The Hotel Lafayette in downtown Buffalo, New York, was the site of the first-ever meeting of the Optimist Club, which gathered during a tumultuous period for financial markets following the panic of 1910. Research has shown that optimism provides a sense of control. As uncertainty hovers over markets today, investors might seek to harness the power of optimism to overcome financial stress and make better decisions for their portfolios. Can investors remain optimistic while also surveilling markets for downside risks?

Economist Brad DeLong, author of Slouching Towards Utopia, and the CFA Institute Research Foundation’s Laurence Siegel, author of Fewer, Richer, Greener, join PGIM Fixed Income’s Robert Tipp, Chief Investment Strategist and Head of Global Bonds, to discuss reasons for investors to be optimistic about the future, particularly as opportunities emerge in the bond market.

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>> In downtown Buffalo, New York, at the corner of Washington and Clinton streets sits the majestic Hotel Lafayette. Built in the early 1900s in the French Renaissance style, it was one of the finest hotels in the US. It was also the site of the first meeting of the Optimist Club in February 1911. A plaque still marks the site where a group of people came together declaring a mission of hope and positivity. At a seemingly quiet yet prosperous time, what was driving their need to spread optimism? Industrialization and immigration were fueling a strong economy until the panic of 1910. The Sherman Antitrust Act had triggered a drop in the stock market of around 25%. While relatively short and shallow, this crash did create quite a lot of uncertainty and financial stress. Today, we know from research that optimism provides a sense of control. And when do we crave control the most? As uncertainty and stress rise. Could the original members of the optimism club have understood the power of optimism to help overcome financial stress and uncertainty? Is there a case to be made today that optimism can help us regulate emotions and improve investment decisions? If only we were living in a time of uncertainty and stress to test this theory. To understand today's investment landscape, it's important to know how we got here. This is the OUTThinking Investor, a podcast from PGIM that examines the past, the present-day opportunities, and the future possibilities across global capital markets. In this episode, three experts will help us decide the case for optimism in the financial markets today. Brad DeLong is professor of economics at the University of California and author of Slouching Towards Utopia: An Economic History of the Twentieth Century. Larry Siegel is currently director of research at the CFA Research Foundation. His recent books include Fewer, Richer, Greener: Prospects for Humanity in an Age of Abundance, and Unknown Knowns: On Economics, Investing, Progress, and Folly. Robert Tipp is chief investment strategist and head of global bonds for PGIM Fixed Income. Optimism sometimes gets a bad rap, but we need optimism to stay focused on long-term goals during rockier times. As investors, being optimistic can help us lower reinvestment risk and opportunity cost and even avoid chasing performance. Research shows that optimism has real health benefits, including longer life expectancy and less heart disease. Perhaps optimism in the financial markets could lead to financial health benefits as well. The last several years have been like a Rorschach test for investors. With fundamentals as skewed as they have been, investors are left to interpret even the most established signals. Bad news can be good and good news can be bad. But focusing solely on downside risk comes at a cost when markets rally. Can we be optimistic but keep an impartial eye out for warning signs? The last 150 years or so have been quite extraordinary, for the most part. We've had reason to be optimistic. Brad DeLong explains.

>> Eighteen seventy really was the hinge of history. After 1870, we get the rocket of modern economic growth and humanity's technological competence doubles every generation, so that each generation is potentially at least twice as rich as the generation that came before. We got an incredibly good system going, one that no previous civilization had. We not only had our scientists, but we also had our industrial research laboratories to rationalize and routinize the discovery and development of new technologies. And then we -- around 1870, we figured out how to organize the modern corporations to rationalize and routinize the development and deployment of technologies. And that, in the context of the global market economy, that also shows up around 1870. That provides enormous material incentives to figure out how to distribute and then how to copy and thus diffuse inventions, new technologies, all around the globe. And those are three things that no previous civilization had. And they are true treasures for making us richer and need to be kind of nourished and supported.

>> How long can we keep doubling productivity and wealth with each generation? At what point do we start to see diminishing returns?

>> On the one hand, our official statistics seem to say that the engine of economic growth started, you know, sputtering and missing on a whole bunch of cylinders starting around 2007. Governments stopped being as open-handed with the investments they're willing to fund in the great private sector industrial research labs, you know, the Bell Labs and the Xerox PARCs and the GE researchers and so forth. There's an increasing financial demand for showing something in the bottom line. And so those research labs begin to get hollowed out as well. One theory is that around 2007, the failure of governments to step forward and also the fact that corporations are no longer as lavished with their industrial research labs has finally begun to tell on the global economy.

>> Rather than doubling our technological skill and the corresponding wealth every 30 years or so, Brad DeLong sees that slowing to roughly every 100 years. While that number is up for debate, it's reasonable to see that our rate of progress is not sustainable forever. Robert Tipp looks at the big picture.

>> This is, in all likelihood, the highest rate of growth and the highest rates of inflation that people may ever see in their lives. We're at a generational high in growth coming out of the COVID recovery, generational highs in inflation. Two years down the road, five years down the road, 10 years down the road, inflation and growth are going to be lower and interest rates will probably be at least a little bit if not significantly lower than where they are now.

>> Timing is everything. And in the long term, Larry Siegel sees continued reason for optimism. According to his recent book, we will be fewer, richer, and greener.

>> We've been growing the global economy at about 1.8% per capita per year. That's a lot when you consider that the population is also growing at a steady rate. And there's no reason why it shouldn't continue. So our forecasts need to take account of the world being richer than it was by a huge multiple and continuing to get richer in such a way that we will be living in a middle-income world in our own children's lifetimes.

>> Lifting the global population to middle class is certainly a worthy goal. But why is a smaller population cause for optimism? In the 1960s, a theory began to take hold that the world has a carrying capacity. According to this theory, population growth would slow only after food, water, and other necessities were depleted. Fortunately, that's not been the case. Wealth has actually been the driver of population control.

>> As the economy becomes more productive and people move into the middle class, they have fewer children. And you could say too few children. The population of China is expected to fall in half in this century. India will clearly be the number one country in the world in population. But whatever the populations are, they're going to be growing at a much slower rate than anybody anticipated 50 years ago or even 30 years ago. And that means that we're not pushing the envelope on using resources to the point of extincting ourselves. We can increase food production. We can increase energy production through things like nuclear power and renewables to the point where we have a reasonably prosperous population in the whole world of between eight and 11 billion for the remainder of the century. And that's a long time.

>> Greener may be a bigger challenge. Climate change represents a massive expense and diversion of resources, and that's beyond what's needed to sustain an aging population.

>> Climate change is not the only issue. We have gotten radically more efficient at growing food. We now have a global food network. When the demand for food goes up in Cleveland, somebody gets to work it. In Indonesia, they're doing something differently. It's just amazing how the supply-demand price system works to achieve that. The latest trends toward deglobalization really for national security reasons is bad because it puts a crimp in the ability of the world economy to react, changes in demand for anything, whether it's food, water, clothing, energy, shelter. Moving away from food, water, and energy, other aspects of the environment are going to improve a lot. Reforestation is taking place at a very impressive rate in places like Europe and North America Deforestation, which is a problem, is ongoing in Southeast Asia and parts of South America. But the balance is shifting in favor of nature as our population gets under control and as we get more efficient at using resources, and a million other things. Air pollution in the United States has basically disappeared.

>> There are also plenty of reasons to be optimistic in the short run. As China reopens and inflation declines, watching for downside risks may blur the upside, such as reinvestment risk. Robert Tipp explains.

>> Banks are well-capitalized. Net worth of consumers is very high. Economic health is generally very good. And so the increase in rates that we've seen, a lot of the first maybe 60, 70%, of what we saw, maybe just getting back to normal, and this may actually have a much less dampening effect on the economy. But in terms of finding the opportunities in fixed income, the yield curves around the world are very flat. And that creates a conundrum. So for example, in the United States, the one-year Treasury bill is pushing a 5% area, you know, in this early part of 2023, which is very comparable to, you know, yields that you may find on longer corporate bonds.

>> Coming off an epically bad year for fixed income, suddenly, bond investors have lots of opportunity. Should they stay with short duration and low risk or add duration and add risk?

>> I think all the options in fixed income are pretty good right now, but there may be an opportunity risk. So that's an unusual feature where people come in on the yield curve. They say, "Hey, you know, 4 or 5%, that's great. I'm just going to, you know, get cash in my money fund or buy T-bills." What they may find is a year down the road, three years down the road, four years down the road, if the Fed funds rate, interest rates have dropped back down 1 or 2 or 3%, they will not have the income stream. They will have lost it because their investment horizon is actually much longer than one year, five years, or 10 years.

>> While green shoots are appearing across the bond market, it's essential to sort through risks and opportunities.

>> On the upside, the green shoots they're at the macro level and at the micro level. So at the macro level, this business of energy prices being moderate, house prices moderating. Those are things that are our green shoots for the bond market at large. If and as inflation comes down, that will be a positive. So that's at the macro level. Another one is to look at the micro level. So in terms of the micro level, looking across the sectors of the market, there are a lot of dislocations there that provide opportunities. So for example, one of the areas that has suffered quite a bit as a result of its higher liquidity than some of the other sectors are CLOs, collateralized loan obligations, which are backed by bank loans.

>> Even high-quality collateralized loan obligations are posting yields typically associated with lower-quality securities. Continued market dislocations make some of these securities attractive on a risk-adjusted basis. Other fixed-income opportunities, Robert looks to housing.

>> Similarly, in the housing market, Fannie Mae, Freddie Mac had been very aggressive in offloading the credit risk from their mortgage securities ever since the financial crisis in an effort to reduce taxpayers' risk. And so that's created a host of credit risk transfer securities. There's some questions about house prices, how weak they will be. But there's also a big drop off in the issuance of mortgage securities. And so that creates an area where their opportunities yields are very high but the supply of the securities is going to be going down. And so should we have a search for yield in the fixed-income markets, you could have a very favorable supply-demand balance in those types of securities.

>> Beyond the US, there are opportunities in emerging market countries, in currencies, or in the local currency debt, or in hard currency debt.

>> Bonds had been out of favor. For a couple of years here, they've taken a beating. But that's created a lot of opportunities at the micro sector level looking across the whole market where we should be able to add value to outperform relative to, say, market benchmarks.

>> Much of the same macroeconomic factors exist across the world, so opportunities should follow in certain countries, regions, and sectors.

>> In Japan, there may be some opportunities over the next year. As they break out of their ultra-low interest rate policy, they're going to be the absolute trailing edge of that. And you may have a relatively explosive sell-off at some points that may create an opportunity in global portfolios. Europe has its own unique set of opportunities and risks. We've seen the corporate bonds that have become incredibly cheap literally on concerns about availability of gas over the winter. We've seen corporate credits in Europe become as depressed as they were at the most uncertain points of the COVID crisis. And so to the extent that the economy turns out less worse than feared in Europe, this could be very strong performers.

>> There's less optimism on the global government bond side, where supply and demand conditions have worsened dramatically. One potential risk in the treasury market is the increasing debt level. Should that concern investors?

>> Back in 1993, I was genuinely worried about the national debt and the deficits. Because it seemed that every time there was bad news about the United States deficit back then, interest rates in the United States went up, you know, and the value of the dollar on currency markets went down. You know, which showed to me at least that the United States back then was getting close to its debt capacity, in the sense that adding to the national debt required that we sell the debt at worst terms, and also was creating the possibility of capital flight from the United States on the grounds that the United States was going to solve its debt problem someday but was likely to do so in a way that would not be good for investors in US bonds. And so back in 1993, it looked to me like a very high priority to get the debt and deficits under control. You know, because, at least, the United States benefited a lot from its ability to sell bonds at good prices, and it looked like a higher national debt would put that at great risk.

>> While it may have been the case 30 years ago that escalating national debt was putting US credit quality at risk, that's less clear today.

>> Now, there are absolutely no signs that people are in any way sick of holding US Treasuries, or there is any limit to the demand for however many bonds that the United States government can sell. You know, it really looks now around the world like there are a huge number of sovereign wealth funds that do not want to report large losses from bankruptcy on any of their investments and so want to hold US Treasuries. You know, a huge number of governments around the world that do not want to go to the IMF ever to beg for a loan and find themselves under some kind of onerous condition and so really want to hold treasuries so they have no need to ever go to the IMF.

>> Continued strong demand for US Treasuries should be welcome news for fixed-income investors. As for equity investors, new opportunities are likely to crop up in certain markets, sectors, and firms.

>> The opportunities have presented themselves already in the fact that value has beaten growth by a mammoth amount, something like 27% points in the last year in the United States. I'm not sure about globally, but I think that it has also in the rest of the world. After a period where growth beat value year after year after year, driving most of the value investors underground, they are sort of hiding from their customers. So there was a lot of opportunity in what's perceived to be underpriced, non-tech, non-glamour stocks. I think that that will continue and in -- even more importantly, in the bond market, we're no longer being punished for being bond investors. When you're guaranteed to lose 1% a year in a safe investment, you're going to take way too much risk. That's no longer the case. You can get inflation plus between 1 and 2% without taking really any risk at all in the tips market.

>> Another lesson that history has taught us and continues to teach us is that optimists may also be realists.

>> The growth that we're seeing in the economy around the world, even in Europe -- and that's one of the weakest areas -- has been surprisingly strong growth. So is something different there, you know, coming out of a pandemic. And the world has seen that historically after the 1957 global flu epidemic, the 1960s were very robust. And after the 1918 Spanish flu, again, the '20s are very robust decades. So is there something psychologically going on? And the reason that could be problematic for the bond market is that it would create a higher for longer interest rate environment. Now, I think the scope for that, the likelihood of that, the downside risk from here is quite mitigated. You know, most of the downside risks that we could possibly have in the bond market is presumably behind us.

>> Perhaps, it's the case that post-pandemic periods are just different. Behavioral economics might one day show that a long difficult stretch sows the seeds for optimism out of need to be hopeful for better times. Or maybe it's simply the return to normal levels of volatility that triggers a different mindset. When it comes to the practicalities of managing a portfolio, downside risk typically trumps upside risk.

>> There is no easy solution to the problem of spending out of a depressed portfolio, right? The solution is to earn more money or not spend, and sometimes reality gets in the way of those solutions. For example, the Ford Foundation where I worked for 15 years wasn't allowed to take new contributions but it was required by law to spend 5% or more. So the real value of the portfolio went down. And it reached its all-time high in 1964. And it's given away tens of billions of dollars since then but never reached the 1964 high in real terms. So, you know, it's a very successful institution with $17 billion. That's still a lot of money. But there is no magic formula for staying ahead of it, what you called sudden tailwinds. It's the Jack Bogle answer. Just be prepared for it because there's nothing you can do about it.

>> In the end, we have more than a few reasons to be optimistic about the future generally and financial markets specifically. We actually have around eight billion reasons.

>> The thing to make you optimistic is that there are eight billion of us. As a group, you know, with all eight billion of us and with 16 billion eyes looking at problems, there's an old line in computer science that too enough eyes, all bugs are shallow. You know, if you can get enough people looking at the problems, someone will be able to think of a solution, especially if you can bounce ideas off of each other. We certainly do marvelous and wonderful things. Right? The Taiwan Semiconductor Manufacturing Corporation tells us that it buys mirrors from ASML in the Netherlands that are so smooth, you know, that if you blew it up to the size of a moon, you know, the biggest imperfection in the mirror would be the size of a small hill. We do unbelievable magical things every day and we rely on them and don't think of them as particularly magical.

>> And that ought to make us incredibly optimistic about our ability to solve whatever problems that society or nature throw at us. Thanks to our experts, Brad DeLong, Larry Siegel, and Robert Tipp, for their thoughts on the global economy. Join us for the next episode of The OUTThinking Investor when we'll explore the rationale and results of sustainable and impact investing. The OUTThinking Investor is a podcast from PGIM. Follow, subscribe, and if you like what you hear, go ahead and give us a review.