Joe Cass   00:00:00

Hello, and welcome. My name is Joe Cass, Senior Director at S&P Global Ratings and a host and the creator of the FI15 podcast. On this episode, we have Sebastian Page, Head of Global Multi Asset and Chief Investment Officer at T. Rowe Price; and Alexandra Dimitrijevic, Global Head of Analytical Research and Development at S&P Global Ratings. So just a quick reminder that the views of the external guests are their views alone, and they do not represent the views of S&P Global Ratings. Alexandra, I was wondering if we could kick off with you by talking a bit about megatrends. So, what do we identify as megatrends? And how are they taken into consideration within S&P's credit ratings?

Alexandra Dimitrijevic   00:00:40

Thank you, Joe. Indeed, let's start by what we mean with megatrends. These are trends that we think have the potential to transform our economies and our society. And, where we have maybe sometimes more open questions and answers, so a degree of unpredictability on how they going to unfold. So, they include, for instance, climate change, geopolitical fragmentation, aging of population, energy transition, AI, all of this. They have in common that a lot of them have a longer-term time horizon, like climate change, for instance. But yet some of them also are evolving at an exponential pace, if you take the case of Gen AI which could impact credit here and now with, for instance, cybercrime or war or some of the more extreme physical risk, climate risk events. So, S&P just published a few weeks ago, a white paper called path to credit materiality, which provides a framework to explain how we assess the implications of these megatrends on credit. And the two key questions here are how they might impact on credit and when they might impact on credit. So, there are five steps to this framework. The first step is to assess the magnitude of the impact of the megatrend. And here, it's a combination of the severity of the impact and the likelihood - that's the first step. The second step is then to assess the channels of transmission of the impact of this megatrend on to credit. So that's through revenues, costs, CapEx, for instance. And then if we assess that either the magnitude of the impact is significant and/or channel of transmission is clear, then that's where we use our scenario analysis. We use a plausible scenario to do sensitivity analysis or stress test to help us assess the potential impact at an industry level or geography level. So that's the first step is the analysis. And the last step is really look at the implication at credit-specific level, and it can really vary. It can be here and now, or it can be in five years, ten years or maybe never. And what's important here is also to understand how different entities manage or mitigate this megatrend that might happen in the future. So, the first one we're going to assess is on climate, climate transition and climate physical risk. And maybe that would be a good topic to come back on fixed income in 15 once we've published that first part on climate.

Joe Cass   00:04:02

Sebastian, welcome to the show. I'd be interested to hear how T. Rowe Price factors global megatrends into your own analysis and portfolio construction.

Sebastian Page   00:04:11

To me, when you think about megatrends, it's all about looking forward, not backward. And this has massive implications for asset allocators, for example, and for portfolio construction. Joe, let me tell you a story that is actually in my book, but it speaks to looking forward and how important it is for portfolio construction. So, if you think of megatrends, we just had 10 years of 0 interest rates, and now we don't. So, what does this mean for strategic asset allocation? The story takes place a few years ago. I'm attending a boring quantitative research conference. Everybody is half asleep. The presenter is Bern Scherer. He's a very well-respected academic and investor. He's done both in his career. And he's presenting a portfolio construction model that focuses on optimization. Someone in the room raises their hand and goes, we should not be using optimizers for portfolio construction because of the GIGO critique. Joe, have you ever heard the GIGO critique, garbage in, garbage out. And if you're doing strategic asset allocation and you understand megatrends, then you know that the long-term expected returns on the different asset classes should change if, for example, now interest rates are higher. But I'll always remember what Bern Scherer answered because he was clearly jet lagged in a bit cranky, but it speaks to looking forward, not backward. He looked at the person asking the question and said, if you don't think you can come up with reasonable expectations about the future, you should not be in the investment business. So, Joe, that's what we do. There are at least three ways to adjust to megatrends. As asset allocators, we need to recognize that they can create value traps. Technology, and Alexandra mentioned AI, has created a value trap where growth stocks have gotten more and more and more expensive relative to value stocks, yet those that have bought value stocks have been caught in a value trap. Second, for stock pickers, it's really important to be on the right side of change. So being able to use proprietary research to understand what to pick Alexandra's example, AI is going to do in terms of disruption in the economy. And if you look at our firm, we have over 300 stock analysts and credit analysts, and that's a lot of what they do. What's different about our asset allocation process is what I'm responsible for, we actually take inputs from stock analysts in our process, especially when it comes to understanding megatrends like AI. And the third point about megatrends is it should influence or drive your process. As investors, we need to show openness to new ideas. And Joe, what I'll say about this is or AI, we think it's real. We think it is an important megatrend that's going to lead to increased productivity, not only in technology companies, Clearly, you can reduce your coding time by almost 30% right away. So this is productivity for tech-heavy companies, but also for traditional companies. And just to illustrate the power, did you know, Joe, that I just came across this paper recently that AI can essentially read your mind. And I'm talking about scientific papers out of University of Texas, out of a university in Japan, out of Sydney. They take an MRI of the brain activity as you read something, and the large language model maps your brain activity to whatever you're reading. Okay, that's kind of cool. Then they take away the text. The AI then doesn't know what you're reading, just looks at your brain activity and can roughly infer what you're thinking. Now it's a cute example. All I want to say is when I think about megatrends and what AI is going to do, who knows? It's the power of openness and imagination and then positioning portfolios on the right side of change.

Joe Cass   00:08:53

Great. Fantastic. Sebastian, you mentioned it there briefly, but I'd be interested to know your, say, three-to-five-year view of things like interest rates, inflation and maybe even the potential future glide path of major central banks, such as the Fed, the ECB and also the Bank of England.

Sebastian Page   00:05:05

Joe, I think inflation could be closer to 3% than 2% for the next three to five years due to supply issues, deglobalization, energy transition, demographics with an aging population, less labor supply. All these forces could push inflation above the Fed, the ECB, and the Bank of England's targets. Add to that pedal to the metal fiscal spending, who knows when that stops, but that's the environment we're in. Add to that geopolitical risk which can create spikes in oil prices, which are highly inflationary. Add to that money printing, right? I could use the wonky term excess liquidity. I've been calling it the blob of money. You ever see the movie, the blob. It's like an old movie where this creature just eats everything. Well, the blob of money, the $7 trillion in money market funds, the excess $3 trillion that's been added into checking accounts, this is not distributed equally, and the lower wage earners are absolutely out of liquidity. But in aggregate, the blob of money is alive, and it has been eating all the negative headlines. So, I think that, that excess liquidity means people want to buy goods, want to buy services, want to buy financial assets. So, it will be hard to get to that sort of last mile and bring inflation to 2%, whether it's the ECB, the Bank of England, or the Fed.

Joe Cass   00:10:51

Thanks, Sebastian. Alexandra, what is, say, the top two or top three risks that we are monitoring, which could impact credit rating trajectories over the next, say, twelve months?

Alexandra Dimitrijevic   00:11:04

I'll get to the risks, and I think looking back to what Sebastian was saying. But just maybe I want to take the opportunity to speak about the way we monitor this risk at S&P Global Ratings. So, we have an analytical governance framework called the Credit Conditions Committee. And every quarter, we meet with our senior expert across different sectors and economies. On the one hand, we define the house base case which is what our 1,700 rating analysts used to underpin their forecast, but we also monitor the key risk that could derail this base case, and that's a key part of the analysis. The first one, as Sebastian was alluding to, is interest rates and the second top risk are geopolitical risk. And if we come back to interest rates, here, the risk that could derail the base case would be that interest rates stay higher for an extended period, and that would be on the back of a stubbornly high inflation with the U.S. economy still running hot. That could delay or derail some of the central bank's pace to cut interest rate. At this stage, our economists forecast for the first Fed cut rate in December and then a bit more acceleration in '25 towards 4% at the end of '25. In Europe, after this first cut, our economists expect another two cuts for this year and on the back of inflation coming down. I have to say, I share some of Sebastian's   views that inflation, core inflation might stay structurally higher than in the past decade. And so maybe as rates come down from the high where they are now, they might not come down to 0 or we might have ended this period or this decade of free money that Sebastian was describing. So, one of the impacts, obviously, if you have interest rates staying higher for longer than in our base case, this could have a negative impact on the lower rated credit, particularly those rated B- and below, which tend to be highly levered, and we have to refinance in a higher rate environment. And as well for emerging markets, either the direct impact of higher rates or indirect impact through unfavorable exchange rates, particularly for those that have a lot of non-domestic debt in U.S. dollars. So, at this stage, we expect default rates to remain elevated through '24 at 4%, 4.5% in the U.S., so above long-term average in Europe as well and start trending down as we get into next year in the base case. The second key risk that we're monitoring is the geopolitical risk. Since Russia's invasion of Ukraine, geopolitical risks have clearly come back on the front stage for any credit analyst and we've really ended an era of the Washington consensus, an era of relative geopolitical stability, globalization focused on low-cost supply chain. We've entered a new era now of geopolitical fragmentation, a lot more prone to event risk instability. It's hard to see the end to this period of fragmentation. There are multiple risks at the moment. You have obviously the war between Russia and Ukraine on European territory. You have the escalation of the situation in the Middle East, especially since Iran's attack on Israel and you have the ever tension between the U.S. and China. All these risks could escalate either voluntary or involuntary and then have some impact on global trade and businesses and commodity prices, as Sebastian was saying or potential volatility in the market. Added to that, in '24, we have over seventy elections in forty countries, including big ones. We just had Mexico, India. Here in Europe, we have the U.K. and now France, (and that was a plan), then the U.S. coming. And all of this creates an environment where there is also more focus on more protectionist attitude, more focus on security in the current environment. So a lot of potential event risk stemming from this geopolitical environment, but also potential more structural implications on global trade, fiscal cost, Sebastian mentioned security expenditures. So these are the two key risks that we're monitoring. We're just running our Q3 credit committee, and we'll be releasing our updated conclusions later this month.

Joe Cass   00:16:50

Fantastic. Thanks, Alexandra. Sebastian, I wanted to talk a bit about your book. It's called, 'Beyond Diversification: What Every Investor Needs to Know About Asset Allocation'. Interested to know why did you decide to write a book originally? What are some of the key takeaways? And lastly, what is the process of writing a book actually like?

Sebastian Page   00:17:14

Thanks for asking. Two reasons why I wrote the book. One is obvious, the other one isn't. The obvious reason is I wanted to share my knowledge that I had accumulated on asset allocation. That's why we all write books. The second that's less obvious, but that I think anybody who writes will agree with. Alexandra, I don't know if you write a lot of articles and so on. But when you write, you learn. So, it's actually for me to consolidate my knowledge and learn really more deeply what I do in asset allocation. So, to share and to learn myself. Writing is the best way to learn. I see Alexandra smiling. She looks like she's agreeing. Let me give you an example of what I mean by beyond diversification. We'll talk about the stock bond correlation and how it completely broke down in '22. Stocks went down and bonds went down, massive, massive bear market in bonds, like the worst bear market in bonds in history. So, people start asking about the stock bond correlation. I have a chapter in there about it. It's very difficult to forecast or understand the stock bond correlation. If you go back eighty years and you look at the 12-month stock bond correlation, it actually flipped sign twenty-nine times from positive to negative, negative to positive. It's been as low as minus 80% and as high as plus 80% so when you're looking at the average and you diversify your portfolio according to the average correlation between stocks and bond, Joe, the analogy I like to use is like saying I have my head in the freezer and my feet in the oven, and I can still statistically claim that I'm very comfortable in that my average body temperature is fine. Well, that's the premise behind beyond diversification. There are three sections in the book, forecasting returns, forecasting risk, and constructing portfolios. Now on how to write a book or why to write a book, I have a day job. It's a pretty stressful day job. I oversee all our global multi-asset business. I'm a Chief Investment Officer. Look, -- the best way is a little bit at a time consistently. It's the power of habits. To me, it's Saturday mornings, I sit down, and I would write. And we were talking offline, Joe, about time-of-day effects. Most of us are much more productive in the morning. If you do that, like, I don't know, two, three hours a week, one morning, but you keep doing it every week little by little, hey, within a year, two years, you have a book. It's actually not that hard if you just unleash the power of habit and make it a discipline, give you a small reward, fill your spreadsheet with how many words you did this week. It's just that simple. It seems daunting when you look at how comprehensive a body of research you want to put together, but just a little bit of time. You know what, Joe, I'm going to get philosophical. This also applies to a bunch of stuff in life. There's this great book titled Atomic Habits about how whatever your small habits are, they add up to big changes in your life and big accomplishments. I'll just leave it at that.

Joe Cass   00:21:03

That's James Clear?

Sebastian Page   00:21:06

Yes.

Joe Cass   00:21:07

No, it's excellent. I agree. I love that book. And Sebastian, kind of a different type of question for you now. You've got now, I think, over 40,000 followers on your LinkedIn profile. How do you view kind of the role of social media as a Chief Investment Officer? And how does it help you?

Sebastian Page   00:21:28

I don't know if 40,000 is impressive or not. I see people with a lot more. So, I don't know. Maybe our listeners' viewers will be impressed by 40,000. Look, I've never been on Facebook or Instagram. I'm just generally skeptical of social media. I see people I love around me get completely addicted. But you know what, for me, LinkedIn is kind of a special place there where people are looking for jobs. It's not anonymous, which means it's much more civilized. And for our firm, this digital marketing is really important. This is how you do marketing now. This is why you have a podcast, Joe. Like digital marketing is important to build our firm's brand. You're based in EMEA. We're kind of like over there, the largest asset manager you've never heard of because we're just so humble as a brand. But asset management is competitive. LinkedIn is a global platform. So, our clients want to know what we're thinking and what we're doing. So, t's an important part of building the firm’s brand. And Joe, if you've noticed, I'm also writing about psychology and leadership and self-improvement, which is, I think, again, really a good match for the LinkedIn environment. So, will I get on X or Twitter or start doing YouTube? I don't know, probably not, personally. But this is the right platform for me personally.

Joe Cass   00:23:12

Great. Thanks, Sebastian. Alexandra, how do you view the role of social media in projecting to the market our research, publications and ultimately, our ratings?

Alexandra Dimitrijevic   00:23:25

I have a lot in common with Sebastian here. I also use LinkedIn. We do, as an organization, use LinkedIn. You won't see me on the other social media. But I agree that LinkedIn in particular, had a pivotal impact on the distribution of the research. It used to be traditionally through media release and the to the website, but then you expect for people to come on to your website to find the research. While with LinkedIn, you have a much, much broader reach also from a population that is well beyond the more traditional institutional investor population. You have a more immediate way to share some information, some research. And what's also really useful is the engagement. So, you have people's reaction on the topic, the comments, the feedback loop, which also helps understand what investors' sentiment or trends in the market. Now we do use LinkedIn a lot for the thought leadership, the ideas, topical research, but we do not use it for ratings distribution or rating news. For that, we use our traditional channel. And what's really important in our approach of social media in general is to keep the same rigor, quality, integrity in the information that we put out on social media in day and age of tech news is really important for the brand to have the same integrity approach. We have a formidable team within the research and marketing that really help us build this engagement on LinkedIn. And maybe if you're interested to follow what we publish, I will share with you three newsletters that you can follow on LinkedIn. One is from my profile, it is called CreditWeek. It used to be an old S&P publication a long time ago. And every week, we pick a topic that is relevant for the market. We interview our in-house experts and share in a three-minute piece, the S&P view on this topic. We also have a newsletter from my colleague, Ros Lang, who's the Head of Private Market Analytics, which is focusing trends on the private market. And our esteemed global Chief Economist, Paul Grunvat, also has a weekly newsletter on LinkedIn. And I think these are really great way for the market more generally to follow what's happening at S&P.

Joe Cass   00:26:28

Perfect. Thanks, Alexandra. So, I've got something new. Let's see how well it works. So, I've decided to put together kind of a short quick-fire round for both of you. And it's kind of -- I'll do kind of -- I'll start with maybe Sebastian and then go to Alexandra. And it’s basically kind of the first thing that comes into your head, and it's kind of based around favorites. So, Sebastian, I'll start with this with you. So, what's your favorite dessert?

Sebastian Page   00:26:53

This is the most unexpected question I've ever gotten on a podcast. Key lime pie
.

Joe Cass   00:27:00

What's your favorite season?

Sebastian Page   00:27:03

Fall, because it's the best running weather on the East Coast in the U.S.

Joe Cass   00:27:10

What's your favorite restaurant?

Sebastian Page   00:27:13

Okay. I don't need a lot of meat, but as a splurge, as a treat, I love going to a steakhouse.

Joe Cass   00:27:22

What's your favorite gadget?

Sebastian Page   00:27:25

Oh my Garmin watch. It rules my life. yes.

Joe Cass   00:27:31

And what's your favorite time of day?

Sebastian Page   00:27:36

We were just talking about that. Definitely the morning, just more productive, especially with coffee you just get more done.

Joe Cass   00:27:43

And I know you're in the U.S., but who do you think is going to win the Euro football Championship?

Sebastian Page   00:27:49

Okay. The answer is I have absolutely no idea, but Joe, you're based in England, right?

Joe Cass   00:27:56

Yes.

Sebastian Page   00:27:56

So, I think England is going to win.

Joe Cass   00:27:58

Perfect. That's the right answer. Alexandra, I'll do the same for you now. Okay, what's your favorite dessert? What's your favorite season?

Alexandra Dimitrijevic   00:28:10

That's summer, I need warm and sun.

Joe Cass   00:28:13

What's your favorite restaurant?

Alexandra Dimitrijevic   00:28:16

Well, I'm just back from Sao Paulo, and I have to say Brazilian, it was fantastic, fantastic food there.

Joe Cass   00:28:24

What's your favorite gadget?

Alexandra Dimitrijevic   00:28:26

It's my watch as well. Keep me on track with my activity.

Joe Cass   00:28:30

And what's your favorite time of day?

Alexandra Dimitrijevic   00:28:33

I'm more evening, after the hard work during the day when you can relax and spend time with the family.

Joe Cass   00:28:41

And last one, Alexandra. Who is going to win the Euro football championships?

Alexandra Dimitrijevic   00:28:45

It has to be France.

Joe Cass   00:28:46

I knew you would say that. Unfortunately, I think you're right. So just a few more questions. Sebastian, what opinion or view on leadership do you have that few others would agree with you on?

Sebastian Page   00:29:03

I've thought a lot about this, and I've been writing on leadership. I'll give you three where I go against conventional wisdom. So conventional wisdom would be that leaders need to be great talkers, great communicators. They should not give up in the face of setbacks and show resilience. And they should be decisive and take action. So that's conventional -- I don't think anybody will disagree with that. I will disagree with each of them. I will say that in my experience, the number one leadership skill I've had to develop over the years is not talking, it's listening. I would say that this idea of never giving up, leaders are horrible at quitting. We get enamored with projects. And then when things don't work, we keep pouring resources into them. There's a great book by Annie Duke titled 'Quit' that shows that actually one of the most important leadership skills is not never giving up is actually knowing when to quit. And the last one on this idea that as a leader, you need to take action, you need to be decisive. You know what I've learned is if you have time to decide, there's no reason to rush the decision. You should take advantage of the optionality that you have, which as hyperactive leaders, we tend to forget. So, there you go, Joe. Everyone thinks leaders need to be great talkers, never give up, take action. No. They need to listen, not when to quit and exercise strategic patience.

Joe Cass   00:30:45

Great. Thanks, Sebastian. Alexandra, we're living through a rapidly changing work environment with hybrid working, Gen AI and the rise of video calls and conversations like these. How are you adapting to these changes? And what kind of advice would you have for others to ensure that they are working as efficiently as possible?

Alexandra Dimitrijevic   00:31:07

First, I want to say Sebastian, might be a great listener, but you're a very good speaker as well and a very good storyteller. We started the discussion on megatrends and Sebastian was talking a lot about AI as well. So, I'd like to really come back on this. So yes, I mean, the pandemic has definitely accelerated the digitalization of the economy and now we have everything online when it works, video calls and podcast webinars, payments online, hybrid working. So there's been a first phase of transformation of the way people work of the economy, which can have long-lasting implication on certain sectors of the economy. But right now, what I'm really excited about is this new Gen AI revolution. And I think here, we were discussing the pace of change. We're on an exponential pace of change since the release of ChatGPT with something new almost every week. And this is going to have some transformational impact not only in technology as Sebastian was saying, but really on the entire economy and on our society. If you look at NVIDIA, Apple, Microsoft, they account together for 10% of the global market cap. I mean this is massive. And I think we're just at the beginning of trying to understand how this is going to impact us on an everyday life. I just read a really interesting book last week, it’s called 'Co-Intelligence' by Ethan Mollick from The Wharton School of Management. I am still learning a lot on AI, so I found that really fascinating to understand how Gen AI is very different from a software, which does what it's been programmed to do. It's more this general-purpose technology. There's no manual to use it. You really have to experiment it, and it really interacts in many ways more as a person. It does things that we didn't think machine could do like being creative, analytical, having conversation. And obviously, they don't have any knowledge, right? What it does is just predicting the next word in the sentence without knowing if it's right or wrong. So, we know that there are hallucinations, that AI can lie, but at the same time, it has a huge potential to augment our capabilities as a human being. What I really loved in the book, Mollick is speaking about how we would evolve as 'Centaurs' and 'Cyborgs'. So, the Centaur essentially is when you have a clear repetition of task between the human and the machine. And to a certain degree, that's what we are already like if I want to go to a meeting at the other end of the city, I'm going to take my app and check what's the quickest way to get there, and I delegate that task to the machine and then here I go. The Cyborg here is a different concept where it's not a delegation, it's a constant iteration and a process of co-creation and co-development between the machine and the human, which is maybe where we're heading now. And what's really important, and that's one of the key advice from the book is, well, invite AI to your table, but be the human at the table because it's going to be increasingly important to be able to control what these Gen AI machines are doing, understand the limitation, understand the risk, making sure that this AI remains in line with our human values, ethical standards and our social norms. So, there's going to be a lot of change here. It's going to transform high-value jobs. It's going to transform sectors of the economy and how we interact as individuals. It's very exciting. It's very scary at the same time. And I'm very excited that S&P had launched our own LLM within leveraging our proprietary data in a safe environment with the protection of the IP confidential information but giving us the opportunity to start experimenting and using LLMs in our job. And also, I just want to mention that we have some really interesting research on our website on the impact of AI on different industries. So, if you type S&P AI Insights, you'll find some really interesting report there.

Joe Cass   00:36:30

Great. Thanks, Alexandra. Sebastian, I know we're kind of squeezed for time. If we could just get one last question in. Over the course of your career, what's kind of the best piece of advice you've been given and who gave it to you?

Sebastian Page   00:36:46

In the early years of my career, I was a bit anxious about the progress I was making. I wasn't getting the promotion fast enough. I wasn't getting the recognition. And I went to my mentors, name is Mark Kritzman. I worked with him for the first ten years of my career. And I was complaining, and he was tired of hearing me complain. So, he looked at me in the eye and he said, Sebastian, do you know the secret to happiness in life? I was at the edge of my seat. And he looked at me and he said, lower your expectations, which, you can take as a cynical comment or a very powerful philosophical comment. Your happiness, your satisfaction is what really happens, the reality minus your expectations. And this is not about not being ambitious. It's about setting goals that are stretched enough that you can achieve. And then thinking long term, ignoring the noise along the way, and just managing your own expectations of things.

Joe Cass   00:38:03

Thank you very much, Sebastian and Alexandra, for your time today. It was absolutely fantastic for everyone watching and listening. See you next time on fixed income in 15.