growth and what we might see going forward.

Forecasting is tricky under normal circumstances. Where do you start?

Frances

Where do you start? You know, you say it's been 100 days. I think I've done enough work to fill four years already. And largely that's because we aren't just generating one forecast or three forecasts, which is what we might have done historically. We are consistently generating a whole slew of scenarios of possible outcomes and then adjusting them, sometimes on the fly.

So, Tim, you mentioned it's April 29th. It's 3:16 p.m. eastern time. My time. And I feel the need to say this because the live scenario in play could change. An hour from now. We just, for example, saw headline, that one trade deal was revealed, but we don't know which one it is. So, the answer to how do you do forecasting?

Well, I've long been a believer that forecasts are not particularly useful. And to look at the balance of risks and scenarios. Well, we've had to do that pretty aggressively, going forward. So, you know, if you're familiar with our current forecasts and we do forecast updates every month, we don't technically have a true recession in our outlook.

And when I think about the balance of risks around this forecast, they're probably skewed to the downside. One of the things that goes into forecasting isn't just what you know, but it's what you realize you can't model. And there's a difference between assumptions. Assumptions are things like how much we bake in of currency movements to offset tariffs and inflation.

We make assumptions over, how many things will, American consumers shift away from coming from China and go in the other direction? But then there's straight up elements we don't know how to incorporate. And there are things like just vast uncertainty that causes hiring and investment decisions. We know that's going to weigh on growth. We know that's going to weigh on hiring, that it may even lead to layoffs.

But the magnitude of the weight of that uncertainty is very complicated for economists to incorporate right now. So, you know, how do you incorporate this the same way you always do with nimbleness and transparency? But you got to do a little bit more work these days as an economist. Hey, I'm not going to sugarcoat that.

Tim

I can only imagine. So, let's start with GDP as a as a point of reference, just to home in on a proxy, if you will. How should our listeners think about the relevance of GDP, to in their everyday lives?

Frances

I don't think our listeners should ever think about, the relevance of GDP in their everyday lives, for a whole host of reasons. One of them is that actually, while it's always true that there's divergences in the economy, in the past several years, we've witnessed this really, important and peculiar event, which is that the economy has gone away, has gone from what we might call E shaped to K shaped.

So high-income Americans benefiting very substantially. Stock markets, housing prices, they've seen dividend income, rental income, and they've experienced less inflation in their basket of goods than low- and middle-income Americans. And what that's done to something like GDP or frankly, any form of consumer spending data is that that number is representing the whole, but it's doing a poor job of representing many income groups.

Low- and middle-income Americans are going to have a very difficult year, and there's going to be areas that are much stronger. So, at the same time, I think GDP is, valuable because I don't know that there's an indicator that's better than GDP. It's summarizing the entire story. But I'm constantly, advising our corporate clients, and our business owners, to really look at who their end customers are and recognize that you can no longer use a single number to represent the whole of the economy.

The only, reason or situation where I might be using GDP is something to really stick a knife into. Is that over the long run, I think GDP is probably still a fairly good long-term estimate of where earnings growth is going in a country. So, over a five-year horizon tends to be a good goalpost.

I also think it's good to look at it from a relative basis. So, we have low growth in the US. So we've had to downgrade that more in the US than we have in other major economies. So, there's still some value in it. But for day-to-day Americans and to a business owners, I really wouldn't be leaning on that indicator.

And maybe that's blasphemy coming from an economist to throw GDP in the corner like that. But we should be cautious.

Tim

It's always refreshing to have an economist blaspheme themself, on a recorded show. But I think you interesting you touched on a very interesting point. And, and I think it's evident in some of the survey data that we've seen, as opposed to the hard data, that there are emotional drivers into how individuals answer the survey data, whether it's, sentiment, Michigan PMI, whatever the case may be, who you voted for actually probably impacts how you see your inflation expectations and how you see what you're going to do with your CapEx budget. As a small business owner.

Frances

Hugely.

And one of the reasons was because the traditionally extremely valuable survey data was just tanking and heading towards recessionary levels. And it historically had been a very reliable way of getting a sense of economic momentum under the surface. But over the course of 2023 and it continues to be true, there was a breaking in the survey data and the hard data, and many investors recognize this.

And consumers are entitled to have a change of perspective and expectations based off of new political parties. But underlying it, I have heard this a lot in the last few years. It's true in the US data and Canadian data, you might hear folks saying, well, households are complaining, but then they still go out and spend.

So, it's just a perception thing. People want to complain in the survey, but actually we don't find that that's the case. The issue with soft data is everybody is being weighted equally within, those data points. So, you and I, Tim, get the same weight, as anybody from any income group. But the top 10% of Americans spend 50% of all of the money in the system.

So, and that number has grown fairly substantially in the last few years. So, the sentiment data is disproportionately weighting low- and middle-income Americans with respect to their spending potential. That is still true. And the value of those indicators continues to be distorted by political affiliation, but also your income group. Now, if you're a policymaker or if you're a business that is serving low- and middle-income Americans, you have to be very aware, and that sentiment data matters to you.

You can't dismiss it. But if you're trying to get a sense of the aggregate momentum in the economy, the whole which, by the way, leads to inflation or how that's going to drive an aggregate index like the S&P, you have the downward soft data. Now as we head into a period where we've seen significant, stock market volatility, I'm actually thinking about it the other way around, which is that, this group, the top 10% of Americans, for example, that have held up the whole they may be, their confidence and their sentiment and their particular income amidst market volatility will become much larger and more relevant than it has in the past.

So, things that we're looking for, maybe beyond traditional consumer confidence data, which is we can, very, very substantially we're trying to get more nuance. Do we see any signs that, any high-income brands are starting to crack? We look at restaurant sales, hotel movements. We're even digging up some of those old school Covid, type indicators like credit card spending, OpenTable reservations to try to get a sense, an early sense of whether that high income household is starting to crack until that high income household starts to crack or we see a pullback on them.

Tim

And switching towards some of the data that came out today, we had JOLTS (Job Openings and Labor Turnover Survey) data, that showed fewer job openings than expected. Which leads me to, of course, ask about expectations for the labor market in the US. How do you think the president's this administration's take on immigration? Immigration policy is going to implement the NFP (US Nonfarm Payrolls) data throughout the course of the rest of the year?

Frances

We have a bit of a differentiated take on the US labor market. I'll die on this hill. Tim. America does not need jobs. America needs workers. They are in for a demographic.

Tim

Francis, we’ve got to unpack that. That was a great line. What do you mean by that?

Frances

We're writing a piece on it, too, so that'll come out soon. America does not need jobs. America needs workers. Often when we talk about demographics, when I've talked about demographics in the past, I've usually been incorporating them and things like 5 to 10 year forecast, long term capital market assumptions that are driving long term asset allocation decisions, etc..

But the demographic bust in the US is here and now. It's impacting our data already. And I don't think it's actually well internalized by data watchers as of yet as to how powerful it is. So just a reminder, the US has the highest share of those over the age of 65 that it has ever had. The US has the greatest number of retirees that it has ever had, and the US has three retirees for every one unemployed new entrant right now.

So, the population is aging rapidly. And that's actually going to keep the labor market quite tight. So, if you look at a broad set of labor market data, we have no hiring, no firing, no layoffs, low quit rates. It is a frozen labor market. Very peculiar to see this. And our hypothesis is that employers have already recognized how difficult it is to hire, and how difficult they will be to hire if you let folks go.

But if psychological scarring from Covid in this environment to when labor shortages were dominating, and we expect that, to continue. So even though we have very low growth this year, we have the unemployment rate rising from 4.1 to 4.8%. Now, Tim, you look like a young soul, but my guess is like me, you've been through a few cycles, and 4.8% is a increase, a tight labor market.

It's certainly a rise in the wrong direction, but my goodness, 4.8% is actually a stronger labor market, than some of the boom periods that we have seen in the past several cycles. And this is because there's a shortage of supply of workers, and this is relevant across so many indicators. It's relevant when we look at things like dojo cuts and, people taking packages to leave government working.

Our suspicion is that a good chunk of those are taking early retirement, just like we saw in Covid. It's also going to impact not just, nonfarm payrolls data that comes through, but data like productivity. And at first, I thought, oh, actually, this is going to be damaging for productivity because I had this perception, true or not, that if you've been in your role for a real long time, you probably had higher productivity.

And if you retire, you're replaced someone with lower productivity. But remember that productivity is output per, dollar, paid or per hour worked. And actually, if we are replacing this older, more productive generation with younger people who are paid less, you might actually get more productivity, per dollar, but out of person. So, it's impacting a range of data.

And I don't know that market watchers and even economists have internalized how many data points this could be impacting how it's going to put a floor under, how far wages decline, how it's going to hamstring. The, the fed, who is heading into an environment that looks a lot like a recession on growth, may or may not tap into two quarters of negative growth.

But what do they do? They have 4.8% unemployment and CPI, high threes and core CPI in the fours. That's not enough data, to give them a mandate for a meaningful easing cycle. And this has to do it. It all comes back. Forget tariffs. It all comes back to America needs workers not jobs. Now pile on top of that that you have some deportations that are occurring.

I guess the last comment I'll make on that is, in in modeling, you know, we typically look at past relationships between two variables. We might say, okay, if, if we lose this much growth, the unemployment rate rises by this amount, but there's going to be a breakdown, not just in, asset correlations, financial market asset correlations, but also in some of the relationships between these economic data points, because the structural trend that folks have been talking about for so long, it's here now, it's arrived.

Tim

And so, in part of that, part of that structural change as you're mentioning, is the reason why the US government spends as much as it does on entitlements. Right? And so, as you think about the federal government's fiscal policy, is it sustainable and how does that impact your line of thinking when you're doing your forecasting work?

Where is that? And I think oftentimes the sequencing matters. Are we going to see wage inflation because we have less workers. And if you can because there's fewer immigrants or and is the market going to move on that or they're going to be empty, ships and California ports because there hasn't been, you know, supplies coming in.

Are there going to be auto supply chain disruptions? Is there going to be a budgetary issue? There are so many things we could tackle, and unfortunately, we're almost out of time today. So, as we think about the government's fiscal spend and the impact on that changing worker dynamic in the age of Americans or North Americans more broadly, how should we think about that?

Frances

Well, you've nailed it. It's going to be the sequence. And sequencing is maybe my word of the year, because I remember back when President Trump, won the election, and, and doing a lot of media at the time about what would it mean? You might remember there was a great deal of enthusiasm about, the good things that could come that may still come to deregulation, tax cuts.

We may still see those. But the perception at the time was that, you know, we'd get to eat our dessert and then maybe scarfed down a vegetable or two later. And instead, what America is getting is a heaping bowl of brussels sprouts with maybe a cheesecake at the end of, the tunnel. So sequencing is going to be really clutch.

Sequencing on policy is very important. But then also how does it hit our economic data? Our anticipation is that we're going to see those inflation numbers start to climb gosh darn fast. We're rolling up on the end of April here. We've already seen tariff revenues start to spike. That means that prices have already started to spike. So, inflation you're going to see that fairly immediately.

And then we've already you may hear there's a mainstream, very large company that has said they will be very vocal and label which, products are getting tariffs. You can see that really, really quickly. It's going to be fairly simple to initially see where those inflation issues are. The job market I expect, will be slower to crack instead of seeing job losses.

Look for things like cut hours. So, if you don't want to fire someone, reduced hours is a really good place to look, and look for folks who are trying to get secondary jobs. Multiple job holder data is another area you can look at in terms of government spending. I have tended to think that the US exceptionalism trade, I think there's two U.S exceptionalism traits.

I'm going to refine that to never bet against the wealthy. US consumer. I think that's really key. Number two was the phenomenal investment in AI and data. Now, that's not Americans using ChatGPT more than us. Here in Canada, which is where I'm based. But actually, the major infrastructure investments supported by things like the Chips act, I don't think that's going away.

Secretary Besson knows this. He has repeatedly said, he knows that every dollar he cuts of that deficit and its spending is going to weigh on growth. And it must be done carefully and slowly over time. But I have a one moonshot idea, Tim, if I may be permitted. And my moonshot idea is that governments are just going to continue to get larger.

And they have to because the social spending needs are going to grow and grow and grow, and they'll grow in countries in most of the developed world. That's not the moonshot idea that the follow-on ideas that, we're going to be in this new continued environment of fiscal dominance over monetary dominance. And I can tell you, Tim, if we had done this, podcast a year or two ago, the bulk of this conversation probably have been about the Federal Reserve.

What is the fed going to do that's the most meaningful thing to markets. It's like going to drive everything. But now, a huge part of my forecast doesn't depend on the front end of the curve. It matters what's happening at the belly in the long end, because that's where the corporates are leveraged to. That's where U.S. housing is leveraged to.

And as long as we stay in this bloated government environment, which again, is global in the DM space, then we're going to stay in a fiscal dominance path. And for all the headlines we've seen out of Washington, I just can't get the math to math, as the young folks say, that stays. So that's three-legged stool of structural American exceptionalism.

I just I'm not chicken it out from under me just yet. Not just yet, Tim, if that's fair.

Tim

I wouldn't either. And I say that as an American. But I would also say that from a perspective of this is a self-inflicted changing of the guard. Right. If you think about the administration, could change paths if they get 1 or 2 quarters or perhaps a midterm election, that doesn't go as expected. Right.

And those who earn less of continue to earn less and have a lower, sort of quality standard of life. Right. And I think that there's some support for trying to bring that back. It's just a question of sequencing. Is it what's going to happen first or they're going to be goods either off the shelves or they're going to be commitments to fund build out and CapEx and so on.

In in the US, from country to American country, companies that are doing work in manufacturing abroad, I often wonder, and maybe we can maybe we can end on this note, like, if you think about the average wage of a worker in emerging market economies versus the US, obviously the US pays more. Is there going to be a sequencing or a balancing of that dynamic in my lifetime?

Right. Like, are we going to get to a place where you start? It doesn't really matter where you manufacture or pay your workers because there is an adjustment to make. Like how far off is that?

Frances

That's real far, far off. But the first thing is, before we can get to what are we? What wage are we paying? We have to have people to work these jobs. So, there's a whole slew of reasons why manufacturing has declined in the United States. And some of those are real problems. But the bulk of them have to do with productivity enhancements that have occurred.

I hear that all the time. I think there are lots of Americans who would happily work jobs like that. Well, unionized jobs that had appropriate pay and appropriate hours. But you're missing labor supply. So perhaps the more interesting part of that conversation, from my point of view, is what manufacturing are you bring back with new technologies associated with it?

Because when I think about American exceptionalism, and some of the values of it, you know, we talk about data and AI, a big portion of that is the productivity story associated with it. So, if Americans want to bring back money factoring and they tie it, AI development, which is much more realistic than tying it to American jobs.

Then I have more economic faithfulness in that development, but it's going to take time. And Tim, we didn't have enough time to get into it today. But there's a lot of other barriers, one of which is the development of AI and data. As tapped out, America's electrical grid. So, before you can even restore aluminum, for example, which in other terms is often called, congealed electricity, you got to solve your electrical grid problem.

So, when you think about timelines, let's just put it this way. And most of our listeners investment horizon, even, you know, structural long-term investors who are planning out 5 to 10 years, the likelihood that we can solve a shortage of electricity and create enough population increase to fuel some of these jobs, fields are very low to me.

Tim

And it's always challenging to cross a shaky bridge. On the positive side, of the equation, it creates opportunities for investors, differentiated outcomes. A differentiated opinions are what make markets. And that has created opportunities for all. Frances, it was fantastic chatting with you today. Thank you so much for your time. And thank you to our listeners for tuning in to this episode of The Navigator.

Sounds like we'll certainly be another eventful year ahead, and we hope to have Frances on again soon. Thanks, and good luck out there.