Joe Davis: 'We Will See China-Like Growth for a Time in the United States'

Episode Summary

Executive Summary: In this episode, Joe Davis, Vanguard's Global Chief Economist, discusses asset bubbles, market outlook, and economic megatrends. He argues that big price increases alone don't indicate bubbles; fundamentals are key. He sees froth in low-quality growth stocks and some cryptocurrencies but not in housing. His team expects strong US growth in 2021, modest inflation, and value stocks to outperform growth over the next decade, with non-US equities likely outperforming US equities. Davis also explores the future of work, emphasizing that technology complements rather than replaces uniquely human skills.

Main Topics: Identifying Asset Bubbles (Priority: 5/5): Davis explains that large price increases are not a reliable signal of a bubble. Instead, one must anchor to fundamental values like earnings relative to prices and real interest rates. He analyzes the US housing market, finding no evidence of a bubble due to supply-demand imbalances, low financing costs, and lack of leverage. He is more concerned about low-quality growth stocks and some cryptocurrencies due to questionable fundamental support. Growth vs. Value Stock Outlook (Priority: 5/5): Davis predicts a reversal of the decade-long outperformance of growth stocks. He cites elevated valuations even after adjusting for technological change, and a macro environment (rising growth and real rates) favorable to value. He expects value stocks to outperform growth over the next several years, though specific timing is uncertain. COVID-19 and Macroeconomic Outlook (Priority: 4/5): The 2021 outlook hinges on health outcomes and vaccine distribution. Davis expects the US to see the highest growth rates since the early 1980s, driven by aggressive fiscal and monetary policy. Europe will follow, while emerging markets lag. He notes an 'echo wave' of recovery across regions. Inflation Risk and Implications for Bonds (Priority: 4/5): Davis anticipates a near-term 'inflation scare' from supply-chain disruptions and reopening demand, but sees this as temporary. Longer-term, continued fiscal spending could raise inflation expectations and lead to more persistent inflation above 2%. For bond investors, he expects modestly higher rates but not a dramatic doubling, and that bonds will remain a diversifier for equities unless there's a multi-year inflation surge. Vanguard's Forecasting Framework (Priority: 3/5): Davis outlines a fundamentals-based approach: using initial conditions like real rates, inflation, and earnings yields, along with long-run equilibrium assumptions, to forecast 5-10 year returns. The framework has modest predictability and is presented as a range of outcomes, not a point estimate. Megatrends: The Future of Work (Priority: 3/5): The pandemic accelerated remote work, but Davis expects a hybrid model, not a permanent full shift. Automation will replace some repetitive tasks but largely complement uniquely human skills (creativity, emotional intelligence, teamwork). He sees job shortages persisting in some sectors, creating a paradox of high automation and tight labor markets. Portfolio Diversification and Alternatives (Priority: 3/5): Davis argues that cash, stocks, and bonds remain the core, but that active management and private assets can add alpha if investors have conviction and patience. He frames private equity not as a separate asset class but as an active risk decision requiring careful due diligence.

Key Arguments: Price increases alone are not signals of a bubble; one must assess fundamental value such as earnings, interest rates, and supply-demand dynamics. The housing market is not in a bubble because low inventory, low financing costs, and low leverage support higher prices. Low-quality US growth stocks appear frothy due to very low or negative earnings and extreme valuations, even after accounting for technological investments. Value stocks are likely to outperform growth stocks over the next several years due to both improving macro fundamentals and the recent overvaluation of growth. Non-US equities are expected to outperform US equities over the next decade, driven by more attractive valuations (lower P/E ratios). Near-term inflation will rise (an 'inflation scare') but many supply-chain factors are temporary; persistent inflation above target is a longer-term risk tied to continued fiscal spending. Bonds will remain a diversifier for equities unless there is a multi-year, large inflation surprise. Correlations may rise slightly but remain historically normal. Technology and automation will replace some jobs (≈20% of industries), but for most workers it will complement uniquely human skills like creativity and emotional intelligence, leading to higher value work and potential labor shortages. The pandemic accelerated a shift to remote work, but a full permanent shift is unlikely; a hybrid model is the most probable outcome across most industries.

Data Points: Expected US Growth Rate: 5% (original 2021 forecast), now 'well above' consensus with projections of highest since early 1980s - Davis's team initially forecast 5% US and Europe growth; fiscal stimulus has since increased the pace. Fiscal Stimulus Enacted: $1.9 trillion - The recent American Rescue Plan will add 'several percentage points' to GDP growth. Job Replacement by Automation: 20% - Davis states that roughly 20% of industries will continue to see jobs replaced by technology and automation. Inflation Expectations (Breakeven): 2% to 2.5% - The bond market's expected average inflation over the next decade is now at a level Vanguard deems reasonable (up from well below 1%). Vanguard's Expected Alpha from Active Equity Management: 50 to 100 basis points - Davis believes skilled active managers can potentially add 50-100 bps of excess return annually, but patience is required. Growth Underperformance vs. Value Correlation with Macro: Roughly two-thirds - Macro fundamentals (low growth, low real rates) explained roughly two-thirds of value stocks' underperformance over the past decade. Historical Period for Comparable Policy Stance: World War II - The combined monetary and fiscal stimulus is the most accommodative since WWII.

Pivotal Quotes: "The more we go into the government spending side, the more we just have to have that conversation with respect to tax receipts to actually offset the expenditures." — Joe Davis: Discussing the need to balance new infrastructure investment with funding sources to avoid persistent inflation. "The more that one can embrace computer as an asset, not as a competitor, the more one's own career value is higher, the more one is able to contribute, and obviously the higher wage and career prospects one will have." — Joe Davis: Explaining the 'uniquely human' skills and how technology complements rather than substitutes for most workers. "We could still live in an environment where there's headlines of potential bubble concern or underperformance for a time from the growth universe. And that may not mean at all that one's broadly based portfolio is experiencing negative returns because the leadership could rotate." — Joe Davis: Reinforcing that a growth stock correction does not imply a bear market for diversified portfolios; leadership rotation can sustain positive returns.

Implications: Investors should temper return expectations for growth stocks, especially low-quality, and consider tilting toward value, non-US equities. Bonds remain a diversifier but with modestly higher correlations and rates. For careers, embracing technology as a complement is key. Policy will face a balancing act between spending and taxes to manage inflation risk.