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During a recent event in New York City, Chief Investment Officer Tony Roth, Head of Investment Strategy Meghan Shue, and Chief Economist Luke Tilley discussed their 2024 Capital Markets Forecast, the team's economic and investment outlook. During the in-depth discussion moderated by CNBC's Sue Herera, the team shared their thoughts on a variety of topics, including the overall economy, the current investing climate, and artificial intelligence.

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U.S. Economic Exceptionalism: Can the reign continue?

Tony Roth, Chief Investment Officer
Meghan Shue, Head of Investment Strategy
Luke Tilley, Chief Economist


Tony Roth: Welcome to Capital Considerations. I'm Tony Roth, chief investment officer for Wilmington Trust. Last week, we held an event in New York City where we shared our 2024 Capital Markets Forecasts, my team's economic and investment outlook for the year ahead. During our in-depth discussion, which was moderated by CNBC's Sue Herera, Wilmington Trust's Head of Investment Strategy, Megan Shue, Chief Economist Luke Tilley, and I shared our thoughts on the year ahead, the overall economy, and the current investing climate.

I hope you find this discussion useful. You can learn more about our 2024 Capital Markets Forecast at WilmingtonTrust.com.

Sue Herera: So Tony, I'm going to start with you because you penned the opening piece and you talk about the dynamic nature of the U.S. economy and the reason it has been able to be dominant in terms of its share of the world economy for so very long decades long, which is rare, and it's based on three basic pillars of economic growth. Tell us about that.

Tony Roth: When we set out to write this report every year. We have a lot of back and forth around what is really from a macro standpoint, the story what's really driving things. And then the goal is to take that. And if we're right, that's really the set of elements driving the economy. It should be really easy to translate it into the markets.

And I think that's what the report does this year really nicely. And what was really evident to us, having been two or three years now post pandemic and looking at what's happening in the U.S. where we had that massive second quarter growth, for example, a third-quarter growth of around five percent. Not that it was really, really even at all outright because the data's a little bit wonky but was how powerfully the U.S. yet again has adapted to a very difficult set of circumstances and sort of powered out in advance of the rest of the world. So, we gave a lot of thought to why that was, and it became evident that that's been the case through most of the major economic crises since World War II. We sat down and we sort of challenged Luke and his team to come up with a reason for that.

And they put together this table, which is really what you're alluding to, around those pillars of growth that lay out the features of about a dozen or so countries’ economies. And it became really clear when we did that, that while the U.S. is not first in every category, we're right up there in almost every category.

And by having the size of an economy that we do, with the features that we do, there's really no other country that's even remotely close. I mean, there's some of the Scandinavian countries that have certain characteristics, like really good digital infrastructure, and there are other countries that have lots of people.

From a demographic standpoint, lots of people makes it easier to find people to work and to accomplish things, but we've sort of got everything. When you look at what's happening in this particular cycle, there's sort of three things that are really acting on the economy in a very powerful way. Two of which are essentially manifestations of this very exceptional dynamism that the U.S. has.

And the third is a temporary phenomenon that may actually be our undoing and we talk about it a lot on the risk section, which is sort of the fiscal state. The first one is the innovative capacity of the country. Due to our pluralism or educational system and whole ethos of entrepreneurialism that exists in the U.S. we have a very unique ability to discover new forms of creation and productivity, etc. That's happening now probably most prominently with artificial intelligence, where we're the leader of artificial intelligence, but it happened as well in the pandemic when we had to find a way out of the pandemic and American pharmaceutical companies were really at the forefront of not only identifying through the new mRNA vaccines, you know, ultimately the vaccine, but also figuring out ways to produce it, distribute it, the whole thing.

So the innovative capacity of our economy is the first thing. The second is the labor market that we have and the flexibility. There were a lot of periods after the pandemic had hit where economists would talk and we would talk with each other and we'd say, gee, are these people that left the labor force, are they ever coming back?

And when we look at the amount of new jobs that have been created.

Sue Herera: Mm-hmm.

Tony Roth: For example, in 2023, and the amount of new jobs that get created every year, and this is good. Another hot labor report, and Luke is like, you know, maybe just quickly say what you said to me about how the supply side versus the demand side picture of the labor force and how it actually helps with inflation.

Luke Tilley: Every time the labor report comes out, and it has been come out stronger than expected for more than a year, there's a lot of concerns that too strong of job growth and too strong of wage growth is going to keep pulling inflation up. People are making too much money. They're going to spend it. They're going to pull inflation up. While that's certainly a factor, what gets overlooked is the supply side. And over the past year, the best thing that has happened for inflation is job growth. Incredibly strong job growth in medical care services, leisure, and hospitality, because those are all the firms that were facing really strong demand but didn't have enough people to provide those services. And the strong job growth, especially over the past year in services in those categories and some others enables firms to do that.

In that way, the strong job growth is a supply-side impact and helps bring inflation down. Now those two things are going on at any given time. The demand side that gets more focus than the supply side. Right now, the supply side is really outweighing that demand side. And it doesn't really get enough play, I don't think.

Sue Herera: You were on the forefront of saying that inflation was going to decline faster than a lot of people thought. We got the CPI report. All the headlines were inflation is coming down, but there were some worrisome things in that report, even though the core was right where it was supposed to be. Does it change your forecast on inflation?

And does it change your forecast on how quickly the Fed will pivot to cutting rates?

Luke Tilley: No, it doesn't change either the inflation forecast or the Fed reaction that we expect. So, we actually expected the Fed pivot that happened in the middle of December, that they would pencil in the three cuts, and that that's not going to be enough.

I think that there'll be five cuts that start at the June meeting and then continue through the year. What we've seen is the jobs report for a year has been coming out and sort of surprising to the upside and wage growth to the upside and a lot of hand wringing over “Isn't this going to cause more inflation?,” yet inflation keeps coming down. You would think after 12 consecutive months of that, people would sort of “Oh, wait, maybe this is what's going on” and get that supply side thing. And what it really comes down to while we were basically right with the inflation forecast, we were too pessimistic.

I was too pessimistic about how strong growth would have been last year. We did expect it to be lower. And I think it points to the economic exceptionalism and the dynamism, all of the labor flexibility that we go to in a very deep way. And it's basically that U.S. firms have The flexibility and the wherewithal and the ability to manage through those high labor costs and to innovate through them innovate labor costs.

Sue Herera: And to innovate through them.

Luke: Innovate labor costs. It's going to keep going with AI. They're able to make themselves more profitable. And what we've seen two years ago, it was the solving of the physical supply chains and goods prices coming down. And then the past year has been on the services side. Through both of those years, it's been the exceptional firms in the U.S. managing through it.

Sue Herera: So, Meghan, as you put together all of the components in this report, and you look at how the firm wants to allocate its resources and its cash, you have an overweight in U.S. large-cap equities. Do you still maintain that? And as I understand it, you're also taking a closer look at small cap as well.

Meghan Shue: As asset allocators, we're constantly looking at where is the relative opportunity? And a lot of what you're hearing from Luke and from Tony is really that the U.S. has been a standout place from an economic perspective and also from an equity and market perspective. We do think that that will continue. So, if we're looking across the globe, where we really want to be is to continue to focus and to put a higher weight in our asset allocation on U.S. equities and there's a number of reasons for this. There's a lot of concern about valuations of U.S. equities and we've seen a stellar performance from the U.S. equity market, a lot driven by a very narrow part of the market. And I think what we're going to see in 2024 is really going to be continued leadership of U.S. equities, which is why we have a higher weight to U.S. versus non-U.S., but really a broadening out of participation.

Sue Herera: Mm-hmm.

Meghan Shue: Other sectors sort of picking up and running with the baton from a valuation perspective. And then also participation from some of those asset classes that started to show some life…

Sue Herera: Right.

Meghan Shue: …at the end of last year. U.S. small cap being one of them where if you're talking about U.S. leadership from an economic perspective, smaller companies getting more of their share of revenue domestically, and then expecting that soft landing, we think small cap can continue to do quite well, but it's probably going to be a year more modest.

Sue Herera: Right.

Meghan Shue: Equity returns.

Sue Herera: Are there certain sectors within both the large cap area and the small cap area that you favor more than others?

Meghan Shue: We do think about sectors. We also think a lot about the factors underlying equity markets. The way we're sort of thinking about it is kind of bar-belling to a degree where we continue to like the mega-cap tech stocks that are going to more likely than not continue to deliver an outsized share of earnings growth this year.

But also wanting to have exposure to some of those parts of the market that have lagged. Sectors like financials and industrials where we've had a very difficult manufacturing environment, a little bit more value, high dividend. We think that that will show life as well. So it's a little bit about kind of playing both ends of that.

Sue Herera: Mm-hmm.

Meghan Shue: Diversifying. And then maybe in the middle where we're a little bit less enthusiastic are some of the more traditional defensive type of sectors.

Staples, for example, where It's probably going to be a little bit harder to pass through cost increases if Luke's forecast about inflation is correct,

Sue Herera: Right. Tony, also the, a lot of this is premised on the fact that the Fed will be able to literally land a soft landing and we avoid recession, correct?

Tony Roth: If we were to have a recession, I think we probably would see a more significant drawdown in equity values, as we typically do see as you enter a recession.

We're pretty confident at this point we're not going to, at least in the next three calendar quarters, we're not going to see a recession. Economic growth is pretty robust. Look at the Atlanta Fed GDP tracker continues to do very well. The consumer continues to be in a very good position.

And financial conditions are easing. They're still very tight, frankly. So I think there's a lot of false news around the idea that financial conditions have eased radically. They've eased a little bit. They're still tight, but as they ease, as we get into the year, that's going to support the consumer, support companies, and will continue to provide another source of growth essentially on a relative basis.

Sue Herera: Luke, I take Tony's point, but as I travel around the country, economic dynamics are very different depending on where you are. There are certain parts of the country that are heavy in manufacturing. When I go there, they feel like they're in a recession. Other parts of the country that have more diversified economies, maybe more exposure to tech, they're doing fine.

What makes you feel as though the Fed is going to be able to negotiate the variances in the economy and bring in a soft landing?

Luke Tilley: Manufacturing is in a recession. If you use the ISM index for manufacturing, I think it's 14 straight months that it's been below 50 and it's really been going through a lot of pain as the spending shifted from goods to services.

And of course, tech companies doing very well. So it's a very differentiated experience. In terms of the soft landing. What is the Fed looking for? They are looking for a slowdown in the economy, which is happening. They are looking for normalization of the labor market, which has definitely happened. So, last year, the biggest change, as I was talking about labor force growth and labor flexibility, about two and a half million people added to the labor force, about two and a half million jobs added, so sort of a one for one there, but the number of job openings fell by two million.

There's a lot of hand wringing every time the jobs report comes out, and it's on the strong side, but what they're really looking for is that normalization of supply and demand, and the demand for labor is really falling, as we can see with the job openings, and that's what's really helped with the wages.

So that's, I think, one of the keys, and really one of the big surprises. Jay Powell in the fall of 2022 was saying in order for us to get inflation under control, there's going to be a lot of pain in the labor market. There's going to be pain. We're going to have to be experiencing pain. Hey, did you hear me mention the word pain?

It was so resounding. And Larry Summers said,

Sue Herera: Well, would you really want to be Jay Powell?

Luke Tilley: No, no no.

Sue Herera: He's looking for an out.

Luke Tilley: I'm not saying, I'm not saying I wanted his job, but he thought that the labor market was going to have to collapse and we'd have to have high unemployment in order for inflation to come under control.

Larry Summers said we need two years in a row of seven and a half percent unemployment to get inflation under control, and that hasn't happened. So, I, I think more than anything, the Fed is sitting around and looking and trying to decipher and figure out why has it come down so much, realizing that not as much pain is needed.

All we really need is for the Fed, and I think they will be recognizing that they got way too pessimistic about inflation. around September, October, November. They've come back down since. And their forecasts are still too high, frankly, for the core PCE is still too high for this year. Over the next couple months, they're going to realize that.

The rates are going to come down. We still put a material risk on recession, 25% to 30% chance of recession, and that's going to be if the, the lagged impact of rates hits a little bit harder than we expect. Things are slowing down in a, in a way that you would hope with the soft landing, and once the Fed starts to bring those rate cuts, it'll really help, as Tony was saying.

Sue Herera: Meghan, you mentioned the fact that you're very domestic in terms of the concentration. Are there other markets, though, around the globe that you think hold value for people, or not yet?

Meghan Shue: To be clear, we're definitely diversified. We hold our benchmark weight. to emerging markets, which has been a tricky spot.

Sue Herera: I bet.

Meghan Shue: Certainly, you've got some areas of growth within the emerging markets space that have really done well, and then China's the elephant in the room. That has just been a really difficult region to allocate to with, over the last couple of years, a much higher risk premium in terms of policy risk, economic risk.

If I look back at 2023, China's probably one of the biggest surprises. If we had been sitting here one year ago, there was a lot of enthusiasm around China's reopening and the economic resurgence that we'd see, and just none of that happened.

Sue Herera: The trade tensions weren't there either.

Meghan Shue: Exactly, and you've got a lot of investors rethinking how to allocate to China and fund flows coming out.

So, that's a tough spot, but we hold basically a market weight there. In the international developed space, that’s something we’re eyeing. Valuations are certainly very attractive.

If you’re looking relative to the U.S., it probably wouldn’t take too much in terms of a catalyst to see some really outsized returns. And actually, Europe has been a really challenged economy and had very robust, on an absolute basis, returns for the equity market last year, so.

Tony Roth: One of the things I was going to add is that when we think about China specifically, it's caused us to essentially maintain a neutral weight to emerging markets and allow our active managers to discriminate among regions and geographies because we didn't have the courage to allocate away from China because China has been such the bull, if you will, in the emerging space.

And if you allocate away from it, then you add all this tracking error to your portfolio. But we're starting to realize now that when you look at the emerging markets, not including China, the price-to-earnings ratios are seven to eight in most of these markets right now. And the growth. is around 25% to 30% more than developed countries and their corporations.

Allocating to EM ex China is becoming an increasingly viable strategy and, uh, that's something that we're, we're talking about.

Sue Herera: But doesn't it play to the concept of U.S. market superiority? If you are looking at where you want to allocate cash without some of the risks.

Even though one year ago it might have been China, I mean, I remember a year ago we were talking about the fact that China still looked pretty good.

Does that not, Tony, basically put forward the concept of the U.S. is the best house on the block?

Tony Roth: Certainly, long term it is. We look at, for example, the reality that since 1980. The U. S. Has basically maintained its share of global GDP at 25% and Europe and Japan have had their shares of global GDP cut in half.

And since the end of the pandemic, relative to long-term trend, our growth is about 2% below long-term trend. Europe is 4% below. So we've added twice as much growth on a relative basis to Europe since the end of the pandemic. So all of the structural secular factors suggest that the U.S. is going to continue to dominate. But from a 2023 perspective, which is our focus on our forecast, ultimately. We're not looking for the U.S. to deliver more than probably high-single-digit returns in the equity space. And so there will be some pockets around the world that will outperform, and particularly with the dollar probably weakening from here, we can't ignore those areas.

Sue Herera: Mm-hmm.

Tony: So right now, we certainly like the U.S. in the developed space the best, but to the question you asked Meghan about emerging markets, for those that have courage, there are some pretty interesting opportunities starting to shape up there.

Sue Herera: You mentioned Japan, and it takes me back to your opening premise about the fact that one of the things that makes the U.S. able to hold on to its dominance is labor flexibility, which Japan does not have. It has problems with its labor force. It has an aging population, which granted, the United States does as well.

Tony Roth: Not to the same degree.

Sue Herera: No, definitely not to the same degree. I think it underlines the premise of the report, which is those three pillars, and especially if you include innovation, really takes the light off of a Japan or a China and shines the light brighter on the U.S.

Tony Roth: Yeah, I think that's true. And Europe has the same problem. If you look, for example, during the pandemic, France and Germany would not allow their companies to lay people off. They wanted to protect them. But it had a very negative effect on those companies’ ability to evolve. When the pandemic ended, they didn't have the same earnings power coming out of the pandemic, and consequently, they're not nearly as productive from an innovation standpoint or from a profitability standpoint as American companies are.

Sue Herera: You could argue, though, Luke, the labor flexibility may be here in the United States, but the Fed was incredibly accommodative. They threw a lot of money at the markets, at the economy, at individuals, and that has pushed us into uncharted waters as it relates to things fiscally, correct?

Luke Tilley: Yeah, the third section of our report looks into those risks and opportunities.

And certainly the biggest risk that we see to the U.S. dominance and that constant share of GDP that Tony is talking about is the fiscal situation. It's the only spot in that large table where the U.S. ranks really poorly. We're hitting that point that people have worried about for a long time, that 100% debt-to-GDP ratio.

Sue Herera: Right.

Luke Tilley: It's kind of an arbitrary number. What happens when you cross 100? There's a lot of research that shows your growth slows after you get past 100. It can really hamstring a country. Japan was a hard-charging country and really taken over the world in the 60s, 70s, 80s, and 90s. 1990, it stopped on a dime.

Real estate bubble popped. But also what had happened is they had added their debt-to-GDP ratio. They had increased by about 30%. Over the 15 years leading up to that and they hit that hundred debt-to-GDP ratio mark So it went from 70 up to 100. That's the exact same thing that the U.S. has done over the past 12 years added about 30% to the debt-to-GDP ratio. We’re at that 100 mark.

For a lot of people you almost get in a place where it feels like a given that the U.S. is going to remain at the top, and you know emerging markets are going to grow fast, but the U.S. is going to be able to hold its place. But one of the main risks is that we may be hitting that place where the fiscal situation makes it much harder for the U.S. to respond and it's a real Achilles heel right now.

Sue Herera: We're in an election year. There's always volatility in an election year and some of it may be around the ability or inability to get both sides around the table and address the fiscal concerns.

Tony Roth: That's right. And we did mention in the report the level of cooperation.

Essentially, that needs to happen in order to keep the overall level of debt relatively stable as a percentage of GDP. So, it's cutting around, you know, given the numbers coming into the year was about $300 billion. But, the deficit in the first fiscal quarter of the year was 500 billion alone.

Sue Herera: Mm-hmm.

Tony Roth: And it's really important to go back and look at what happened in the fourth quarter from a market standpoint in the U.S. because both of the major inflections that we saw in October when the market sold off and then in November, beginning of November, when the market took off. They were directly tied to the messaging from the Treasury department around the magnitude of treasurer issuance. First after the debt ceiling situation, Treasury Secretary Yellen came out and said, well, we're going to have to issue a lot more debt to refund the general account, I think $320 billion more than expected.

And that sent the equity market into a tailspin. Ultimately, she came out in November and talked about the total issuance for the next fiscal year. And it was lower than expected. And that's what actually initiated the big equity rally that we experienced. As we get into 2024, the total level of Treasury issuance is going to be very critical and whether there's buyers for that paper.

If the Treasury expands the pie or expands the level of issuance and we still have a sticky inflation situation, that could potentially be a real problem because it means that the real yield you get for that Treasury paper…

Sue Herera: Mm-hmm.

Tony Roth: …is a lot less attractive. If inflation is very low, relatively, and they're issuing more paper, it'll probably still get sold pretty well because the real yield will be attractive.

So, so a lot of nuance in how the amount of deficit we're going to have in this fiscal year could actually impact financial markets.

Sue Herera: So if you had to pick one or two statistics that you think are the most important or influential for the market right now for each one of you? Which would it be? I mean, I know you watch inflation, so it might be the CPI for you.

But is there another indicator that you think is really important that might not be top of mind for most investors?

Luke Tilley: Outside of inflation, huh? Yeah, I think the core PCE is the main one. In terms of what's driving it, it’s how consumers are spending. So it's nothing hidden, it's nothing secret, but we've seen consumers slow their spending dramatically over the past couple of years. Retail sales right now running at about 4% year over year.

A year ago it was at 8 a year before that it was at 18. We need to see that continued slowdown in consumers for the soft landing.

Sue Herera: Mm-hmm.

Luke: That ties directly to the inflation number .

Sue Herera: Meghan?

Meghan Shue: I would say earnings There's a lot of really positive expectations baked into the market for this year in terms of about 11% to 12% earnings growth, and it's threading a very small needle, I think, in terms of…

Sue Herera: Are you that optimistic?

Meghan Shue: I think we're probably going to come in lower than that. We've already seen fourth quarter revised down about double what we typically see in terms of earnings revisions. But if we're going to get the inflation forecast and the slower growth forecast that allows the Fed to cut, it probably means earnings might not hit the targets that that are being priced in right now.

So I think it's going to be  helpful to watch what the fourth quarter shows. Also continue to be really helpful to, to listen to guidance and what management's saying about any concerns, slowing consumer, but maybe not to a concerning level that would be sort of hitting that sweet spot.

Sue Herera: Sweet spot.

Meghan Shue: That Goldilocks, if you will.

Sue Herera: Tony?

Tony Roth: Yeah, for me, I think it's real rates. It's understanding where the real rate environment is. And if it gets very sticky where it is now, which is around 2%, so it's higher in the short end of the curve and the long end of the curve. But if real rates get stuck in that area, that implies that inflation is not coming down because the Fed is not cutting.

And that's really the scenario. I think that's most likely to lead to a recession is if real rates get too high or stay too high and they don't come down quickly enough.

Sue Herera: If indeed we do miss the soft landing and go into recession, every recession is a little different, just like every crisis in the market is a little different.

Is the economy on strong enough footing, and the consumer on strong enough footing, so that if we did miss the soft landing, it would be a shallow, short recession? What are your thoughts?

Tony Roth: Well, I think that, yes, it would probably be a shallow, short recession because the economy is on very good footing when you consider the productive nature of the economy.

Productivity is doing terrific, and so I think that companies are hoarding their workers because they're seeing the productivity gains and they're seeing the consumer doing so well. So I think that that would make for a fairly shallow recession, but whenever we have a recession, you also have fiscal support.

Sue Herera: True.

Tony Roth: And from a short term standpoint, we're not in a political environment where you're going to see Republicans play ball with the current administration and want to provide any rescue, if you will, from a political standpoint, if we have a recession this year. Having said that, I also think that the Fed is going to be under a lot of pressure to manage the economy in a way that avoids a recession, if at all possible.

So to the extent that we start to see a real deceleration in growth and there is a plausible argument from an inflation standpoint to continue to really take the foot off of the brake, the Fed will do that, I think, to try to make sure it's not perceived to be playing politics by causing the economy to go into recession, etc.

Sue Herera: Right.

Tony Roth: So I think that…

Sue Herera: That's a delicate dance.

Tony Roth: It's a delicate dance for the Fed, but they're definitely going to be under a lot of pressure if we have very slow economic growth to lower rates.

Sue Herera: Thoughts, Luke?

Luke Tilley: Absolutely. I mean, when inflation's at 9%, they had to do everything they could to bring it down. We're closer to 3% now, and they have said, explicitly, we’ve got to treat both sides of the mandate now, too.

They're focusing as much on the unemployment side. It's the first time just over the past couple months that they have explicitly said we have to consider both sides of the mandate kind of equally and, uh, what that means in very much layman's terms is they don't need to clobber the economy over the head just to get us from inflation of 3% down to 2%.

Sue Herera:   Right.

Luke Tilley: It's really not worth it. They're going to be feeling that pressure that Tony is talking about and you can, with a very straight face, say, yeah, we're going to cut rates from 5%. to 4%, to 3.5%, and still call it restrictive, which would be true, but you're taking your foot off the brake, as Tony said.

You're not putting your foot on the accelerator, and I think that they have the ability to do that.

Sue Herera: And if indeed we did get a short, shallow recession, how would the market react, do you think? What are the implications?

Meghan Shue: Typically, in a recession, and it does depend on the depth of it.

Sue Herera: Right.

Meghan Shue: You see earnings contract at least 10%, probably more like 15%.

We'd probably see the market pull back. I think you'd probably see at least a 10% correction in the market, but it's been a very tricky cycle.

Sue Herera: That could be healthy too.

Meghan Shue: It could, it could. A bit of a reset. It's been a tricky cycle. We had a deep draw down. And no recession, and we've had arguably rolling recessions through the economy, whether it's real estate or manufacturing, so I think in the case of a mild recession, you'd probably see one of the more modest equity market corrections that we've seen historically in terms of recessionary drawdowns.

Sue Herera: Now, what is perhaps on your radar that might not be on someone else's radar? What keeps you up at night, Tony? What do you worry about?

Tony Roth: Well, again, I worry about the government spending too much money. Where real rates are today and where treasury's nominal rates are today, it's not that attractive to buy a treasury bond for 10 years or whatnot.

If in fact we get to a point where We continue to have the inflation that we're having, and the government continues to spend money and has to fund that it’s going to become even more difficult for the government to have successful bond auctions, and we'll get to a point where we end up with a much deeper yield curve because nobody wants to buy long term U.S. debt.

Sue Herera: As a firm, have you been laddering the bond portfolio? Have you been going out in duration?

Tony Roth: We have been pretty tight on duration. We've been close to the benchmark, but under the benchmark on duration, which has hurt us a little bit as rates come down, but we've also done a great job from a credit research standpoint.

As spreads have come in, that's helped us in our portfolios. We've done well in fixed income overall because of our credit work. We've been very conservative and cautious by not extending out too much in duration, actually.

Sue Herera: Fair enough. What worries you, Megan? If anything at all, maybe, maybe not.

Meghan Shue: No, I worry a lot.

Yeah, I'm a very stressed person, so I'm, there's definitely things that worry me. I would say what worries me as a markets person who looks at the shape of the yield curve, who looks at the tightening of the senior loan officer survey, all of these things that I do worry in hindsight would have been like, How did we miss this?

We had all of the signals that we needed to get. And this has been a very unique cycle. But I think it's also quite possible that all of the refinancing that happened with consumers with the housing market, with businesses refinancing at very low rates, that maybe it hasn't made the U. S. economy immune to the Fed tightening that we've already seen.

But just maybe that impact is being delayed and pushed out, so we have more of a lag than we typically do with those indicators like an inverted yield curve.

Sue Herera: Now I know economists look at the numbers and try and factor out emotion, but what worries you?

Luke Tilley: Within just the econ forecasting space it's that if we're wrong about the soft landing if I'm wrong about the soft landing and we end up going into recession, that cake is already baked. And it is really just that lagged impact of the higher rates hitting firms harder than we expect. Because if firms decide to pull back on capex, they have slowed down this year, their intentions have slowed down, but it's still positive.

If their hiring intentions slow down and the jobs go negative, we are going to have a recession. I mean, that's all you really need is job losses and we will go into recession. And if that happens, it's basically because the rates are going to hit harder than we thought. That's what I'm worried about.

Sue Herera: Okay. I would put to all of you that the theory that's out there right now is that AI is going to save the economy, create different jobs, help U.S. firms, and U.S. firms dominate the AI space. Whether you're talking about chip production with NVIDIA, whether you're talking about the top tech firms dominating AI.

And there are some who predicted that AI will usher in a super cycle of growth. Do you guys agree with that? Tony?

Tony Roth: Yeah, largely, we agree with that. We define it a bit more broadly than just AI. We would say it's innovation. So you can look at a lot of innovation that's happening in the energy space, whether it be finding more hydrocarbons or whether it be finding new ways to enhance battery efficiency or electric motor efficiency.

A lot of that is driven by AI, but not all of it. In pharmaceuticals, the ability to find the right compound to help with cancer, a lot of that's driven by AI, but actually not all of it. AI is probably going to be responsible for a large share of the innovative capacity of the economy, but I don't think we should put it all onto AI.

But it's AI, along with the labor flexibility that we have in our economy, that is going to, I think, create the super cycle for the U.S. Now, the one thing to note is that that doesn't mean that there's going to be equity. We still have a problem in this country of income distribution. AI could have the impact of widening the income distribution between the haves and the have nots, and that creates other problems both socially and politically, et cetera.

So, we have to be sort of mindful of that and sort of aware of that, that these super cycles, while great for the overall economy, don't speak to the distribution of those successes.

Sue Herera: Interesting.

Tony: And so that's just something to, to be aware of because it's that disparity in distribution that also causes a lot of political polarization as is being felt not just in the U.S., but in a lot of countries around the world.

Sue Herera: Mm hmm. Meghan?

Meghan Shue: I think AI is very exciting and what we've seen is a lot of the enthusiasm priced into sort of the first order companies. The AI producers, the tech companies, the software companies. I think what is a longer-term story. So you have to really lengthen your investment horizon 5, 10 years is really seeing the productivity and earnings benefit to all the users of AI, which I don't think is really priced into the market at all right now, in part because it's really hard to know…

Sue Herera: Right.

Meghan Shue: …how to quantify that and just which types of companies will be able to reap the greatest benefit.

But I think there's a big story there that's not even remotely priced in at this point.

Sue Herera: And what's the economic impact overall, do you think? As Meghan so aptly pointed out, there's a lot of, some fear about AI. There is also enormous enthusiasm about it but there's uncertainty. We're not sure exactly what the impact could be.

Luke Tilley: The impact will be huge and it will be productivity and it will be over a very long timeframe. The most exciting things to think about are some of the things that Meghan mentioned, you know, the finding the right compound and medical services that that Tony is talking about.

From just a pure economics perspective, if AI can help everybody do their job 2% to 5% better the overall economic impact over years is just absolutely astounding. And it's not as sexy to think about somebody who's using it to write a little bit more reports or do it just to be a little bit more productive here and there. The sum impact of that would be extremely similar to the personal computer where…

Sue Herera: Right.

Luke Tilley: …when that comes out, all the scary stories are about how it's going to replace and nobody's going to have a job. Or the internet, where a lot of people are thinking, what are we even going to use this for? I don't even know how to use this. But it sort of permeates companies and it makes it easier to have a meeting or to send an email from one end of the, the, the building to the other.

And it's those millions of tiny increases in productivity that would cause something like a super cycle and help with profitability and help with all of that.

Sue Herera: And with the breadth of the U.S. economy, that could be huge.

Luke Tilley: Yeah, absolutely.

Tony Roth: I want to just add on to that, because a lot of people think about AI and they think, you know, I missed the boat because I didn't buy NVIDIA or haven't bought Microsoft early enough or whatnot.

And those are the providers of AI. We manage a lot of equities that we allocate to external managers and we manage a lot internally. And we have built, if you will, a hygiene around security selection in the equity space. What is good for this type of company in that industry group from an AI standpoint. So, for example, we were looking at the other day at two health care insurance companies. Where one has deployed AI in a very, very effective way in terms of how it communicates with its, the client of a health care company.

Sue Herera: Policyholders, client interests.

Tony Roth: Policyholders, patients, whatever they call them, right? The difference in consumer satisfaction was so large that this first company that deployed AI in its communication strategy had a much higher level of client retention and new client attraction versus the other company, which was years behind.

So you find applications where you don't expect it when you're actually looking to buy securities and put them into the portfolio. And it's building that muscle memory today around looking at companies, every single company in every industry group that we think will lead to much greater equity performance, superior equity performance over time.

Sue Herera: This group of very, very smart people have put together a wonderful case as to why the United States is probably, and the U.S. market is probably still the best place to be. Thank you guys very much.

Tony Roth: I hope you found this discussion useful. As you think about your own investment strategy. Visit wilmingtontrust,com to learn more about our 2024 Capital Markets Forecast. We will return with new episodes and insights in the coming weeks. 


This podcast is for educational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or recommendation or determination that any investment strategy is suitable for a specific investor.

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