2020 is another country

Robert L. Reynolds
President and Chief Executive Officer Putnam Investments

Edited from a speech given at MutualFundWire’s Thought Leadership Series Influencers’ Summit 2011 Boston, Massachusetts October 5, 2011

My thanks to Sean Hanna for that very generous introduction and also to MutualFundWire for asking me to join you this morning and try to look out a decade or so. The truth is, Sean, that compared with the big stories of 2011 — like Greek default, the debt ceiling, S&P downgrades, high unemployment, low housing prices, wild volatility — I’d rather talk about 2020 any day! Still, I have to say that I totally agree with something that Yogi Berra once said: “Prediction is very hard — especially about the future .” But this much I am reasonably sure of: When the year 2020 rolls around, we will not still be obsessed with Greek debt, eurozone banks, or U.S. housing prices. These issues, which are so painfully compelling today, will be resolved for better or worse. Come New Year’s Day 2020, we’ll be facing new challenges, but also new opportunities — many of which we can’t even imagine. That’s why this talk is called “2020 is another country.” And yet despite the many, many unknowns and surprises that lie ahead of us, I do want to suggest to you that there is a lot about the world of 2020 that we really can foresee at least in broad outline. In the interests of time, I am going to just skim the headlines on four key drivers that are already shaping 2020:
•Globalized securities markets •Demographics •Emerging investor needs and financial innovations designed to meet them •The coming race to solvency, which is the next phase in the sovereign debt mess we’re all tangled up in right now

A globally wired world
Let’s start with some thoughts on global markets. Here, the first, most powerful lesson from the crash of 2008–2009 is that the world’s capital markets are now thoroughly wired; their fates are linked. Riots in Athens, tsunamis in Japan, debt downgrades — all of these ricocheted around global markets at near light speed. Diversification still has significant value to be sure. But correlations across oceans and time zones are growing stronger. These linkages across stock, bond, and derivative markets are what facilitated the global electronic “bank run” of 2008 and elevated the U.S. Federal Reserve Board to a new role as the world’s “balance sheet of last resort.”

But despite the shocks inflicted by the crash — and thanks, in part, to massive government bailouts and easy money policies — global equity markets have largely rebounded, rising more than $22 trillion from their low in 2008 to over $54 trillion by 2010, according to the World Federation of Exchanges.
However unnerving this most recent wave of volatility has been, it is unlikely to derail the huge increase in the number, depth, and trading volume of global stock and bond markets that we’ve been seeing since the 1980s.

I don’t know if we’re up a trillion or down a trillion today, but however unnerving this most recent wave of volatility has been, it is unlikely to derail the huge increase in the number, depth, and trading volume of global stock and bond markets that we’ve been seeing since the 1980s. To the contrary, governments everywhere are competing to foster robust capital markets, even while they work to develop new and stricter oversight and regulation. No serious policymakers now favor a return to isolated national capital markets. And given what we’re seeing in Europe, it doesn’t seem that bank-based financial systems like those on the continent are any more secure than financial systems that rely mainly on capital markets as in the Anglo-American model. Just to cite one example close to home here: It strikes me that money market mutual funds in the United States have a much better record of avoiding losses to taxpayers than our banking system has. So capital markets are here to stay as a core element in our financial systems alongside traditional banking. The utility of capital markets for reaching social goals like retirement security or financing education or medical care tells me that their role will continue to grow through 2020 and beyond. And that suggests several key implications. First, as investors, we all need to shift to a fully global mindset in our personal and institutional investment strategies. We need to assess individual securities in the context of the global markets and the industrial sectors they compete in. We need to build truly global portfolios, with no home-country biases. This trend has been under way for years now, but I believe it still has a long, long way to go. Second, as “citizens” of the global marketplace and thought leaders, we should support strong, fair, and transparent regulation to restore public confidence in securities markets. Good rules make good markets. And we also need regulators who will step up, as many failed to do, regrettably, in the run-up to the 2008 crash. Personally, I would like to see all financial services and markets held to the kind of high standards that have made the ’40 Act and the mutual fund industry great American success stories of the past century. Naturally, we all want to maximize freedom and creativity in our capital markets, but we should also recognize that not every market practice or financial innovation necessarily adds value or enhances public confidence. When in doubt, as with high frequency trading or synthetic ETFs today, regulators should take a deep dive and carefully determine whether these practices really do add value and liquidity. A third implication of the continued rise of capital market finance is that these markets will exert powerful pressure on governments and political leaders to adopt sound and sustainable fiscal and regulatory policies. Some of you may recall the wish expressed by former President Clinton’s advisor, James Carville, who wanted to be reincarnated as

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Capital markets’ influence is likely to grow over the decade to 2020 and push governments everywhere in the direction of fiscal restraint and accountability.

the “bond market” because of the huge power that would give him to shape national policy. We can see that almost daily now as markets press European governments to cut national deficits and resolve doubts about the stability of their banking systems. Capital markets’ influence is likely to grow over the decade to 2020 and push governments everywhere in the direction of fiscal restraint and accountability. Let me turn now to another force shaping 2020 that may be even more powerful than capital flows. It moves very slowly, but with the force of a glacier. I am speaking, of course, about demographics.

The demographics of global aging
Here are two numbers that express the most positive untold story of our lifetimes: 48 and 72. What are they? They are, respectively, the average life expectancy of the entire human race; 48 years in 1950, 72 years in 2025. This really is amazing. In the course of a typical baby boomer’s life, human life expectancy on earth will rise by 50%. This is an absolute net gain despite multiple wars and a steady diet of mayhem, which the media reports on every day. No similar advance in human well-being has ever happened in so short a time — in all of recorded history. But rising longevity is having some quite stressful effects. It is, for example, straining public and private pension plans across the whole developed world, with the greatest pressures, for now, being felt in Europe. In the United States, the number of citizens over age 65 will rise from just over 40 million today to nearly 55 million by 2020 as the huge baby boom generation edges into retirement. The overwhelming majority of these people will be drawing on America’s programs that support seniors — Social Security and Medicare. Congress can’t vote down this huge rise in demand for support; the president can’t veto it. So we are going to have to make some real, painful changes in national policy, picking a solution set out of three ugly options:
•Either we raise the share of revenues going to the federal government well above the average of 18% seen since World War II, or •We cut back, deeply, Social Security and Medicare, or •We slash every other type of federal spending from the Marine Corps to NPR

By 2050, demographers tell us that roughly one in four citizens of developed nations will be over age 65, but only one in five Americans will be.

That’s an unappetizing menu, I know. But it’s the truth. And it makes me very glad that I’m not running for public office. Here is the good news, though: When it comes to demographics, the United States is in much better shape than most of our major trading partners. We have higher birth rates than Europe, Japan, Russia, and China, and we allow more legal immigration than the rest of the developed world combined. So our population will be growing all through the 21st century, and so will our active workforce, by about 5% over the next 20 years, while the number of working-age Europeans falls 11% and Japan’s working population plunges by 17%.1
1 United Nations, Populations Division, 2011.

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By 2050, demographers tell us that roughly one in four citizens of developed nations will be over age 65, but only one in five Americans will be.2 So yes, America is aging. We are going to have to make some serious reforms to our entitlement programs. But we should be able to adjust more easily than our friends across the waters. For one thing, we’ll have a lot more kids paying FICA taxes!

Emerging investor needs: low-volatility and lifetime income solutions
Let’s turn now to some emerging investor needs and product innovations that we’re going to see in the investment world by 2020. You don’t need a crystal ball to anticipate rising demand for low-volatility investment products or continued growth in demand for asset-allocation-based “solutions” beyond funds that are bound to specific style boxes. I am convinced that we will also see a huge appetite for “total-return” or “absolutereturn” strategies that offer at least the possibility of delivering economically meaningful, positive returns — whatever markets do. The prime drivers of demand for these types of products will be investors close to or already in retirement. These investors have been badly shaken by two black swan events in less than a decade, and they are getting seasick from recent volatility.
We will also see a huge appetite for “total-return” or “absolute-return” strategies that offer at least the possibility of delivering economically meaningful, positive returns — whatever markets do.

Some have suggested that this kind of higher volatility is just part of the so-called “New Normal.” But I don’t believe that investors — especially older, more affluent investors — will ever get used to these kinds of market swings. That’s why I expect to see steady, rising demand right through this decade for products and strategies that offer at least the hope of less rocky, more predictable returns. We could see just as dramatic a rise in demand for “low-vol” and absolute return type funds as we saw over the past decade for target-date lifecycle strategies. Something else we’ll see for sure will be an explosion of offerings in the lifetime income arena. It’s simple, really. Baby boomers are the first mass generation of self-directed retirement investors ever, and they are turning 65 at the rate of roughly 7,000 a day. What they are discovering — and millions more will discover each year — is that turning a life’s savings into a reliable source of lifetime income is actually tougher than accumulating that nest egg to begin with. We are going to see a flourishing of lifetime income offerings: annuities, partial annuities, non-annuity drawdown plans, and many, many other income innovations. I want to close now by touching on a fourth trend that will shape the next decade: It is what I call the “Race to Solvency,” a competition that every serious nation on earth is going to have to join.

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United Nations, Populations Division, 2011.

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The race to solvency
As I see it, we are now in the midst of what you might call “The First-World Debt Crisis.” The prime issues driving the news and the markets tend to be questions about sovereign credit risks of default driven more by fears of political paralysis than by absolute lack of resources. Just this moment, there is a wave of worry that suggests that many investors fear these public debt crises will prove impossible to solve.
For much of the rest of this decade, I expect the major nations of the world to be forced, like it or not, to engage in a race to solvency, curbing deficits, restoring fiscal and trade balances, and finding ways to reboot their economic growth.

But what I want to suggest to you is that we will find ways to resolve these challenges using many of the same techniques used to deal with the Third World debt crisis: capital haircuts, loan-restructuring, and refinancings. I am not saying it will be easy. But I am saying that debt crises do get resolved, always. This one will too. For much of the rest of this decade, I expect the major nations of the world will be forced, like it or not, to engage in a race to solvency, curbing deficits, restoring fiscal and trade balances, and finding ways to reboot their economic growth. Globalized capital markets will demand that nations compete on these terms, and they will. The “prize” for the winners will be continued access to affordable credit and global investment flows. And among the major competitors, the United States is quite well positioned to win. Here are just a few reasons why:
•We have a much stronger tradition of limited government and far more reliance on individual and family responsibility than on the welfare state. •It should be far easier politically for the United States to get back on a path of sustainability than for our friends in Europe or even Japan. •Unlike Europe, we not only have a common currency, but a common government and central bank. •What’s more, Americans can already see from the Europeans’ current struggles the consequences of simply allowing deficits and debt to pile up to a tipping point and then having to slash government benefits under market-driven crisis conditions.

Even those Americans most committed to sustaining social welfare programs and a true safety net are beginning to recognize that our entitlement programs require major change, either by us or by some very ruthless market forces. The good news is that we are already moving to address our long-term deficit problems. America’s political discourse has changed fundamentally. Following President Obama’s health-care bill, for example, policy debate on health care is now focused mainly on curbing cost increases, and it will be for years to come. After the very disappointing results in terms of jobs from the massive surge in government spending in 2009 and 2010, any appetite for more tactical stimulus spending is gone. In its place, we are seeing a demand for more strategic, pro-growth reform of our tax code. As we speak, a bipartisan select committee of Congress is struggling to find, by this Thanksgiving, an additional trillion-plus dollars in cuts to future deficits. Even if Congress fails — and it may — there will still be major, automatic cuts in defense and other discretionary spending — painful ones.

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America will be relatively younger than our major global rivals, less burdened by welfare-state expenses, and far less dependent on imported sources of energy.

The issue of national solvency will not go away. America’s next presidential election and the politics of the rest of this decade are going to center on ways to reboot economic growth and job creation, cut spending, and get our debt under control. I believe we’ll do that. In fact, I expect that come 2020 we will look back on 2011 with the same sense of relief that we now look back on the stagflation, gas lines, and national malaise of the mid 1970s. What’s more, by 2020 the next phase of America’s future will begin to positively influence our expectations. Seen from the perspective of 2020, America’s demographic and economic advantages over global competitors will be much more visible than they are today. America in 2020 will not only have a still-growing population, but will be heading toward well over 400 million people by mid century. By contrast, the populations of Japan, Russia, most of Europe, and even China will be in decline by 2020, with some of them on track to a population implosion by century’s end.3 America will be relatively younger than our major global rivals, less burdened by welfare-state expenses, and far less dependent on imported sources of energy. Our per capita GDP will still be the highest in the world — more than four times higher than China’s, according to the World Bank. And America’s culture of innovation, our openness to continuous change, will still be carrying us forward. One last point: America’s leading corporations are in great shape financially at the beginning of this decade. They have been earning record profits; they now hold over $2 trillion in cash on their books.4 They have truly global footprints, drawing 40% plus of their revenues offshore.5 There is actually a case to be made that core U.S. equities could have major upside by 2020. Obviously, none of us know how markets will perform from here to 2020. And we know that we’ve just lived through a lost decade with negative returns to the S&P since the year 2000. But unless you believe our economy is in for such sustained hard times that equity markets will do worse from 2000 to 2020 than in any previous 20-year time frame, then the opportunity risk of missing gains over the next decade may be very much higher than the downside.

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United Nations, Populations Division, 2011. Federal Reserve, 2011. U.S. News & World Report, 2011.

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What history tells is that Americans don’t just get worried when our country goes off track. We fix things.

Conclusion
I know that optimistic vision for America’s future may seem to some people here like wishful thinking, especially given the rocky markets and depressed national mood we see today. We all know the vast majority of Americans now fear that the country is on the wrong track. In September, Gallup reported that only 19% of Americans are content with the way we are being governed. That’s an all-time low. So let me say very straightforwardly: American success is not inevitable. Rebooting our economy and our spirit is something that Americans are going to have to argue about, fight for, and believe in. And yes, it’s possible that we won’t agree. Maybe our political system will freeze up. Maybe we’ll find no will to compromise. And if that happens, we will decline. But somehow I don’t think so. In fact, I don’t think anyone, ever, has won by betting against America. And the reason I am confident is precisely because we’re all so worried. One of the healthiest of all American traditions is our constant tendency to doubt ourselves and worry about our future. We have had these waves of anxiety every couple of decades or so since about 1776! But what history tells is that Americans don’t just get worried when our country goes off track. We fix things. Winston Churchill had it just right when he said: “You can always count on America to do the right thing, after trying everything else.” I have to believe that America is too strong, too resilient, and too optimistic a culture to accept the near stagnation and joblessness that some call “The New Normal.” Now, I know that others are not advocating the New Normal; they’re just predicting it. So let me make a prediction of my own: Americans are going to demand something better than that from our political leaders. We are going to get our country on a path back to national solvency, and we will be outgrowing our debts well before we pop the champagne corks on New Years Day 2020.

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The views and opinions expressed are those of Robert L. Reynolds, President and CEO of Putnam Investments, are subject to change with market conditions, and are not meant as investment advice. Mr. Reynolds is affiliated with Putnam Retail Management.

Putnam Investments One Post Office Square Boston, MA 02109 putnam.com TheRetirementSavingsChallenge.com
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