Dan Lefkovitz (3:02)

Yeah, it seems like all the talk of stagflation has sort of receded. Curious whether you think there's any risk of inflation flaring up.

Joe Davis (3:10)

Well, I think more important than the inflation flaring up, Dan, is just the fact that it's remained stubborn above 2% now again it's in the low to mid 2% range. It's not going to turn over the fixed income market in any way, shape or form. I think we do have some head headline risk if businesses have really been waiting for clarity. But I think that will push both ways, at least on the bond market because you'll have some of that drag on growth. So we're not overly concerned on stagflation. I think where you would be concerned is if there was a really rapid rise that's being also followed on by which is tough to see continued vigor strength in the labor market that would keep the Fed on hold for an extended period and the financial markets aren't priced for that.

Christine Benz (3:57)

I wanted to ask about the equity sell off back in the spring when we saw treasury bonds drop at the same time stocks did kind of in the worst of that period. Should we be worried about the nice inverse correlation that Treasuries have had with stocks that that is undoing itself in some way? I know that some people have been worried about that. I'd be curious to get your take.

Joe Davis (4:22)

Well again in our diagnosis is in the next several years bonds will clearly still remain balance which is that negative correlation you mentioned, Christine. But I think with our diagnosis, we put our finger on it over three years ago is that we're going to have a higher interest rate environment which we currently are in now. I'm talking about three years ago we were closer to the zero bound. And why that's important is in that environment, oh a good decade or more we had really negative correlations. So you talk about supercharged diversification. We're still talking about bonds as a ballast. Maybe the correlation is, I don't know, 0.1 or 0. When stocks fall you're generally going to have bond prices eventually increase. It just won't be as rapid on average as in the past. Maybe not just because you have slightly higher interest rate but that comes with a very positive dynamic which is higher income for bond portfolios writ large.

Dan Lefkovitz (5:19)

Despite interest rates seeming to remain higher for longer. We have seen some weakening in the dollar since the start of the year. Wondering what you see as the major forces pushing it down and should we be worried?

Joe Davis (5:30)

Well, again, I think it's not so much worried because I think, and Dan, I'm not going to pick on your words, it's more of just worrying. There's two forms of worry. One is you're aware of it from a risk management perspective and then secondly one could be very alarmed. I'm not alarmed but I think it's a glimpse of one potential future. I know we're going to get to the book. I think what ultimately is driving some of the dollar weakness, it's partly related to our building national debt and fiscal dynamics. This gap between revenues and expendit. Know the tariffs were generally at first the headline but underneath that gets effectively financing a financial dynamic. So I'm not alarmed with a capital A, but I think it's a glimpse of a future where there may be a little bit higher interest rates that we have to demand from overseas investors will demand for sustaining our debt. But again, I don't want to paint that as an alarmist picture but it's a glimpse of one potential path if AI doesn't really accelerate.

Christine Benz (6:29)

So we have seen non US stocks perform pretty well relative to US for the year to date.

Joe Davis (6:36)

Finally.

Christine Benz (6:37)

Yeah, right, right. And I wanted to ask about that because you and the team for several years running coming into this year had been pointing to non US as being inexpensive relative to us. Is that still the case even with the rally factored in?

Joe Davis (6:52)

It is, although that's a, you know, I'd say to be fair to all your listeners, you have to hold yourself accountable to forecast. And it's a dated narrat. Someone could be kind and say oh Vanguard was early. You could also say we were just wrong because you're talking about five years saying that there was a prospect for overseas outperformance. Now again that drags in the valuation which you mentioned. Christine, I will take a step back. We've been digging at this hard because what's really going on with what some call US exceptionalism, this sort of US equity market stellar outperformance and how sustainable is it? Our rationale for all investors to have some non US exposure really has nothing to do with, in other words how cheap or rich certain markets are. That has a bearing on how much you have say of non US Stocks. But in terms of why would one have any at all? I mean our founder Jack Bogle wasn't a huge fan of overseas investing. It comes down to two reasons and it's around risk management. One is the fact that on average over long periods of history, roughly 4% of the stocks in the US and 2% globally have driven roughly half of the equity risk premium. You've talked about this on the show and otherwise, it just so happens the past decade virtually all those companies have been based in the United States. So I think from a risk management perspective, if you don't have any non U S exposure, you may not realize that that's a really strong technological bet that the future 4% of companies will solely be based in the United States. I mean it could, but I'm not 100% confident that would be the case. And you could do one minus the probability of that happening is a loose rubric or rule of thumb to have non U S exposure. The other is modest risk management. From our currency I mention mentioned, you know, some of our fiscal pressures. I am not being alarmist on the US dollar but from a risk management perspective that's also a modest reason why you'd have some non US Exposure. And that has nothing to do with the relative valuation of stocks in the US and overseas. Now then that would bring in how much you would overweight non US Joe.

Dan Lefkovitz (8:56)

When it comes to deficits and the debt, you do write about this in the book and you don't seem, as I'm not going to use the word, worried. You don't seem as alarmed as others about the debt growing. Why is that?

Joe Davis (9:08)

Well if it gets back to your word, Dan, and again it's a formidable issue. So in one sense I think the value, why I felt compelled to even write about it in the book is, listen, of all the forces we care about out there, it's becoming increasingly apparent, at least through our framework, our data driven framework, that fiscal deficits are a serious matter. More so than I think some may may believe and perhaps some in the political sphere would believe. And so they are having a modest effect. We know given our framework underneath the surface they're modestly pushing up interest rates, they've pushed up inflation expectations, they've even pushed up where we first came to this conclusion, the so called neutral rate or where the Fed funds rate levels off over a long period of time. But they're not at alarmist levels yet, not at a 6 or 7% 10 year treasury which we see very low odds of that happening over the next year or two. So in that sense, sense you would say, yeah, I'm not alarmed with a capital A. However, when we look out four to five years, if you don't have a lift from technology, they're going to have a more meaningful impact than I think the bond market realizes. It means a compelling real interest rate for bond investors. But that would be a little bit of transition period. But I want to underscore this is not an imminent transition in our framework. That doesn't mean, I mean, in one sense you could say, okay, I'm not alarmed by it, but if you have a 3, 5, 7 year investment horizon, you have to have it on your scorecard. And thinking through the risk on the.

Christine Benz (10:39)

Horizon, I want to segue into talking about your book coming into view. And I think it'll be a nice transition because when I talk about globalization, the conventional wisdom these days is that the era of free trade and globalization is over or at least in decline. Yet in the book you talk about the fallacy of globalization's retreat. So maybe you can talk about what you think conventional wisdom gets wrong.

Joe Davis (11:07)

Well, I think it was really focusing on a key component of trade that's at least in my judgment, Christine is rarely talked about. Now, that said, I want to tariffs and the movement of goods, whether it's a piece of cheese or a car part, they're obviously fundamental to supply chain and manufactured goods. Everything that we purchase, say, for our own household. But when you step back, that's roughly only one third of consumer spending in the United States is goods and two thirds is services. And even within goods, manufacturing goods, we all know, I think would appreciate that technology and productivity, the sort of innovation rates, where the new products come from, that's a bigger driver of growth and earnings over a long period of time than the efficiency of doing those existing products and where they're produced again. So trade and tariffs are important. But what I find remarkable is what's never mentioned is where the ideas for the products are coming from themselves. I talk a little bit about a popular consumer product such as the iPhone, and how the nature of innovation has changed and has benefited from the globalization of what I call ideas. So where is the human capital ideas coming from? If you looked 100 years ago, they pretty much would have been within this whole country. The United States was the primary driver of ideas through competition. It's not all collaboration. There's more global sourcing of ideas, including from China. And I think regardless of the tariff rates that we slap on different countries, I Think that's a reason to be a little bit more bullish on growth than perhaps one would be if you just looked at tariffs themselves. And so that's what I mean by the fallacy of globalization's retreat. I mean, unless you're literally shutting down the Internet and the movement of people across all goods, and again, there's some headlines on that too, it's very unlikely that globalization is going to retreat in the broadest sense.

Dan Lefkovitz (13:02)

The book deals with this concept of megatrends and I just wanted to maybe get you to talk a little bit about how you define a megatrend, why you think they're so important and how do you factor them in. Some of them seem so long term and kind of difficult to forecast.

Joe Davis (13:16)

Sure. Well, I think what's eye opening to me is I've been in the economics profession for over 20 years, which is a fancy way for saying I'm getting old. But ever since I learned in graduate school, and what's a common approach to this day is if you care about the economy, if you care about the financial markets on any short to intermediate horizon, it's what's reported in the business press, it's what's GDP or the Fed's going to do next six months. These are all important things, by the way, something I'm asked to opine on internally and externally. My team does research on the near term. However, what I think the industry really underestimates is two dimensions. One is the fact that these so called trends that in one sense, to your point Dan, they're so slow moving that someone says, you know what, unless I care about the next 20 years, I don't have to worry about them. Right? Like ah, they're so, they're kind of like glaciers in the ocean, right. They move so slow that it's like watching paint dry. It turns out that, you know, small changes in these trends have a large bearing on the business cycle. I'll give you an example. If you just look at the past two years, the biggest surprises in the growth and inflation and the equity market front have been things such as, oh, we had changes in immigration. Well, that gets the demographics and small changes there. We've had obviously movements in tariff rates in the supply chain. That's globalization, which sounds like a megatrend, but it is moving. And then underneath the surface, some of the investment around AI and even some of the productivity boosts that we saw the past year or two, which is affecting the labor market and corporate earnings. These things that when you zoom out, they look like they're slow moving, but actually when you try to capture little changes in their movement, you actually really improve. I can tell you that those changes in the so called megatrends explain half of the movement in the S&P 500 from month to month and quarter to quarter. Which means even if you're a near term investor, looking through the lens of these forces is actually really important. And I think that's news to many in the profession. It's changed how we approach macro forecasting. It could change how the industry forecasts them. You shouldn't hold these things constant, rather they're a living breathing organism that affect the day to day more so than I think we realize.

Dan Lefkovitz (15:31)

That's so interesting. How do you quantify that?

Joe Davis (15:33)

Well, I think you use the best what we did is for our framework. When I got tired, just take a step back. Dan, you have really good questions from our clients, investors, really smart people. They're listening to your podcast, they have views on AI globalization and all the questions we've tackled today thus far. But when you would ask me my opinion, I think I would give an informed response. But there wasn't really quantified estimates of how much AI could drive growth or how much could inflation rise if we step back in globalization. Give me probabilities of magnitudes because if we can start talking about that, whether it's growth or the stock market now we can start talking about risk management in a portfolio context because without that it's tough to do. And so that's where we set on a path to incorporate all these so called trends which move around along with the near term stuff that people care about. CPI for inflation and interest rates of the Federal Reserve and the 10 year treasury yield for the bond market. All we've done is incorporated them in one living breathing system and operationalized the best of the data science field and the academic economic world has. So we didn't create any new theory. What we did is we joined them all, which are really three different groups. In academia you have those that focus on business cycles, those that focus on asset pricing such as stocks and bonds, and those that focus on these long term growth trends. And all we've done is united them because we had practical problems that we had to answer like what is the stock market, how is that going to react if AI lifts automation or if it doesn't and what's the timeline in that doing so. So again I think we're trying to bring by definition our approach has limitations because it's a model. So any Model has limitations, but we're proud of the fact that we've united them in one system and that's opened my eyes for sure. And it's because of our economic diagnosis and quantifying these forces that we felt compelled to write the book. I would not have done it had the sort of outcomes of our diagnosis not been so different than what I think consensus expects.

Christine Benz (17:35)

Joe, I wanted to ask, you mentioned the profession. Why do you think there is this tendency to focus on very short term data about what the latest inflation report was or the latest jobs report or whatever? Why do you think the gravitational pull is so much there when you think observing and incorporating these very long term trends is a really good direction to go in?

Joe Davis (18:01)

Sure. I'll give you three. I think one is listen, if you're an active manager, so some of your listeners could be managing their own portfolio, they're trying to take modest risk to their long term targets. Say Christine, you gave them in your book for my retirement plan, but they're willing to take a little active risk. I work with our portfolio management teams there. I think when you're thinking about relative modest positions versus a benchmark, there's a tend to focus on six to 12 months because that's really the business cycle. It's where the Federal Reserve can do things more or less expected. I think that is natural. I think secondly, it's the comfort with the most recent. I'm not saying it's a bias, like recency bias, but it's what's right in front of us right now. But because that has such prominence, my point is that that's just overweighted solely those things. It assumes that all the changes we see in the economy are related to what economists call demand, meaning if GDP is higher than expected, it's because consumers are spending more. And all of our framework is saying, well sometimes that's true, other times they're actually spending more because actually incomes are going up because we actually have productivity increasing, which is really related to technology. So we're getting to the root source. And we saw this during the soft landing. I think many what was eye opening to me, Christine, is that many thought the Federal Reserve pulled off a soft landing because they got interest rate calibration just right. So now remember, they cooled growth down in the labor market just to keep inflation right there with avoiding recession. Surprisingly, it turns out in our framework it was because 80% percent of the soft landing was due because these megatrends were moving. It was the immigration, the huge surge across the border that really cooled the labor market more than the Fed did. And we had good luck from a productivity, from a technology perspective. And so that matters in terms of where you say value the stock market. And it has different implications for interest rates. If demand is too hot, you should have the Federal Reserve raising rates. I'll give you a concrete example. If, however, growth is high because these megatrends, these shocks are hitting the year very positively, you should have the Fed not raising rates at all because you're going to have growth go up without inflation. So it matters in the near term. And then finally, if you're an asset allocator, one of the fundamental. But this brought me to some of the rationale. I did this. I remember Jack Bogle asking me what's a reasonable framework to have expectations for earnings and interest rates. He was really getting at these megatrend forces. If I'm on an investment committee, should I assume 4% interest rates for the US which is where they currently are? What's the risk assessment if I'm an investment committee or a financial advisor constructing a portfolio? That's where I think, personally, we believe the industry should put a little bit more weight on these megatrends because they're going to explain virtually all of GDP growth and earnings over the next seven years.

Dan Lefkovitz (20:50)

So there's this fundamental premise in the book, Joe, that the status quo for the US Economy is unlikely to persist. Status quo regarding growth, inflation, financial returns, even. Why is that?

Joe Davis (21:02)

Well, and this was a surprise, the eye opener for me, and full disclosure, I'm asking my role at Vanguard chief economist, I felt what's called consensus surveys. What's the outlook for growth, GDP or inflation or the stock market for the next three, five, seven years? And for GDP growth and inflation, I'd put down what most put down, which is 2% growth and 2% inflation. I wasn't being lazy. It was the fact that maybe there's comfort because everyone else says the same thing. Virtually 90% of the economists say the same thing. And I've been in that crowd because it was kind of like probably indirectly, I was doing in my head in a more narrative sense. Well, we'll have a little bit of lift from AI a little bit, but we're going to have slower demographics through the aging of the baby boom. And so net net, we're going to be roughly at the same growth rates in inflation, 2%, 2% as we have on average for the past 10 or 15. That's hence status quo. No real change. It was only when we developed this data driven framework. Did I see that? That was just a lower probability event. We have trouble generating that as greater likelihood than 20% because of the push and pull of these medium run forces and in particular the push down on growth and up on inflation and interest rates from our deficits because they're structural and they compound over time, versus on the other hand, AI. I'm calling it AI, although it could be another technology. But AI is probably the most likely one. AI pushes upgrowth and keeps inflation at bay. And what I was surprised to find is the push and pull of those dynamics over the next three or five years generates effectively statistically a bimodal outcome which is not the normal status quo distribution where you get 2% on growth and inflation with the risk of a little black swan on either side. It's just very unlikely we're going to get that fulcrum. It's more of a seesaw. And one of those forces are going to push us one way or the other other.

Christine Benz (23:02)

So let's follow up on that, Joe, because in the book you talk about two possible outcomes from that tug of war. Can you walk us through that? So this is a tug of war between technological innovation, probably AI and an aging population and rising deficits.

Joe Davis (23:20)

And rising deficits. So again, we're incorporating a lot of forces that could matter, geopolitical risk and uncertainty, even climate. But you nailed it on the head, Christine, in terms of the two that rise to the top, aging and deficits on the one side, which push up interest rates and the prospect for technological change, much like we saw in the 1990s, if you recall, in the computer and the Internet. On the other side, we don't always get these sort of see saw dynamics because we've tested this framework back 130 years. It's just there's times in history when these megatrends are pushing in certain directions. So let's break it. Each one, the more optimistic one, is the most likely. And I think what's powerful is from a risk management management perspective, we've put odds and quantified the probabilities and magnitudes of this. So it's roughly a 50% chance that over the next five to seven years we will see GDP growth that's meaningfully above the consensus expectations. So roughly over 3% for the United States, well above consensus expectations, roughly double them. And we get that with our deficits not being a serious issue. It doesn't mean we've grown out of them, it doesn't mean that they've gone away. But like the late 1990s. We don't talk about it because we have strong earnings growth and economic growth. And we get that along two dimensions of AI. The first one is it starts to lift automation. Yes, there's significant job disruption, some job loss. But the fact is is that through our framework, the biggest issue with US economic growth is that we have a lack of automation. It's subtracting the most from economic growth in 130 years. And we know this because of our framework incorporating all these factors. And so it effectively comes at the right time. It effectively means, and I didn't know this until we quantified it, Christine, it effectively means that the rest of the bab boom that is retiring right now. We're in peak age 65 right now in the United States. The number of people who are age 65's peak in the year 2025. It's effectively that that generation from here on through say the year 2032, it's as if all of those Americans, those individuals do not retire at all because of the lift that AI comes to offset some of that loss in the labor force. So demographic traffics don't become destiny because of technology. And we've seen this multiple times before that it's a very positive dynamics. In effect we grow into the valuations that we have in the United States. And from a positive investment perspective, the greatest beneficiaries are outside of the US technology sector. In the US it's the areas that have really dragged. It's outside effectively the mag 7 because AI makes value based companies, say healthcare or finance a little bit more productive. And then you get some new products. I wish I knew what they were because I'd be able to retire from Vanguard, but I really don't know what they are. And it lifts a little bit of the valuation. You go back to your fair question, Christine on outside the US We've seen this in other second half of other technology cycles. The non US sectors do a little bit better. So I would call that a good convergence. And AI wins and deficits don't really rear their head at least over the next seven to 10 years. However, you can see where a lot rests on AI. AI is important, it will have some effect. It's already having a modest effect on growth. But if it does not continue to progress, which means advance in its capabilities and our projections show that more often than not they do. But there's a 1 in 3 chance because we're still early here, that it plateaus at a lower plane. And if that happens you can see now where we had not gotten the lift through automation, new products through, through, let's call it AI. We have GDP now through no lift in innovation. We now have demographics dominating. We have GDP growth not at 2% now it's starting to inch closer to 1. Our deficits however are still now are 8 or 9% of debt to GDP in peacetime. So without a recession, that starts to push up inflation expectations in our framework, the Federal Reserve however, fights that which only leads to another modest headwind to growth. So you get a higher interest rate environment without the growth dividend with it. And you have equity markets that are not prepared for that. Earnings start to disappoint because you have lower economic growth. And you can see the flywheel goes from positive to modestly negative. And you have in the us given where valuations are, I hate to be a downer, but you have an elevated risk of a lost decade in the US stock market market. So you can see the stakes are high between this tug of war and this was the eye opener to me, it's over the next seven or 10 years. That's why I felt compelled to help investors because as an economist I can't say, hey, there's two doors we go down. There's a good one and there's a not so good one. Good luck to you with investing. Right. So we try to push ourselves to say from a risk management perspective. How can I think about a portfolio that's kind of resilient to both scenarios?

Dan Lefkovitz (28:20)

Yeah, I was going to ask about what you think the implications are for portfolio positioning. It sounds like you think global exposure.

Joe Davis (28:27)

Is key when it's more for the heads and it's not being defensive. I just did the mea culpa. I was on this podcast on the Lawn View three or four years. I said non us and that was from a valuation perspective. This is from a risk management perspective. And we can debate the weights I assumed in the book just because there's tons of of what someone's benchmark is. I made up just a representative one. 64 to US only. Which investors in the US tend to have significant home buys has served them really well, by the way, for the past decade, let's be clear. But you'd want to have a modest position outside the U.S. 20% is where you at least would want to be in our framework. The irony is that when you have a deficit dominate scenario where AI becomes more like social media, we use it all. And I'm picking on AI here, but we're Just too early in the technology, despite it being around for five decades, it's not being used widely enough that if it plateaus it becomes like social media, we use a lot of it, but it hasn't lifted growth like the personal computer, which is where the right hand side in our most likely scenario is. And so from there it actually there's some transition here, but it actually pushes you in the fixed income from a risk management perspective because you have an environment with deficits dominate. You have higher if you think real interest rates are high now on average 2%, a 10 year treasury yield of 4 minus 2% inflation, you can get, I don't know, seven years from now you can get a 6% 10 year treasury yield. With the Fed still trying to keep inflation around 2. So bond investors would be asked to pick up the fiscal tap, but they're compensated for it. And so that's where it pushes you from an asset allocation perspective in a defensive nature. And that's ironic because it's called deficits dominated. It would potentially suggest to some that you'd want to steer clear from fixed income on a strategic basis. Exactly the opposite. So that's the irony that was the eye opening for me as an asset allocator is that on the upside, if I'm the most bullish on AI, I tell people if you're the most bullish on AI, you would actually want to invest outside of the Mag 7 and technology sphere because it's going to be that transformational. And I'm not picking on those companies at all. I'm talking about the second half of the chessboard. And if you're pessimistic on deficit and you're pessimistic on AI, I would strongly suggest you consider fixed income. And of course in our balanced scorecard we have probabilities elevated in both scenarios. So it doesn't deviate you materially from the 60 40. If the risk will alter one scenario or the other. You could see that. But it doesn't do that because you have this sort of bimodal future. But I would say fixed income, the only way you get gold or some of these other really end of the world scenario concerns, we've seen gold up a lot this year is it's a deficit dominated scenario, actually estimated this world, if you have the deficits dominate, but you have the Federal Reserve who for whatever reason doesn't care about inflation anymore, they effectively are subjugated, they take the backseat to the treasury or to their mandate, then you get a higher inflation world. Yes, in our data driven framework, it's possible. It's roughly a 5% probability. If you go down that path, then there are two assets that you'd want to consider, but they're only 5% of our probabilities. But you would consider things such as gold or unhedged fixed income, but that's a really more of a tail risk. But you know, that's why you don't see that dynamic because you have the Federal Reserve trying to hold the line in volatile markets.

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Christine Benz (32:50)

I'm sure you don't want to get political, but I am curious to get your take on the independence of the Fed chair and what you see as maybe the importance of that to our system. Can you talk about that?

Joe Davis (33:02)

Well, I think the independence of the Federal Reserve and the Federal Reserve as an institution has been one of the finest institutions, if you're an investor or just a global citizen, perhaps had one of the greatest contributions, a public good, so to speak, Christine on the welfare of the economy through keeping generally stable inflation. They're not infallible. They can make mistakes as any group of individuals can. But when we talk about the depth and the trust in US Financial markets and generally even with all the shocks from COVID and some deficits, how we still have fairly anchored inflation expectations on average, that's really a testament to Federal Reserve credibility. So I know some of that is in the headlines. I still have confidence that we will see that. But for whatever reason, if you're worrying about that, I think the one thing that's different from the past where if there was that threat or if we didn't have the Federal Reserve at all, is that we do have the bond market and particularly the inflation protected market that gives us real time inflation expectations. And so I think that's a little Bit of a governor. Governor. A market can be a little bit of a governor. Should you worry about one path, which is code word for saying, listen, if someone was really seriously talking about losing fed independence or if the Federal Reserve was just going to effectively say, you know what, we're going to be easier on inflation than we ever have been, I think the bond market will be a little bit of a governor to that. And I don't think those dynamics will change anytime soon.

Dan Lefkovitz (34:30)

Well, getting back to AI and its impact, you've got a lot of great history in the book and you talk about, you look for some historical precedents for technological disruption. You draw a contrast between two professions that have been disrupted by technology, telephone operators and mutual fund accountants. Curious if you can talk about that juxtaposition a little bit and what those precedents can tell us maybe about AI.

Joe Davis (34:52)

Yeah, well. And again we started doing research on AI almost a decade ago. Again, we weren't prescient. I was reading a lot increasingly research that, particularly the technology field. Dan, this is going to be a big deal. Right. But we started looking, well, how is it going to change the nature of work? And I think I used those two professions as an example that you can have a technology come along. In this case was the personal computer and related telecom technologies in the 1990s that effectively the same technology boosted the prospects, the number of jobs and the average pay in those jobs very positively. That was the fund accountant. It fundamentally changed the nature of the fund accountant. But wages went up, the number of accountants went up. Effectively the computer, I'll call it the computer with air quotes, the computer was a compliment to that job. At the same time, that same technology obviously was the last nail on the massive automation of telephone operators. What we found fascinating by our top down, data driven framework as well as when you look at any technology, including AI, and if you look at through our lens of tasks, and we're not the first ones to do this, been a lot of academics who've looked at tasks. So think of a job description. You have a decent chance sense of knowing how a technology will affect the labor force over the following decade. In other words, you don't know exactly how the future will unfold, but you can have a sense, high, medium or low, because you could have looked at a job description. I talk about this in the chapter. You could have looked at the job description of a fund accountant and a telephone operator. And if you were reading Computer magazine in the late 1980s, you would have had some sense of what was going to happen to those two professions. The real trick though is knowing that the technology, whether or not it will continue to advance AI right now has certainly some eye opening capabilities, but it's certainly not. We don't have average general, you know, advanced general intelligence, we don't have consciousness, we don't have the merging of AI with robotics at a very advanced level. And so there's always some uncertainty to these projections. But I use those same, those two professions to give some glimpse of. And we looked at 800 all the occupations in the US but I focused on four in the book. And it's mixed. But on average we're talking about more likely than not, not over the next seven years, the greatest change in how we do our work since at least the personal computer, which is a pretty big deal.

Christine Benz (37:16)

I wanted to ask about your career advice. It seems like new grads are job hunting in one of the least hospitable markets probably since the great financial crisis. In the book you do offer some advice on how young people can set themselves up for success and make themselves kind of future proof. Can you discuss some of the key messages that I'm thinking that people at all career levels could maybe internalize a little bit?

Joe Davis (37:41)

Yeah, and I will do my best. You know, I'm certainly not an educator, Christine, and I do have 30 years of experience of what not to do and what I wish I knew, but I just learned perhaps the hard way along the way. But I'm asked this question a lot, particularly with AI, you know, what should I major in as I'm entering the workforce or if I'm 45, you know, and I'm dating myself. I remember work, walking into the office and seeing something on my desktop called Microsoft Excel. And I'm like, should I use this thing or not? It sounds dated but I'm like, I had some co workers say, you know what, I'm close to retirement, I'm not touching this thing, I'm not learning anything. So what I would say though, and this for any technology but for AI and I've had to educate myself, one is I would say one, one thing that everyone should do. And it's helped me a lot and that is has nothing to do with technology itself. But I say to everyone, I at least aspire personally to read three hours a day either in my domain or in tangential areas because the more I can be aware of, the more context I will have to connect the dots whether I'm using technology or not. And I tell my children are both college age, I just so now I'm gonna sound like a father, a parent, but I say social media doesn't count. That's actually a penalty. So if you're an hour on social, you gotta do four hours, but now sound just old school or dated. But I think if you just read voraciously, if you know what other smart people have known and written and podcasts such as Law and View would count for sure. You now have that collective wisdom of hundreds of people. And I benefit from working with a hundred other fellow researchers at Vanguard. You ask me certain questions, Christine or Dan, that I know the answer to, not because I did the research, but because I'm building upon what I that I've read. And so that can be a huge. Particularly starting out in the career. When I started out in Vanguard, I didn't even know what an ETF was. I only knew the very basics of mutual fund. They don't teach you that in grad school. I was working on matrix algebra. That helps on some things, but not in others. The other one would be on the technology itself. So if you're 20 and you're in college, or if you're 35 and your career is really starting to zip, or if you're like, my age, I'm in my early 50s, and you're like, well, I still have 10 years before retirement. Retirement. In any of those episodes, I'd be saying, try to automate. This is going to sound sensational. Try to automate your job away with AI. And what I say about that is the learning by doing it. I don't know all the full capabilities of AI. I say that with air quotes because if I'm using it as much as I can, either two things are going to happen. Either I'm going to get 30 or 40% more productive, which means I have a case at the end of the year to ask for my boss for a raise and I could help my peers. Also, if we're in a phone flat job labor market, let's be honest, life is competitive. I want to be more productive than the economist sitting next to me. So that's helpful. The other one is, let's say there's only about one in six occupations, but they exist. You start to find out, you know, what, I can do 60 or 70% of my job, maybe not today, but I can see the writing on the wall. That gives you a little bit of time to start thinking about tangential occupations. Is that a fun consideration to think about? No. But, Dan, back to your question of the telephone operator. Maybe it's 1985 and you have a little bit of time, it's not 1995 yet. You have a little bit of time of thinking about what I would do in perhaps the second chapter of my career that's not thrust upon you in 1994. And so I say that with humility but also a point of caring because I look at the data and as an economist you can be cold just looking at statistics but there's people behind all these numbers. And so I've seen it in my own family what the positives and some of the headwinds that technology can create. And so that would be the two pronged advice I give would be on the reading front and then use it as much as you can and you're going to learn something from it. Either way it's going to be beneficial to you over say a two year period.

Dan Lefkovitz (41:40)

We have a lot of financial advisors who are listeners of this podcast. In the book you do discuss AI's potential impact on the financial advice business. Curious if you could talk a little bit about that where you see AI affecting. Affecting financial advisors practices.

Joe Davis (41:55)

Yeah, well I know one and something that obviously Vanguard has been a big proponent of even trademarked called this advisor's alpha and the positives of behavioral coaching. That's one of the fundamental. It's where we see as one of the number dimensions of the value of advice. If you can try to quantify which is tough but when we've done that we've seen the power that the financial advisor can do. I can tell you my personal life, the value that they have brought particularly when markets get jittery. Also just giving you greater confidence to make the decision that you could have done it on your own but it gives you greater confidence. It's that emotional value of advice and you know, technology. I think AI can do some of those dimensions too. But I think the role of a human centric advisor I long believe is more on a bull market. But that doesn't mean change isn't coming. That's why I picked financial advisors as one of the just representative occupations I think the most exciting. Again, I am not a financial advisor. I don't pretend the practice, you know, I don't know the depths of practice management. All I know is I can look at financial advisors relative to 800 occup and by doing that over the past decade what I can say is from a technology perspective I know the value of behavioral coaching. A lot of people focus on that and so they would say okay, just spend all of Your time doing it. I don't think it's that simple. I think that's a lump of labor fallacy. I think instead think of. I think what's going to happen is that the value of advice is going to go up and the scale of the practices potentially will go up. I think the expectation, what's in the financial plan will also go up through the technology. So for example, I would not be shocked five years from now. Maybe I'm a little too early, but there's not healthcare diagnostics from my iWatch or from some diagnostics that's not fit into my financial plan. That's basic. So think of what happened. Car assembly, completely different occupation 100 years ago. But think about that. The assembly line made it more quick to construct a car, yet the value of the car went up. Think about that. Less time spent on the car. There's fewer car workers, but the wage of the. The auto mechanic went up. The value of the car itself coming off the assembly line went up. Why? Because there's more bells and whistles in the plan now. I got 500 horsepower, I got airbags, and I got a lot of other diagnostics. Today a car is a computer. I think financial plans, if you read the AI and what it can do in the job task, I think for financial advisors, table stakes for what's in the plan will go up, but the ability to scale the practice could go up for those advisors that are able to harness, harness that even if the time spent on each plan goes down. So it's exciting. If I'm a financial advisor, it means some change, just like it does for economists or nurses or other fields. But I would be bullish on the sector. But it doesn't mean it's just status quo and how one does job. And again, full caveat. I am not a financial advisor. I'm just looking at how financial advice looks relative to 800 occupations that we've diagnosed.

Christine Benz (44:49)

You also make a link in the book between active management and AI. I'm wondering if you can explain that and perhaps Joe, tie that back to Vanguard's own efforts. It seems like Vanguard has been a little bit proactive at active management over the past, I would say five or so years I've been hearing that from people at Vanguard. Maybe you can talk about that.

Joe Davis (45:11)

Yeah, I think I've been at Vanguard over 20 years, Christine. I think in one sense it's a bit little, a little bit back to the future. And I think what no one would disagree with and certainly Vanguard deeply believes is it's the power of low cost investing because we know 50% of the assets in any market, private or public, will outperform. 50% of the dollars traded will underperform. And so if you can minimize the cost, this is Jack Bogle's elegant beauty of all of his research. You can minimize the cost the more you at the end investor, the listener on the podcast gets to keep. So that's beautiful. I think what was just, I think sometime emitted from that conversation is just Vanguard. And I think any investor should believe in lower cost investing, period. Not that's only indexing. I think the thing that got left out and I remember the early days of Vanguard, it was okay, if you had to paint the ends of the goalposts, you would have high cost investing, which tended to be active strategies because indexing was in its infancy. And then you had this low cost index at the other side of the spectrum. But what I've long thought and always look for it is just look low cost vehicle. So if there's a viewer listener that has 150 basis point index fund, I would strongly suggest that they sell that. Even though I can't provide financial advice as well as I have assets I can't provide. But if something is 20 or 30 basis points, you think about the net return and if you have a manager that you think can add, oh I don't know Christine, 50 basis points or even 1 percentage point in the equity space on average over long periods of time. If you think they're going to be smarter than the average person, they have a little bit more skill if they're charging 30 basis points. But you think they're going to add 1 percentage point or 100 basis points in alpha net net as I have an alpha expectation as the end investor of 70 basis points. And so I think the combination of low cost and skill has always been important. Jack Bogle probably launched more active funds than any head of any of the company of Vanguard's history. And I think that's a little bit of surprise. But what has not changed is the focus on low cost. That's why I think many invest, I think can be served by a blend of low cost index and low cost active strategies. You generally don't go 100% active just because of the possibility of extended underperformance. But rarely do you get, I think for investors with any modest risk tolerance, active risk tolerance, do you get 100% index portfolios. And if that sounds surprising coming from Vanguard, I'm trying to set the record straight and all the research we've done, my group over the past, you know, 20 years.

Dan Lefkovitz (47:46)

Joe, you made a comment earlier I wanted to come back to about value stocks and how they might be a surprise winner from AI Wondering if you could lay that out a little bit more thoroughly.

Joe Davis (47:54)

Yeah. And this was a surprise. I didn't know this, you know, and it's not infallible like motions of the tide, you know, at the ocean, if the tide's going out, they're definitely coming back in. But I said the odds are tilted that way. Right. And what was a surprise to me is that they're stylistically so very loose, loosely. There's two phases to a technology cycle. So first of all, you have to know that you're actually in a transformative technology cycle. Did I know in 1992 that personal computer. I know now personal computer was transformative, but did I really know in 1992? Probably not. Our system, our data driven framework, gives you a modest sense, but with uncertainty in real time in 1992, because the signals it picks up today, it says we're certainly likely to be in this extended technology cycle, which means there's a general purpose technology likely to emerge now in periods when they happen. I wish we had hundreds of those examples, Dan. We just don't. Right. You have electricity, you have combustion engine. And people, even economists, debate what a general purpose technology is. Just because we use something a lot doesn't mean it lifted everyone and fundamentally changed society. The microwave oven, it's a new technology. It's not so much a general purpose technology. If, however we are in that, and our odds are more likely than not that AI is a general purpose technology, what happens is there's. What I was surprised to find is that there's two phases to the technology cycle. The first phase is what I call just the production of the technology. It's starting to spread. There's a massive investment into the space. A lot of new businesses are formed trying to produce the technology. It was in the personal computer, it was hardware, software, some of the dial up Internet. I'll use that as an example example because it makes it tangible now. And some will say, oh, there's a bubble that emerges. I don't know. I mean, yes, generally not, but I don't want to make that claim. And that's really almost immaterial to the second half. What emerges in the second half, the investment cycle, is what was surprising to me and gets to your question, Dan. And as if this technology is that transformational as we think it is, it starts to benefit companies through higher earnings, through productivity, through new products. With that technology as a platform, I'll give you two examples. Example. So in the personal computer, now, I know with benefit of hindsight, things such as online shopping, companies that sold all, I don't know, books and music ended up being 4% of the company. I'm trying not to use company names, but you can think of like the Jungle Amazon merge, Right? But that was not technically a technology company. By the true letter of the law, it was consumer staple, and with it was electricity. Guess what powered the assembly line? Well, two winners emerged. They were called Ford Motor Company and General Motors Motors. Now, electricity didn't lead to their profitability, but without those disruptive technologies, I don't think we're talking about those companies today. So it spread to sectors outside of electricity in the one hand and computers in the other. But that's how technology works. And if it's not that transformative, then it hasn't lifted growth, then it's a dud to begin with. So that's what was surprising to me, is that we play out now, you have to give this five or seven years. And again, the irony is that outside of the tech sector, parts of those investing universes don't have the multiples that say the Mag 7 or the technology stocks do have. And I'm not saying they're not delivering value. I just said that this AI has the likelihood of being as transformed as a personal computer. That's pretty high praise. But what it says is if it is truly this transformational, other opportunities emerge. And that's where it pushes you at the margin. Given the multiples outside of value and outside of the United States. It's not being skeptical in technology, quite the contrary. It's actually saying no, if this thing has legs and it's going to spiderweb into outside of Silicon Valley.

Christine Benz (51:44)

Joe, for our last question, I wanted to ask you about an anecdote that actually kicks off the book. It was lovely. It's about you having lunch with Jack Bogle right after you started at the firm, or maybe even when you were interviewing. Maybe you can talk about that and talk about Jack's impact on you and your career.

Joe Davis (52:01)

Well, I think it was when I had lunch with him. And everything at Vanguard has a nautical theme to it. So it was in the kitchen galley. To this day, I was just at the galley, actually, before. Before our conversation, Christine. And I think what was telling was twofold. And a lot of companies have great culture. I think you can tell a company's culture by how you spend as a leader, how you spend your time. And so, Jack, I just got my key card. I'm a new employee. I've been here six months. I'm out of grad school. I know nothing. Right. And he made the time to meet with me. I mean, here he is, the founder of the firm. He could have won the Nobel Prize Prize. And not only did he make time with me, he was asking me about my background. And I tell a little bit of the book. He was asking questions that I hadn't been really asking. Economists, you get the next six months. They're good, the important questions. But he's like, hey, Joe, I'm excited you came to Vanguard. Can you help me think through? I have this simple framework. He was being humble. I mean, he actually had a pretty good framework, thinking about valuations and stock market for financial plans. But he's like, can you help me think about how I could think about earnings from the economic perspective? And that was actually the megatrends. I didn't use that phrase at the time. I wish I had a better phrase than megatrends. But he was on to something. So it shows you the power of resin, but more importantly, it showed the humility he's spending time with. Who's a nobody? I was a nobody. And that said a lot to me. It's why I told the story. And it's something I try to keep in the forefront of my head, no matter how busy as a leader you get. There's been so many people in my own life that had made time for me. Am I paying it forward? Christine, I know, you know, I've been at Morningstar. It's the same culture. It's a giving, servant leader culture. And so that's why I told the story. Yeah. There was an economic motivation, by the way, it took me 20 years to complete that project he asked me about. Jack probably would have done it in two years. And I also did. Alyssa, I'll leave you with this. I now lead the group that was really Jack Brennan, who was head of the company at the time. He could see the aging of Jack Bogle. And so I thought we needed a. To carry on some of Jack Bogle's thought leadership. And I give Jack Brandon really great foresight to do that. So now I lead that group that I was hired into. Now we have over 100 crew members or 100 employees. I think that's how many people it takes to fill Jack Bogle's shoes. But he's been an inspiration to this day I owe Jack Bogle a lot and all the leaders of vanguard that have followed since then and including other experts outside the profession. Because you learn from everyone and if you can put that into your own thinking and your own reading and put 10% of yourself into it, I think you're going to be good over your career.

Christine Benz (54:43)

Well, Joe, that is wonderful advice. Thank you so much for being here today. Congratulations on coming into view. We've really enjoyed our time with you.

Joe Davis (54:52)

Thank you. It's an honor to be on the show again.

Dan Lefkovitz (54:54)

Christine thanks so much. Joe.

Christine Benz (55:02)

Thank you for joining us on the Long View. If you could please take a moment to subscribe to and rate the podcast on Apple, Spotify or wherever you get your podcasts, you can follow me on social media at ChristineBenz on X or at Christine Benz on LinkedIn and anlefkovitz on LinkedIn. George Cassidy is our engineer for the podcast and Cary Gretchik produces the Show Notes each week. Finally, we'd love to get your feedback. If you have a comment or a guest idea, please email us@thelongvieworningstar.com until next time. Thanks for joining us.

Podcast Disclaimer Narrator (55:44)

This recording is for informational purposes only and should not be considered investment advice. Opinions expressed are as of the date of recording and are subject to change without notice. The views and opinions of guests on this program are not necessarily those of Morningstar, Inc. And its affiliates, which together we refer to as Morningstar. Morningstar is not affiliated with guests or their business affiliates. Unless otherwise stated, Morningstar does not guarantee the accuracy or the completeness of the data presented herein. This recording is for informational purposes only and the information, data analysis or opinion it includes or their should not be considered investment or tax advice and therefore is not an offer to buy or sell a security. Morningstar shall not be responsible for any trading decisions, damages or other losses resulting from or related to the information, data analyses or opinions for their use. Past performance is not a guarantee of future results. All investments are subject to investment risk, including possible loss. Individuals should seriously consider if an investment is suitable for them by referencing their own financial position, investment objectives and risk profile. Before making any investment decision. Please consult a tax and or financial professional for advice specific to your individual circumstances.

Joe Davis (57:12)

Sam.