Transcript:
Karen Watkin: Welcome to AB's Alpha Females, the Multi Asset Investment podcast from AllianceBernstein. I'm Karen Watkin and I'm a fund manager in the Multi Asset Solutions team here at AB. The Alpha Females are those women who have developed unique areas of expertise and made their mark in the investment industry. For many clients, generating income from their investments is a priority. But market conditions are very different now from those that we've had over the past decade. So, taking a flexible approach to income and getting original and informed perspectives to investing is more important than ever. In this series, my guests, the Alpha Females, share their expert insights on the key questions for investors on the hunt for income. They'll also be telling me about their career journeys, the challenges they faced, and the lessons they've learned along the way. What a difference a few years makes. Just five years ago, we were living in a world where interest rates were close to zero and the value of bonds, loans to governments and large companies were not delivering returns. Investors on the hunt for income were forced to look for other and potentially riskier investments to find sufficient sources of yield. But today, the macro-economic environment is completely different. We have higher interest rates and higher inflation, which brings a whole different set of risks for investors to navigate. Understanding what's going on across the global economy and how that affects investment strategies at the coal face is vital to ensure we can generate compelling levels of income for clients alongside attractive risk adjusted returns. My guest today is someone who is an expert in studying those shifting macro factors and importantly, forecasting how they might evolve in the future. Sandra Rhouma is a European economist on the fixed income team here at AB with a PhD in economics and the early part of her career spent at the European Central bank as an analyst. She has both the theoretical and practical experience to develop deep economic expertise. So, what are the challenges of interpreting the larger economic factors and how does the work of a central banker fit into the business of asset management? Sandra, welcome to the podcast.
Sandra Rhouma: Thank you, Karen.
Karen Watkin: So, let's begin by understanding a bit more of what you do as an economist. Can you start by telling us a bit about, you know, what do we actually mean when we're talking about the macro picture? What are some of those key drivers that are really important to understand from an economic perspective?
Sandra Rhouma: Sure. So, we economists, we usually think about the economy as the business cycle, right? And you have the business cycle that fluctuates around the trend. So, the trend is a long term structurally driven drivers of the economy, while the business cycle is like you're either in an expansion or A recession. And when, for instance, we forecast GDP growth, inflation, we try to predict when we are going to shift from expansion or recession around that trend. So, this is kind of the short to medium term perspective or outlook. The long-term forecasting is much more challenging because you have to take into account what is going to shift the trend around which the business cycle is evolving. So that's population ageing, climate change, whether or not we have structurally shifted to another trend, for instance, after the pandemic, whether this has impacted the level of GDP growth, for instance, on a permanent way or not. So this is what we mean by economic factors and drivers is what is going to drive in the short run these macroeconomic variables, GDP growth, inflation rates, exchange rates, sometimes, although it's very challenging these days, and the difference between the short term and the long term, and how the long term is impacted by decisions, policy decisions that are taking place within the next few months.
Karen Watkin: Could you help us set the scene a little bit to perhaps just give us a potted history of what we saw over the last few years in terms of the kind of broader economic regime we were in.
Sandra Rhouma: It was different from one region to another. In Europe, specifically before the pandemic, we were in a low growth, low inflation environment. And it seemed to be permanent. Right, the pandemic changed things quite dramatically because of the pandemic. But then also the energy shock, I think it's much more the energy shock that has, you know, shifted inflation way higher. But that also means that, you know, before the pandemic we were in a zero lower bound constraint. Central banks, not all of them, but the ECB specifically the bank of England, had rates at zero or even negative, which is like unseen. And this inflationary shock pushed them to hike their bank rate. And it seems like because the inflation is higher and is now potentially going to consistently meet the inflation target over the medium term, we are probably not going back to that environment of low rates. So, I think that's, that's the major difference that we've seen over the last 10 years. We're shifting from a low-rate environment with quantitative easing to a rates that are reasonably high but consistent with inflation targeting or inflation meeting the target and central banks reducing their balance sheets, so engaging in quantitative tightening instead of easing. And I think this will proceed not so much because the growth outlook is more promising in Europe, but just because of this inflationary shifts.
Karen Watkin: Yeah. And you talked at the beginning about your work as an economist and how you think about those longer-term forecasts and what the catalysts Might be to see a shift or a kind of change in direction perhaps for some of those kind of trends of growth or inflation. Can you tell me a bit more about what you see now, kind of looking forward? So, what are some of the kind of longer term or secular drivers that you think will impact the type of economic regime that we might expect over the next kind of five to 10 years?
Sandra Rhouma: For example, I think for developed markets, two topics that come back quite usually is climate change and population ageing. Research has not reached a consensus, is far away from a consensus with regards to these two drivers of the long-term trend. So, I think we should not jump into conclusions when it comes to the impact of these drivers or other drivers on the long-term trend simply because we don't know. I think we should keep our minds open to the different options. It could be disinflationary, but it could also be inflationary. You know, again, coming back to this time difference between the short run and the long run, you have some papers that show that in the short term there, climate change could be inflationary, but as we move towards a 3, 5, 10-year horizon, it's actually disinflationary. So, you have a lot of things to take into account that relate to for instance, the level of development of an economy. The emerging markets are more likely to suffer from this climate change and their consequences and therefore to be much more inflationary for these economies compared to developed markets. So, you have a lot of things to take into account. And when it comes to population ageing, for instance, it's the same I think instead of jumping into conclusions on what will be the impact in 10 years time, because quite frankly, we don't know. The best strategy as an economist, but as also an investor, is to consider all possible actions and to evaluate which one is the most probable. And as we learn more from academia on the possible impact of these structural changes, we can adapt our portfolio decision making, let's say, to those changes. For instance, I've worked a bit on the neutral rate and where does the neutral rate is today compared to pre pandemic, especially in Europe. And you know, when I observe productivity growth, population ageing, these things have not structurally changed compared to pre pandemic for them to justify higher neutral rates now compared to pre pandemic. So, my conclusion is that probably the neutral rate in Europe is still between 1% and 2%. So, this is how I like to take into account those trends, just by keeping my mind and my mind open to the different options.
Karen Watkin: Tell me a bit more about what you're building out in terms of your kind of economic forecasts. How does that then feed through in terms of the financial markets and ultimately what our portfolio managers can do to kind of take action around those forecasts and you know, position their portfolios appropriately.
Sandra Rhouma: It's more the directionality. Are we going to slow down or you know, accelerate in terms of growth? Is inflation moving towards the target? So, if it's bumpy, don't panic, take a step back and remember what the economist said about the next six months. It's still moving towards the target, but it might be surprising on the upside or the downside from one month to the other and to also again not overreact to one data point that might, that might actually contradict our baseline but stick to that forecast.
Karen Watkin: That's really interesting and I think that's right, that actually the forecasts from your team as economists help give us that kind of longer-term horizon to think about the bigger picture and the, the path that the economy and the markets are likely to be on. Rather than like you say, you know, as, as portfolio managers or investors, you know, we can be easily kind of drawn into that shorter term focus right when we're staring at our Bloomberg screens and seeing, you know, individual kind of data points or headlines that are moving markets considerably. How do you marry that kind of longer-term horizon with some of the shorter-term data points or kind of market dynamics that you're seeing? And that dynamic is an economist kind of building longer term forecasts but working very closely with portfolio managers that are seeing the value of their investments change minute by minute.
Sandra Rhouma: I think the strategy that I've built over the last two, three years that I've been working in this sector is to again, it comes back to being open minded about different scenarios and assigning probabilities to that scenario. So, I always have the baseline scenario which I think is the most probable scenario. So, for instance, I think European growth is going to slow, it's going to be very close to a recession actually because of the uncertainty that we are experiencing these days. Inflation is moving back to target. The ECB will cut to below 2%. That's my baseline, that's the one I assign the highest probability. And then as I get the data points from one month to the other, I just try to assess whether this is enough information to change the baseline. And I will try to understand whether the new information we're getting, whether it's enough for me to change the baseline to another scenario that I have around the baseline. So, if the risk is that the ECB cuts by even more than what I assume in the baseline, well, does the data actually support that risk scenario? And in that case, I will change the baseline to a new baseline. But this takes time.
Karen Watkin: And so, I mean, in today's environment, where we've got such a high degree of policy uncertainty, right, particularly coming from the new U.S. administration and what we've seen in terms of tariffs, how do you navigate that type of environment? Is it a matter of having a wider range of kind of risk scenarios that you're considering? Is it having lower probability in your base case? How do you navigate such an uncertain kind of economic backdrop like we have today?
Sandra Rhouma: So, in this specific case, because the uncertainty is really high, I have at this stage different risk scenarios with different levels of tariffs, for instance, and again, it's not really the point estimates that matter, but the directionality compared to what I call a counterfactual scenario, which is a hypothetical word where we didn't have tariffs. So that would be my forecast last October, for instance, or last November when it was unsure whether the US Administration was actually going to go ahead with the tariffs. So, I present these risk scenarios, and I compare them to the counterfactual.
Karen Watkin: That's really interesting. So that kind of counterfactual scenario that you talk about that essentially gives you almost that kind of clean baseline to build your other forecast, rather than what could easily feel like a bit of a moving target. Right. In today's environment where the tariffs are moving so rapidly, to understand the kind of incremental impact must be really tricky.
Sandra Rhouma: Yeah, the counterfactual is very useful in my view, really to understand again, what the tariffs and the uncertainty are associated with tariffs mean for the growth outlook. If I was just to present the different risk scenarios, you wouldn't exactly know where I stand, what that really means in terms of shift in growth and implications for inflation.
Karen Watkin: And so tell me a bit more about what your experiences at the central bank taught you before you made the shift over to asset management. And can you share some of the interesting lessons learned during your time at the ecb?
Sandra Rhouma: It was very interesting to be on that side of the market. Right. So, I started in banking supervision, and I was supposed to be working on the stress EU wide stress test exercise where we stress the resilience of the banking system. But then the COVID pandemic started, that was postponed. So, I worked on bank liquidity and whether they had enough liquidity during the COVID crisis. And that was very Interesting. So, I've seen that side of the central banking which is, I would say, close to the banking sector so you would think that it's close to the market, but it's very, very different from what I'm doing right now. I was not following market pricing; I was not following the changes in asset prices in general. And then I moved to something that is more in line with my academic background which is following the US economy. So being a US economist I was part of the international department at the ECB I think one of the main differences is how we approach the market in such institutions where essentially at the ECB and I guess in every other central bank, the market is this entity that is living its life essentially and we just observe it without really following it on a daily basis. The good example of that is that we had only one Bloomberg license for a whole floor. I open Bloomberg maybe once every two weeks while now I have it open every, every, every day, the whole day. When I moved to the private sector, the financial industry, this was probably the biggest change because you always have to follow the market. Not just, you know, the Bloomberg, it's just all the information that can change things from one day to the other was quite overwhelming at the beginning.
Karen Watkin: And how have you sought to kind of navigate that constant influx of news flow and data while still keeping your kind of economist hat on and that kind of long-term horizon?
Sandra Rhouma: So, at the start I wanted to read everything and be aware of every single news which ended up being not only very mentally tiring but also not very useful. What I've learned over time is that you need to filter the information between the white noise and really the news that are important from one day to the other. For instance, which central banker is much more influential than others and which ones should we follow more closely compared to others? You have central bankers that I like to say I hear them, but I don't listen to them simply because at the end of the day what they say and what they think doesn't really matter. And I think I got this with the experience of knowing which one actually moves the needle. While all the central banks are much more influential and what they say matters, everything they say matters. So, I can focus on these three instead of focusing on 10 and that makes my life easier.
Karen Watkin: Absolutely, yeah. And what do you love about being an economist?
Sandra Rhouma: There is always something going on. First of all, you're never particularly today, particularly today and it's always, sometimes it's things that are completely unexpected. The pandemic was unexpected. The energy crisis after the war in Ukraine started was unexpected for an economist, but there is always something going on. Unfortunately, it's always a crisis. Most of the time it's a crisis, but you know, it's a, I like to say it's a social science, it's not a science. And therefore, you need real life experiments, you need those events to happen for the job of an economist to exist. But there's always something happening that can again change the long-term trajectory of a specific country or of the world as it is. Think of tariffs today and where we will be in two, three or five years time. So, it keeps you curious and always asking questions because it's not just about GDP or inflation, it's really about day-to-day life. At the end of the day when we talk about these things, where are we heading in terms of as a society or as a world? So, I think it's almost like a philosophical question. But I like to be an economist because of that reason. It keeps you curious and asking questions. And also, the interaction with all other social sciences. I try to make the effort to not just be an economist, but also to hear what historians have to say about what's going on today, what other social scientists have to say about what we're seeing today in terms of tariffs, in terms of rearment in Europe, in terms of geopolitical events. Because these are not just important from an economic perspective or for an investment strategy, but they're important also for other social sciences. That can be informative to me as well.
Karen Watkin: That's fascinating. And so, what would you say are your three kinds of key insights in terms of what you think investors should remember today about the current economic regime?
Sandra Rhouma: I think they should remember, although I'm not sure they will because again, it's the nature of the job. First thing is to not jump to conclusions. Things can be very different than what we expected them to be. And it's, you know, a data point or a data or an estimate is just an estimate. So that would be the first thing. The second thing is there's always a lot of uncertainty and we can go from one regime to the other very quickly. And we've seen it with tariffs. And it's not just tariffs. Again, if we go back to the last 10, 15 years, it's global financial crisis. We've experienced lots of crisis that shows the pandemic, the energy crisis that, that essentially show that what is true today might not be true tomorrow. The third thing Maybe have a bit more openness to think about the longer term in terms of the trends or the changes that we are seeing today. Not just look at this next six or 12 months, but have some interest on the next five years if we can have this debate, this conversation that is maybe lacking in the industry again, because the long term will be the short term at some point.
Karen Watkin: Yeah, you're right. And I think it's so important that actually we do keep sight of that bigger picture because fundamentally it's about having a view or developing that understanding about, you know, what would the world be like that we live in. Right. Not just from what it means for financial markets, but everything around us. And like you say, with economics being that social science naturally so intertwined with everything else that goes on, like you say, looking back through history or understanding what's driving politics and how that influences things is absolutely critical for us to piece it all together, which is ultimately what we need to try and do as investors.
Sandra Rhouma: I often say these days that I cannot wait to be in two or three years time. I'm just curious to know what's going to happen. Where will we be in two or three years time? Even if it's with myself, I'm brainstorming, like what can happen if this happens? There is a lot of political uncertainty, not just economic uncertainty. So in a way it's fascinating, but it's also kind of not scary. But it can have big implications for the long term and it's unfolding now.
Karen Watkin: So, yeah, absolutely. It's certainly an interesting time for us to be navigating as economists and investors.
Sandra Rhouma: Exactly.
Karen Watkin: Thank you so much for your time today, Sandra. I absolutely loved our conversation today.
Sandra Rhouma: Me too.
Karen Watkin: So, my main takeaways from my conversation with Sandra as our European economist was first and foremost that she just has such a. A calm, steady approach to the way she thinks about things. And actually, I think that's so valuable for us as investors that she has this kind of steady hand and remains really deeply rooted in thinking about what the long-term trajectory of the global economy is going to look like. And as part of that, she did a great job of explaining how important it is to be able to sift through the noise and not get distracted by some of the headlines that we see today and really remain focused on what is important in terms of the facts that she considers, but even the voices that she listens to and how that helps shape her decision making. The other thing I thought was really interesting was how she talked about the way she looks to navigate a period like today where we're grappling with so much uncertainty across the global economy. And I really loved her idea of having this counterfactual scenario so actually taking, you know, a clean slate and thinking about what is the baseline, what is the starting point, if I wasn't dealing with all the shifting sands that are happening today and again showing really the way she's able to then route her research and analysis to create probabilities and forecasts for what the future might look like. And I think what Sandra's done a big, brilliant job of is really giving us that broader context and setting us up for what we'll hear from our future guests in this series about how do investors need to think about unpicking the type of environment we find ourselves in today? And particularly for those investors looking for income, how do they navigate the shifting picture of inflation, interest rates and growth that we'll face throughout the global economy going forward? And with that, this brings to a close this first episode of Alpha, the Investment Podcast from AllianceBernstein with me, Karen Watkin. If you've enjoyed this episode, don't forget to tell your colleagues and friends about it. It only remains for me to thank Sandra Rhouma. This episode was produced by Richard Miron from Earshot Strategies.
