Transcript:
Rick Brink: We have a world of people attempting to retire. And so in the decumulation phase, a sequence of returns matter, cash flows matter, and one of the things that comes clearly out of the research that I've done is a little bit of alpha goes a long way.
Rick Brink: Hello, everyone, and welcome to this second installment in AB's new series, Beyond Consensus: Thoughts from the Dismal Roundtable, of which we are some of the members. Over time, other seats will be filled, but given today's topic, we decided to get the band back together. From the London office, first, Inigo Fraser Jenkins, Co-Head of Institutional Solutions, and Alla Harmsworth, Co-Head of Institutional Solutions, Head of Alphalytics. And from the cozy confines of our respective residences, Eric Winograd, Head of Global Economists and Chief US Economist, and I’m Rick Brink, Chief Market Strategist within AB’s Client Group.
In the first episode of all of this, we tackled US exceptionalism and the policy-driven potential impacts, both cyclically and structurally.
The reason for all of us reassembling is because we wanted to revisit it three months later. Now, whenever I've done something like this, I've always thought of it as a mall map, as in “you are here.” Three months in, we're not at the same place that we were a few months ago and we wanted to tackle it. We're going to begin with the macro, Eric, because obviously that's going to set the stage. But one of the words that kept coming up when you and I talked about this was clarity and the alternate title that this almost was beyond mall map and truncated tails. So, tell us the story of truncated tails.
Eric Winograd: When we spoke a few months ago, Rick, we talked a lot about uncertainty. Recall that we were in the very early stages at that point of the tariff roll-out in the US. We weren't sure what fiscal policy was going to look like—that there hadn't yet been a bill passed and it wasn't sure what that would look like in the United States. Central banks around the world had started to ease, but it wasn't clear how far they were going to go. It just felt like there was a lot more that we didn't know than there was that we did know. And now three months later, I don't want to say that we have perfect clarity because, of course, we're never going to have perfect clarity, but we know a lot more than we knew back then. We know what the parameters of the fiscal package in the US are, we know what the bill looks like and we have a sense of how the market is going to respond to that. We have truncated the tail there. The worst case didn't play out in terms of the fiscal package and how the market reacted.
Similarly with tariffs, while everything isn't quite yet done and dusted, we know a lot more than we did a few months ago. The US has reached agreements, or tentative agreements at least, with a variety of countries. We have a sense of what the regime is going to look like, and we have a general sense of how the economy is responding to that. We don't have perfect clarity, but the worst-case scenario, the sorts of tariffs that could push the economy in the US and globally into an immediate recession, those tails have been truncated. While we're not operating in a world of perfect clarity, I feel like we know a lot more than we did and that lets us take a longer term, a more concrete if you will, view on assets and financial markets.
Rick Brink: Where does that put us? Yesterday, for everybody that's listening, we had our big global fixed-income research review meeting that happens every month, and Eric and the team dove into this exact topic. Why don't we get the highlights of where that leaves us economically, just some of the views? Obviously, we've got a big Fed meeting coming up. This is Labor week, so we've got a lot we can cover. Let's maybe talk about the view for the economy. Let's get into maybe the Fed and then I want to give it a little bit of a recap because we have a jobs report, actually, that just came out.
Eric Winograd: As we look forward with those truncated tails, what I think we see within the economy right now is an economy that is slowing. Growth in the US was roughly half the pace in the first half of this year that it was last year. It looks like it will continue to slow over the next few months. The payrolls report that we received, as you mentioned Rick just a few moments ago, makes very clear that the US economy responded to the imposition of tariffs in April, and the subsequent uncertainty, by slowing the rate of hiring quite dramatically. Businesses in the US are not hiring at anywhere near the rate they were several months ago. They're not laying people off necessarily, but they aren't hiring at a rapid clip. And that's consistent with our long-standing economic view, which is a manageable but meaningful slowdown in growth.
We look for growth this year in the US to be less than half of its potential rate. We're looking for growth of around 1% or somewhat below that, and I think the data are tracking in that direction. I don't want to say that's good news because you never want to say that a slower growth rate is good news, but it is better news than what you might have feared earlier in the year, in the sense that, the tail risk, the recession risk appears to have been truncated.
The fiscal package I think is part of that in that we're not getting a significant fiscal consolidation, but neither are we getting a significant fiscal expansion. I don't think that fiscal policy is really supporting growth this year, but I don't think it's really going to detract from growth either. That leaves us to look at the sort of normal variables from a macroeconomic cyclical perspective, and that tells us the economy is slowing. At the risk of oversimplifying, when the economy slows and when it's growing below potential, central banks cut rates. That's what they do. They are there to boost growth back to potential, and that's what we expect the Fed to do. We have a long-standing view that the Fed will cut rates by a total of 75 basis points this year, and we still have that view. We think that any inflationary pressures from tariffs, and to be clear, there are some of them, but they're likely to be temporary. They're an adjustment to the price level rather than a durable change in the rate at which prices accelerate. And as a result, I think the Fed can prioritize the labor marketing, can take a risk-management approach and can observe that with the growth rate of hiring slowing it's not appropriate any longer for policy to be above its long-term neutral level. They need to cut rates and get them back down at least to neutral, and I expect they will over the course of the next few months.
Rick Brink: I think a couple of things there you alluded to this and your comment is, there's a difference between inflation in the noun and inflation expectations. From the first administration we've talked about many, many times that was more of a step-up in prices. The Fed looked through it and 12 months later, it had exited the data. It was “nothing to see here.” The boogeyman for central banks is classically not prices today; it's the risk of prices tomorrow. So, reacting to that from a policy perspective is big. One thing I'll ask you about is the unemployment rate is taking on some unexpected level of force maybe versus other labor metrics because it's numerator-denominator. Could you talk about that?
Eric Winograd: Most of the time we tend to focus just on the rate of hiring because labor supply is fairly static. It doesn't change, or if it does change, it changes very quickly. It changes in line with demographic trends, and demographics are very, very important, but also move very, very slowly. We tend not to focus on the supply of available workers; we focus on the demand for it, which is what monetary policy can address anyway. The monetary policy can't increase labor supply, but it can influence labor demand.
The issue in the US right now is that when we talk about the policy framework, and I'm not talking about monetary policy here, when we talk about the channels through which the Trump administration is acting on the economy, we have to consider migration policy, too. The cessation of inward-bound migration and the rise in deportations, although we don't know the magnitude of it, have served to reduce the supply of available workers.
When we look at the hiring, that just tells us about the demand. The unemployment rate tells us about the demand but also the supply. Fed Chair Jerome Powell has said that the unemployment rate may be more important now than the rate of hiring, and I think he's probably right. When you have rapidly changing labor supply, the unemployment rate may tell you more than just the run rate of hiring. The unemployment rate as of this morning ticked up to 4.3%, which is still relatively low by historical standards. It's also the highest it's been in several years. It has been in a range between 4% and 4.2% for more than a year, moved out of that range to the upside today and has sort of moved steadily higher over the last couple of months. It's now up from 4% at the beginning of the year to 4.3%. It's not alarming in and of itself, but that's a trajectory. That's a direction that I think the Fed would like to arrest. They would not welcome, in their own words, a further weakening of the labor market. That's a big part of the reason, if not the primary reason, that we expect them to cut rates moving forward. Unemployment at 4.3% is fine, but employment ticking up month after month after month isn't.
Rick Brink: To continue your forecast into 2026, there are additional rate cuts that are expected as we go through that start to put us awfully close to the neutral rate.
Eric Winograd: That's a place where we disagree with market pricing, right? The market seems very content to price an extremely soft landing, one in which the Fed never actually has to cut rates below neutral. To refresh, the Fed's estimate of neutral is around 3% or 3.25%; it's sort of a rough estimate because no one knows precisely what it is. The market seems to assume that the Fed will be able to cut rates back to neutral and then stop, and that will be sufficient to stabilize the economy and to get things moving again. Then we'll just sort of march off into the future with everything in equilibrium. That's possible. But it is also contrary to most history, which is to say that when the labor market weakens enough to lead the Fed to cut rates, you generally have to cut below neutral in order to get things back on track. That's our forecast. I think the Fed will have to cut rates below 3%, and I expect that they will over the course of the next few quarters. We expect more rate cuts than the market expects at this point.
Rick Brink: As you said, and something that I've pointed out as well, history agrees with you or the idea of getting below R-star anyway. I see Alla nodding in the background, which is my cue to go to London because we need to talk about equities. Inigo, you were pretty forceful when we chatted in the first installment about US exceptionalism in the equity space in US large-cap. I don't want to call you out for success, but obviously the S&P has done what it's done since we met three months ago. I think maybe the market was paying attention to you, but that's just my own bias. But there's a story there. There's an anatomy behind where these returns have come from. So, why don't you give us a little bit of a story of how we got to the numbers that we've got right now?
Inigo Fraser Jenkins: There has been kind of an extraordinary return on the S&P this year really, and certainly extraordinary in the sense of the kind of conversations that we're having with people. Back to the beginning of the year, investors were really worried about the overall level of the return outlook and were really concerned about US versus non-US returns. There was this attempt to call for an opportunity for non-US markets to do better and we pushed back on that. Other than tactical shifts in flow, that sort of key driver of US outperformance for many years has been earnings driven, and we've seen the same thing happen again basically. On one level, the return on the S&P has been extraordinary, but at the same time, it's earnings led. We're seeing both in absolute terms of the return of the market being driven by earnings, not by multiple expansion. The relative return of the US versus the rest of the world is also driven by excess earnings growth. That's important because, certainly, when people think about the Mag 7 or the performance of the tech sector and look at the absolute multiple that it is on, or think about the size of those returns, people often want to compare to previous tech cycles such as 1999 and 2000, but it's very different from that because these are profit-making companies. It's not a multiple-led competition that we're in.
If you sort of map that onto where the earnings growth has come from and it's putting it in line with […] comments, yes, there obviously are signs of slowing taking place. When we look at the drivers of corporate earnings growth, there are enough things in that that are still robust that mean our one-year forward forecast for US EPS growth is of the order of 9%, which is below potential. It's certainly a long way above where it looked like it was going to go in April. It's a pretty robust number. It's not enough to support another huge leg of outperformance perhaps, but certainly a robust number.
Although there is a mix of softening numbers in some areas, but still strong activity stats elsewhere and levels of optimism in certain areas of the economy that are robust enough, it means that we think that there can be further positive returns and equities, albeit slow ones. I guess where the concern in that comes out is more in two different areas. One is the scale of the concentration of those returns from tech, and the second is whether there is a certain level of complacency about volatility levels. I'll deal with the second one first because perhaps it's easier, but when we look at high valuations on global stock markets and compare that to history, there's a normal experience that does not necessarily lead to a sell-off, but it does tend to lead to periods of higher volatility. And then you contrast that to the VIX or the MOVE index or fixed income and it looks like there's a very low level of all priced in. It feels like that's a bit out of kilter with the scale of geopolitical/policy adjustment that we've seen just in the last six months and valuation.
I am aware that I feel a bit like a broken record on this because I've been saying that […] should increase for some time and that's not been the right call, but I still think that is something that can happen. The second thing is on tech capex. Obviously there has been this extraordinary run of AI capex. It looks like it'll come out this year somewhere between 1% and 2% of GDP, and that's a massive number. It's only really been exceeded by really extraordinary prior shifts in technology, such as the railway boom in the mid-19th century in the UK, which got to about 2% of GDP as far as we can tell, or the postwar infrastructure boom in the US was about 3% of GDP. Of course there's some question marks around that. There's question marks in terms of what the payback is on it. There's question marks in terms of what the life cycle of this infrastructure is compared to those prior infrastructure booms. There's certainly plenty of uncertainties. At the same time, that's investment that presumably sets a stage for, at least in the near term, an underpinning of that tech earnings growth. Not something that looks like it reverses anytime soon.
Rick Brink: The hope you're talking about in infrastructure, something that I was talking about recently is, if we do get the infrastructure, the whole rhythm to this is no data center, no AI, no power. The potential in even spaces like value where all of the stuff that goes into producing the power and the widgets and the whatnots one would presume over time, that gives us a little bit more breadth. Yes?
Inigo Fraser Jenkins: Yes, indeed, and that's something we have done quite a bit of work on, Alla and myself. It does imply there is a broader range of participation in this and certainly one of the emerging constraints is power grid generation, et cetera. Of course it has spiller effects in terms of forecast, in terms of power demand and therefore climate impacts, but that’s a story for another day.
Rick Brink: I love this format, by the way, because I can look directly straight ahead and I know I'm on the right track because I'm getting the Alla head nod and I can change course immediately if there's this sour look or she just dropped something, I know I've gone off the rails.
Eric Winograd: It’s like real-time feedback.
Rick Brink: It's real-time feedback. We’ll come back around on AI because you mentioned capex, I mentioned AI, and so the capex for AI and what AI means is a whole different thing. But I want to sort of keep us on track here. Both of you have talked about what we're getting, but you've also alluded to what everybody's kind of ignoring and some of the things that might be problematic that at least, at the moment, we're all kind of looking through. Eric, you talked about this yesterday, so if you could, I'm just going to toss that part out to you. It's the other side of the coin while we're looking at the good stuff.
Eric Winograd: We talked earlier about truncating tail risk around the near term, and I think that's exactly right. Over the course of this business cycle, things seem a little bit more certain. But if you zoom out past this business cycle, if you look out past a year or two, I think the tails have widened quite significantly and I think this is something the market isn't focused on. The market is very clearly focused on the here and now and is trading based on how the economy is doing today, and that's generated the results that Inigo has talked about and so on. You look further out though, the risks really are rising. Particularly in the US, the way that the policy framework is evolving has the potential to be quite disruptive. We're talking about the loss potentially of Fed independence, which is something we hadn't seriously considered coming in.
I think we understood that the Trump administration intended to uproot large parts of the foundation of the economic system, but not this one. And this is really a key underpinning of economic stability. We have a lengthy history of what happens when central banks are not independent and to sum up what happens, what happens is inflation, right? It's not really an oversimplification to say that that is the outcome of central banks losing independence. That's a big deal, and it's compounded by attacks on the statistical agency. Think about why we produce statistics in an economy and it isn't for the benefit of financial markets. I mean we certainly use them, but it's for the benefit of policymakers so that they can respond appropriately to changes in the economic outlook. If we're not generating unbiased accurate statistics to the best of our abilities, how are we going to expect policymakers to respond to that? Imagine a world in which the economy starts to perform very poorly. You would normally expect Congress to act by enacting fiscal stimulus to try to boost growth. But if the statistics agency, at the behest of an administration, any administration, doesn't produce numbers that tell them the economy is weakening, how are they going to respond to that? How do you respond to something that you can't see? These are all things that are circulating in the ether. They probably don't matter right now, but they could matter very significantly years from now.
Inigo Fraser Jenkins: Picking up Eric's point, if you look out beyond the business cycle, of course it's always possible to say that the future looks uncertain. You can go back at any point in time and say, oh, things look uncertain. But there are some really good reasons now why uncertainties look larger and potentially more nonlinear than they have been in the past. A few things I could point in that direction. One is there's the policy framework that Eric alluded to and I'd say that’s the sort of thing that spills over into geopolitics as well. I guess the second is AI and the extent which it displaces jobs. The third is climate. In terms of the mean-level impact on GDP growth at 10 years hence, it's arguably not necessarily something that people want to make a huge adjustment for, but the radical forecasting area in terms of […] is something that we haven't seen before. That raises some interesting questions in terms of portfolio design—what it means to find diversification when, through the lens of policy and climate and, in principle, AI you have these huge levels of uncertainty.
Rick Brink: Thanks, Inigo. I'll come back to you one more time, Eric. Alla, you're coming up. I'm getting ready for the tactical and strategic, so we need to get to the actual allocation, put it all together. I'm building this up, and part of building it up is we just talked US macro. Eric, can we talk a little bit about non-US macro? Obviously, there's a lot going on both in the developed and the emerging world. What sticks out to you?
Eric Winograd: What sticks out to me, honestly, is a potential realignment of the way that the world works. I don't want to say that this is baked in the cake because I don't think it's certain, but I have in my mind the pictures from this week of the leaders of Russia, China and India all standing together in one place and shaking hands. I'm a child of the Cold War and so you can envision sort of a version of that in which you have this bipolar world where countries are forced to choose a side. That is something that I don't think most of us would have expected to see. Certainly, those of us who grew up during that period wouldn't have wanted to see that. It's possible that it won't play out that way, but the results of the policies that are being pursued, largely in the US frankly, may push us in that direction.
We've gone through the last 25 years, a period of deepening global ties and deepening globalization that has led to, I would say, an unprecedented increase in wealth around the world and an unprecedented improvement in living standards. Not one that has been allocated evenly of course, but still one that is unprecedented. I do wonder what the world looks like if you deglobalize, if you move away from that, whether you can still build the same sort of global economy, whether you can generate the same sort of wealth, whether you can generate the same sort of standard of living improvements that we have seen in just a very different sort of structural framework. It isn't necessarily the case that we’re guaranteed to go in that direction, but I think any reasonable observer would observe that the risks of that sort of outcome have dramatically increased. I like to think of it in the context of if I were ever to write a book when I retire and write a book about the last 25 years of economic history, the most important event will have been China joining the WTO, which I think is very clear and very evident in globalization.
I wonder if 25 years from now the most important event might be the breakup of that trading order and what that has meant. We'll see 25 years from now, maybe I'll write that book.
Rick Brink: I look forward to it. Although I promised myself a long time ago that I was going to. Back in 2000, 2003 or 2004, I was going to write a book called, “How Cameron Diaz Brought Down the Middle East” and it never happened. I wish you luck and I will say, let the record show, that I said “precipice” on the last episode. Inigo, were you going to say something?
Inigo Fraser Jenkins: Going to pick up on that in terms of, I'm thinking about living standards and change in regimes. I guess one thing that we've spoken about in the previous episode, but it comes up a lot, is this sort of background fear of inflation risk. Yes, perhaps we've sort of truncated the tails in this business cycle, but I think the one thing that lurks in the background is on a few levels. The idea that inflation risk in the longer sense is still there partly through these policy decisions that are made. Then the question is, how is that reflected? Because I find it quite odd that you don't really see this reflected in five-year/five-year inflation swaps. Arguably, the 10-year breakeven has edged up a little bit, it's at the top end of the range last few years, but you've seen it reflected a lot in the prices of gold, platinum and silver. Those are big moves. Gold and platinum weren't that correlated before this year. There is a fear coming in, which could be a partly inflation fear, partly back to the de-dollarization issue, which I’ve spoken before. That does seem to have taken root just in the last a few months. That's something I think that needs to be watched and also think actually built into portfolios.
Eric Winograd: It is really remarkable, right Inigo? That despite, I think, a wide understanding, perhaps not a focus on it, but a widespread understanding that the risks of longer-term inflation have gone up dramatically as you see a deterioration in policy independence. Break-even assets, breakevens implied by TIPS and surveys of inflation expectations don't really show any impact of that even as the assets you've talked about–I would add Bitcoin to that as well–are showing some concern. I think there's reason for concern, and it goes back to things that I think we've both said, markets are focused on the here and now. They're more interested in what's happening in this business cycle than what might happen beyond it. In a lot of ways, they're very complacent. It takes a significant amount of imagination to think about a world that looks dramatically different than the one we're in. And while that is a possibility, it's not a guarantee. The question for markets and the question for portfolio construction I think is, how you balance those things? How do you think about the here and now, which looks kind of okay versus the longer-term risks, which appear to be mounting? You have less uncertainty now, more uncertainty later. What do you do about that?
Rick Brink: Inigo, you teased this, so I'm going to throw it out. We're talking about inflation—by the way, markets are just kind of thinking if you look five-year/five-years forward, if you look out into the distance, this is definitely a “this too shall pass.” But since you've invoked it, let's talk a little bit about some of the alternates that are out there, gold's behavior, cryptocurrencies. What's the general take there? I mean obviously from a larger perspective in portfolio construction, how do you talk about it?
Inigo Fraser Jenkins: We've had a long-standing view to overweight gold and crypto in portfolios. Whether people agree with that or not, it's certainly come up in a ton of client meetings. I really can't think of client meetings about the strategic outlook that don't involve conversation about gold, at the moment. I think there are a number of drivers to come together to point in that direction. It's this question of public debt and what the path out of that is. Our conclusion is you have to be a real techno optimist to think that AI can generate enough growth to get you out of here. This implies there is this inflation risk. There's obviously the independent central banks risk that Eric referred to. And then there are non-economic reasons, too. The host of countries such as China and […] countries, the need to de-dollarize as a matter of national security frankly, and that implies upward pressure on these non-fiat assets.
When we get into conversations with clients around that, the question is, how do people think about that being in their portfolios? And for me, the way into that position really is—the advantage of gold is that it's an asset that has a correlation with equities that remains zero, even if inflation rises. That's clearly not true of nominal bonds, for example. That's the root in. We're finding clients asking us a lot more about, should there be diversifying across other assets that potentially come under that overall umbrella? Hence these conversations about silver, platinum, cryptocurrencies as well.
Rick Brink: Thank you. Since you mentioned bonds, I'll throw my two cents in. I think I usually get my contractually allowed 30 seconds on fixed income and bonds. The thing is, watch the curve, watch the shape of the curve and see how it's sort of evolved in the past 12, 15 months and how it's going to go going forward. At the front end you still have a little of inversion. There's obviously a little bit of stuff playing around with the 20s and the 30s, and expectations of fiscal imprudence and what that's doing. Honestly, I think that's more of a trade at the moment. We live in a world where those have been trades, there were trades during COVID and you would get short squeezes into rates. What I'll point out is, is that right now real yields are still attractive and based on what Eric was talking about, if that's the path you expect that's going to happen through the Fed and as we make our way out into next year, then you should, as my grandpa would say, “Get while the getting's good before all the good getting's been gotten” and thank you very much.
I had to practice that for like an hour before we did this.
I think that the base level of rates on a real basis, the inflation debate notwithstanding, which is completely fair, I think the real level is lower than where we are now. I think this is an anomaly and I think eventually if there's a demand for income and when we go seeking income, history also says curves tend to flatten. Being aware of curve shape and slope and taking advantage of real yields, I believe, especially in the US as we go through a cutting cycle, is something to really pay attention to. Don't lose sight of credit. I've talked about high yield quite a bit in my daily life. High yield has continued to perform really well. Yields are still at an interesting level powered by Treasury yields. That's the anomaly versus spreads.
That's something you continue to watch. The One Big Beautiful Bill in fact, as I'm looking at Eric's visual from the […] for yesterday, there was a ton of research done by a corporate credit team on the beneficiaries of the One Big Beautiful Bill and how that shows up individually across companies. Obviously, you would think about that from an equity perspective and you should, but it also portends the behavior of the credit spreads individually in these companies and potentials for upgrades. So, don't sleep on the impact of policy on credit spreads and pay attention to the cycle through cutting and what it does to the shape. And please be attentive to investing in it. Don't get hung up on cash. I know we talked about that for a long time. Once that goes away it's gone. Just be mindful even of boring bonds.
Alla, it's your turn. We talked about everything and your area of expertise is making sense of everything when we build a portfolio. Last time we talked about both the structural strategic portfolio and the tactical one. Let's maybe talk about the tactical. Has anything changed and how has it changed from when we spoke a few months ago? What's it look like?
Alla Harmsworth: Sure, thank you. Probably no surprises given what we've talked about and actually some nuance change, but no major change. The spirit of our tactical positioning is very similar to last time as we've discussed. The US is still the core holding of portfolios. It's our highest conviction […] certainly within the equity market. We'll continue to overweight the US over a tactical horizon. Reason being the profitability, the higher ROEs than in the rest of the world, the high earnings powered by AI. And we think that is going to be more likely to continue than not in the near term. We've made some small changes to positioning within equities in other regions. We've actually become slightly less negative on Europe. Not getting very excited here, but just moving it from underweight to neutral. We think that the focus on defense, on competitiveness, on resilience, security could be a positive, could help growth.
It's a bit of a muted view because I guess the ability of the region to pay for all this stuff is still kind of a bit moot, but we still think that it could be good. So, we've gone neutral.
There's also a lot of valuation support and within Europe, I think areas such as a high-dividend yield as somewhat sort of more defensive parts of the value stocks could be an interesting opportunity. Things like financials, industrials, what I was exposed to, infrastructure build-out and defense. We continue to like Japan elsewhere in developed markets. Corporate reform, the return of inflation we think are a good thing—that's a tactical and a strategic. Emerging markets we're still neutral. There we need to be selective and ideally we would find an active way to invest in those regions to sort of get that nuanced approach where obviously different countries offer very different things, but the region as a whole I think offers a good opportunity to be exposed to all these key long-term trends that we've talked about, whether it's AI, infrastructure, climate change, et cetera. That's the equity market.
In terms of fixed income, we do continue to be a bit more cautious on US long-duration bonds and that's also a view that we echo strategically. We prefer to be at the shorter end of the curve for now and in other areas such as euro area and UK, credit is interesting in part, so we probably prefer credit in Europe as well.
Tactically and strategically, we are very much cognizant of the inflation theme, hence our continued exposure to gold and crypto. It's also a hedge for de-dollarization and just a really good defensive hedge. We're happy to have that in place both in the short term and the long term.
You can probably see actually our strategic and tactical positioning, although drivers are very different, are actually quite similar. There isn't much of a divergence between the two. We've mentioned infrastructure; I completely agree with Eric and the rest of you. I think it's an area, again, which is at the cross section of this key investment trend with a much bigger macro uncertainty. It's longer term. We sort of position more about this key trend if you like, than about the traditional macro relationships. Infrastructure, we think both public and private, is a very interesting area, which is exposed to a number of these themes and is a good way to protect ourselves against inflation, as well with yields typically tracking inflation. I've kind of covered both. Strategically, I completely agree that we face an unprecedented level of uncertainty. Portfolio construction is a challenge. We need to construct portfolios which are robust to very, very, very different potential outcomes. Where we used to be able to have more certainty on what equities will do, now the likely outcome range is very, very wide. We like to consider very different scenarios, perform something called robust optimization where we construct portfolios which reflect lots of different outcomes. It gives us more diversification and, what helps to achieve the diversification for us, and this remains a key tenant between our portfolio construction strategic allocation, is we want to have exposure to as wide range of return streams as possible. We don't think about bonds and equities, we want to invest across traditional asset class betas, we want to utilize factors both long/short and long-only and cross asset, and would definitely want to be exposed to the alpha streams as much as possible both in public and private markets.
That's our way to achieve diversification and to be more robust in whatever might come about. To recap, the long answer is, we still like US. We believe that it will continue to outperform, unless other regions outearn the US, which we don't think is likely. We believe in AI, we want that growth tilt within the US market. We want to have more of a value but defensive value tilt in the world outside of the US. We want real assets infrastructure. We continue to like gold, crypto and perhaps other precious metals as the multiple hedges against all sorts of things.
Just one little comment on active and alpha, it's obviously been a massive challenge to find alpha, which is robust and high. We do still think that in a world where we continue to expect lower returns in most passive asset classes strategically, we really need alpha. And so alpha is a key part of our portfolios, of our allocations. We want to look for it in the long-only world and the long/short and cross asset as well.
Within the equity markets, the areas that look promising now are emerging markets and EFA. Some value managers have been doing well, so we want to look for exposure there. The US large-cap space remains challenged, but again, alpha and looking for alpha is something that's a very important part of how we invest. We think now actually in terms of return dispersion and the proportion that seems to be coming from security selection versus factor exposures is a good time to fish for the alpha. We just need to know how to do it.
Rick Brink: Thanks, Eric. Thanks, Alla. My two cents on alpha. I know we're an active management firm, of course we're going to talk about alpha, but I approach it from a mathematical perspective. My pursuit in a world of declining potential absolute returns or real returns over time is we have a world of people attempting to retire. In the decumulation phase, a sequence of returns matter, cash flows matter. One of the things that comes clearly out of the research that I've done is a little bit of alpha goes a long way. You'd be surprised over a decumulation period that might run 30 years, what 30 to 40 basis points of alpha in a given year will do to the terminal value of the portfolio. Think of it more from a mathematical perspective. If we have moderating base level returns, if you can squeeze out a bit more in any way that you can do that, it has really meaningful implications for terminal levels.
We are up to the end of our time, but I do want to throw a teaser out because if I get my wish, I'm going to suck Inigo into something mid-quarter because our overlords have told us they would like us to do something intra-quarter and Inigo is knee deep in research on AI in productivity and labor impacts. I'm doing something on AI now. Just at a high level as a teaser and almost lock you in spiritually to doing this, what's your sort of high-level takeaway on the idea of AI's impact on labor as a result of productivity gains?
Inigo Fraser Jenkins: Happy to be locked-in spiritually. Thank you for that as an intro. All of these questions that come up in so many meetings are the series of issues around AI, but the two really macro aggregate ones that stand out are: one, what is the size of the productivity gain likely to be; and two, if you're positive on that, does that also necessarily mean that there is a huge structural change happening in the labor market in a negative way? First thing to say is we have to be super humble about making any forecast about productivity gains because the ability to forecast that for decades has been very poor, but also it can't be seen in isolation. I think people get very excited about potential productivity gains and what this can do to growth. You have to realize that's not happening in the vacuum.
It's happening in the background of some real serious downward forces on growth from old-fashioned demographics. As Eric said, it moves slowly, but we can forecast it really well, unlike AI. The downward force that comes to growth from climate change, which is probably negative, but really hard to forecast, and some other forces too, such as globalization. The question is, is the plausible uplift from AI enough to counteract those down forces on growth? It's going to be a stretch I think, and you'll have to make some forecasts on AI, which imply productivity gains that are large in the context of the last few hundred years in order to offset that fully. The second one is really unknown at this stage. If you do forecast high-productivity growth, how much of that has to come from job displacement versus making individuals more productive, but there is likely to be quite significant job displacement.
Of course, the pushback on that is all the previous rounds of automation since the steam engine have not led to a structural increase in unemployment. To say that it does, it has to be saying in the famous words, “This time, it's different.” But there are some reasons to be quite worried about the prospect of the labor market, particularly in terms of the sectoral composition of where AI seems most likely to have an effect tend to be the least unionized sectors. That looks like a round of automation is very different from the ones we've seen in recent decades. It's this interaction really of growth from AI versus downforces on growth and growth from AI versus job displacement are these two big macro trends that I'm sure they will be talking about. Not just this quarter, but we have five to 10 years probably.
Rick Brink: Yeah, and certainly six weeks from now because I think what you said is actually legally binding. Thank you for that.
Inigo Fraser Jenkins: You're going to hold me to it.
Rick Brink: That's going to happen. I have a 50-year beverage bet with a former colleague because the old story about technology is, is it labor destroying or does it create jobs that we didn't know were going to exist? I think that debate about whether or not new technology creates the jobs we didn't know were going to exist in the future and to what degree it does that versus what it takes away is kind of the center of it for me. Let's table that for six weeks from now or this will turn into a three-hour podcast.
This gets us to the end of our chat today. As always, these are not just my colleagues; these are my friends, so Inigo, Alla, Eric, thank you very much for joining. I have a blast doing this with the three of you. Again, we will have more of our colleagues joining over time. There's so much for us to get to. That's going to be coming soon. But in the meantime, thank you for your support out of the gate of this series. Hopefully you're finding this useful. If there are ideas you'd like to see around the world from some of you that we see watching us, let us know and we'll work it into it. But for now, thank you very much and we'll see you on the next one.
