RAOUL PAL: Mike, welcome back.
MIKE GREEN: Thank you, Raoul, it's good to be here.
RAOUL PAL: Hey, listen, this whole theme we've been looking at it, has everything changed? And one of the things you and I have talked about and you all might go to expert on, I've been looking at demographics, and I'm actually doing a piece on this-- something, again, that you and I have looked at in detail-- I just want to try and get an understanding of what has changed here in terms of flows, where the pensions-- there's a bunch of stuff I want to look at.
But the whole top-down thing that we've been worried about about what does this do to pension fund returns and what are people actually doing right now. I don't know where to start, but where do you want to start?
MIKE GREEN: Yeah, I don't really know where to start either, actually, because this is one of the really interesting challenges as you think about those sorts of dynamics is we know that the impact has been catastrophic, right? So we know that the returns even on a year to date basis, while some parts of the market like the NASDAQ are up quite sharply here in the United States, if I look at overall portfolio exposures, they haven't done what they need to do. They haven't delivered that 7%, 8% on a year to date basis that are required to meet the assumptions that are in play.
And most of these states are running significantly underfunded pension plans anyway. Most corporations have pushed it off into some variant of a 401(k), et cetera. And so people are broadly feeling pretty good with the markets broadly having risen in a manner similar to what we had discussed in April, right?
But as we look at it now, we've lost the ability to generate those returns off of bonds. We've lost any of the sort of excess revenues that would have accrued to most states that were struggling with this. So California, for example, has blown a massive hole in its budget. New York has blown a massive hole. Chicago has almost stopped pretending anymore, it's gotten so extreme.
And so all of these things-- we've talked about coronavirus as a catalyst, it feels like the catalyst has occurred that the events are directly in front of us, but we haven't seen it yet. And as a result, we're kind of slowly walking over the cliff saying, is everything OK? It feels that way.
RAOUL PAL: So just to give people an understanding-- so I'm looking at the S&P, it's up 5% on the year. The NASDAQ's up 30% on the year. What do you think the average pension plan, these kind of state pension plans or big corporate pension plans-- where do you think they are on the year?
MIKE GREEN: Most of the data I'm seeing are suggesting that they're somewhere in the 0% to 5% range. So because bonds have done relatively well and because the major equity markets have done reasonably well on a year to date basis, I think that they're probably in that range. That would be my expectation. I think that's broadly true for most institutions as well.
There certainly were a lot of entities that chose to de-risk at the wrong time. Certainly, things looked very grim as we came into the March, April time period. And for reasons that we discussed, we had a slightly different view. But many of the strategies that people would employ that historically they have used to generate excess return have turned quite disastrous.
So regular viewers of Real Vision have heard me talk about the yield enhancement strategies, selling vol strategies, et cetera. By and large, those have been very, very hard. The performance for things like call overwriting strategies, which has been a traditional one, has just been awful-- I mean, just terrible, terrible, terrible.
And as a result, if you had engaged in a call overwriting strategy coming into April, for example, you would have given up almost all of the gains for relatively small fixed income principle-- the premium that you would have received. And so that's been, I think, very difficult for the larger institutions. And at the same time, the states have just seen their budgets blown out and the ability to add incremental dollars in is really suspect.
We forget that these are not fiat, right? They can't print dollars. So California can't print dollars. Chicago can't print dollars. New York can't print dollars. We're very dependent upon the federal government.
RAOUL PAL: And if you look at-- I've always followed the chart of tax receipts year on year versus the business cycle. Now, tax receipts have all gone negative. And that was flowing into all of these pension plans. So there's a bunch of flows that have stopped as well.
MIKE GREEN: Well, we're seeing that. So this last employment report had relatively positive numbers coming from the private sector as we rebuilt and reopened in some areas. I do want to caution people-- we have to be very careful in interpreting job information. So there are the data that's used by the Bureau of Labor statistics here in the United States, and the US tends to be the model for this. In most areas around the world, we get even worse data.
We just need to be very careful as we think about dynamics of seasonality adjustments and sampling criteria and how things are treated. There are some better tools out there that have been developed in this crisis, as there always are. If you look at things like the Dallas Real Time Population Survey in contrast to the BLS, it would suggest that we haven't seen anywhere near the sort of improvement in unemployment that the headline numbers would suggest.
But we're seeing the states do exactly what they always do, which is behave in a pro-cyclical framework. Because they don't have the revenues coming in, they have to cut. They have to reduce employment. And we're seeing that. We're starting to see those numbers turn. And those are major employers that then play into this next phase.
And I think you've quite accurately called what this next phase looks like the liquidation phase-- that we've moved out of the crisis, we've dealt with the initial cash shortage through things like PPP, and while that may have been inefficient in a lot of ways, it did provide a mechanism where employment effectively became cost-plus.
So you could borrow money, expect to have it forgiven-- initially, 75% of it needed to go to payroll. That was then lowered to 60%. Today, those funds are starting to run out. We're begging for stimulus. We're starting to see the impact of the reduction of the unemployment benefits, particularly on the less affluent in our society. But we're not yet at the point where it's become very clear what the actual damage is. The businesses are just now starting to close. The businesses are just now starting to discover that there is no recovery of many of these debts.
So before this, you and I were talking about some of the data that I'm watching closely-- things like consumer expenditures on durable goods or home improvement type expenditures, which has just exploded. So everybody at home suddenly-- like you know that deck that I wanted to put on? I'm going to put that deck in. Or since I can't spend money going to restaurants, I'm going to buy an RV and I'm going to take my family on a trip, and we're going to do remote schooling, et cetera. All of these things have transpired.
Those are pulling forward. That's a substitute. And the thing that worries me most is as we look at next year, yes, I think that we'll see some recovery of services, but a lot of people are pretty much tapped out. They've either borrowed to buy that recreational vehicle, and so next year they're not going to stay in a hotel. They're not going to replace that service. They're going to use their RV again. But it has very little stimulus for the economy once it's already been bought.
RAOUL PAL: So it's basically an inventory build at the household level.
MIKE GREEN: That's what I'm seeing. And paradoxically, I think we're all seeing this as well-- certainly we see it on Twitter-- where people are increasingly engaging in almost a Marie Kondo type exercise where they're saying, oh my god, how did I get all this stuff in my house? I ordered all these things off of Amazon. I need to start throwing them away. So my wife gives me a hard time for my Amazon complex, but it is a shared phenomenon that we all have said, well, what I really need is a thermometer to sample guests at the entrance to my house-- a non-contact thermometer, right?
And so now you go on Amazon, and you discover the thermometers you couldn't buy six months ago are all being marked down 50% because there's crazy amounts of thermometers that are out there to be sold.
This sort of inventory purchase-- what's called pantry stocking, effectively, at the household level-- has been explosive. You saw it initially with toilet paper, and then it turned into things like decks and recreational vehicles. And now we're probably going to have the hangover, right? It feels like the corporate sector is relatively low on inventories, which is starting to show up in prices. We're beginning to see used autos as people have moved out of cities and into the suburbs and discover that they needed either a first automobile or a second automobile, those inventories have been drawn down, production has been relatively tame. But, man, it's awfully hard to imagine that next year, you're going to see anywhere close to the same demand.
RAOUL PAL: So I want to pull some threads together you and I have talked about over the years. So here we are in a situation where every year there's more baby boomers retiring. We've got a potentially advantageous window in markets where they're pretty much at all-time highs. And it feels that we've got a period of economic weakness coming forwards, even regardless of stimulus because of the factors you've talked about. Unemployment's rising, businesses have gone bust, and that brings more unemployment, which brings more businesses bust-- that whole kind of insolvency crisis that happens.
Surely, that whole baby boomer population is going to start liquidating their portfolio if this continues for a period of time, because they didn't really-- and that's what I want to get into with the flows, the mismatch between millennials and the boomers that you look at so closely. How are you seeing this all play out?
MIKE GREEN: Yeah, so the interesting thing is that we're actually starting to see the flows deteriorate. We're actually starting to see some of the selling that you're talking about and that we've been worried about broadly. It continues to have much less impact on the passive sector. And so we're actually seeing an acceleration of gains of passive. And so this is part of what has been so frustrating to me personally as I watch how the model plays out.
Because as we know-- you've heard me say this statistic over and over again-- the younger generation is passive. The older generation is biased active. And so what we're seeing is the active managers being sold, the passive managers picking up those shares. It's creating increased what I would refer to as inelasticity of markets. And so when the active market participants, the discretionary managers try to express a macroeconomic view, either risk on or risk off, it causes the market to behave in a more violent fashion in each direction. Likewise, August and September was a fascinating experience, because we saw the beginning rumblings of what I would argue kind of happened in 1998 where the market had been relatively strong. If you go back and you look at '98, the market broadly had been very strong. And then it began to morph where small cap value, industrial, utilities, et cetera actually began to sell off in a fairly meaningful way from 1998 through 2000 seeing multiple contraction, et cetera as people bailed on the idea that this was a broad healthy market and instead began to focus in tech. And I would argue we've started to see that. That's by and large what seems to have been the lesson that has come out at this point.
RAOUL PAL: And I think one of the points you've raised that I think people keep missing is because a lot of people, I still see it, with the value versus growth and all of this thing-- I don't see how this isn't structural that just continues and continues. If you've got the richest, largest population on earth selling active portfolios for the next 15 years, outside a cyclical kind of market movements, on a structural basis, it's almost impossible to outperform, right?
MIKE GREEN: It's really, really hard. And so if you look at what we have seen on a year to date basis, I think it's a great template for it where you've had accelerating gains into passive. As much as everyone wants to talk about this process reversing, it's not. And we know why it's not. We know it's this demographic feature that ultimately means that you're going to see people moving.
And even when they begin to retire, they tend to fire the active manager that they had in their 401(k). And as they take those distributions, if they don't need them immediately and they reinvest it into the market, a disproportionate number of them are putting it into passive vehicles. And so this whole process is just accelerating. And that, as the audience has heard me say over and over again, creates condition for valuation inflation-- valuations rise as passive gains share.
That in turn takes anyone who is remotely cautious and turns them into a loser, which then just further accelerates this process. So you're trapped with a system that is built, in my opinion, incorrectly.
RAOUL PAL: I mean, and you've nailed this from the beginning. It's structurally evident that this is going on. And I don't see the baby boomer side of the equation changing here. So we've got a fixed variable. The only other variable is the millennials, really, because we in the middle don't matter.
So it's those millennials. So let's talk about those guys now. What changes their flow? Because I think that these guys are getting tipped out of jobs too, and that they had checks and they had stuff to keep them going, but I'm not entirely sure that they're going to have that marginal propensity to stick it in the market going forwards if the economy's slower than expected. What do you think? Is there a risk here?
MIKE GREEN: When you say marginal propensity, right, I think that's challenging. Because if anything, the millennials have been given a message that says, no, absolutely buy the dips, right? I mean, nothing could have been more clear from the experience coming off of March.
RAOUL PAL: Yeah, but it's whether you can or cannot. The issue is the economic situation we're talking about, that we talked about a few minutes ago, does that create a situation where they can't buy the dip? And then, as you said, then the volatility is all the opposite way for a while.
MIKE GREEN: So that's what I struggle with. And we haven't yet seen the evidence that that is accelerating, but we are beginning to see the deterioration in flows that would suggest that there is less capital available for people to make those incremental purchases. And I would argue by and large that we've started to see this if we look honestly at what's happened in the market.
If you're a small cap investor or if you are anything other than the NASDAQ, effectively, the past couple of years have largely been a wash. So the S&P is modestly higher than it was in February of 2018, but not dramatically higher. The NASDAQ is meaningfully higher. There's been an element of momentum outperforming value dramatically that has frustrated any number of individuals. That type of characteristic, I think, people tend to lose in terms of the broader performance, because it feels like we've done so well this year. But to your point, it's been a very narrow experience.
RAOUL PAL: Yeah, and are you seeing any changes with these employment numbers and all the other things in those passive flows from the millennials?
MIKE GREEN: We're starting to. But we can't separate-- so just to be clear, we track passive flows. And there was a good piece that came out just the other day that was highlighted, I think, by Eric Balchunas at Bloomberg where he was highlighting the fact that Vanguard has gained roughly nine times the inflows versus their nearest competitor. Now, a lot of that is because they're in the process of rotating their mutual funds to their ETFs. There's reasons behind that. There's very technical reasons behind that. Primarily, Vanguard had a tremendous advantage in their mutual funds where they had obtained a tax patent that creates what are called heartbeat trades-- so money that is pulsed into the ETF space. That had given their mutual funds an advantage. That begins to go away in 2023.
And so they are starting the process of rotating people into ETFs. And so that's a big chunk of what we're seeing. But we are absolutely seeing the inflows slow-- absolutely seeing the inflows slow. What we're seeing now, I would argue, is almost the reverse of what we saw in March-- very similar to kind of the September through January time period where, if you remember we talked about this last time, as you went into September of 2019, the Fed began to behave in a more aggressive manner towards the inversion of the yield curve, the active manager community basically abandoned the idea that there was an inevitable recession ahead and re-risked within their portfolios.
As they did that, we saw the markets pull strongly from September of 2019 through basically January of 2020. And then when they realized that there was actually a recession coming associated with coronavirus, they had to unwind their portfolios, and that caused the crash that we saw in March. The data would appear to indicate that we've seen a re-risking in the active manager community-- basically a FOMO type dynamic has pushed them in.
It's not as aggressive as it was in January of 2020, but it's definitely there. And so if I think about where the risks lie, it's that we discover that next year doesn't look so good. And so those active managers de-risk. If they do that again, we're seeing even less support coming in from buying from the passive managers. And so I think there's a very real risk that we see a significant market event here.
RAOUL PAL: Have you looked at correlation analysis between these flows and volatility, let's say?
MIKE GREEN: Well, that's one of the things that you and I were talking about this beforehand, where I was sharing a screenshot. One of the things we track very closely is factor volatility, right? So the dynamics of what's working, what's not working. And broadly, what we saw is just an explosion in factor volatility.
So while we know that momentum has broadly won since the crash in March and has continued to outperform, much to the chagrin of most value managers, I believe for reasons that we've highlighted, we're seeing tremendous volatility in those