The CEO of a $445 billion fund manager speaks on the future of US tech stocks, inflation, and the next economic downturn

Business Insider’s Sara Silverstein recently spoke with the CEO of Principal Global Investors, Jim McCaughan, about the future of US tech stocks, inflation, and the next economic downturn. McCaughan thinks the real decline in the market is two or three years away and relates the current market environment to early years of the internet boom with more room to grow. Following is a transcript of the video.

Silverstein: And what about tech stocks?

McCaughan: Tech stocks are the future and I think that’s one of the reasons why the equity market is justified at this level and why the economy is changing the way it is. And, you know, I’d point out that in the US market as a whole, the top four or five stocks are mostly technology. Facebook, Amazon, Google, Microsoft, those are the really big stocks in the US market. That means there is a market here that can grow and can develop and can really drive a lot of the future of the world. If you look at other markets around the world, they’re old economy stocks. There are many fine companies in Europe, but they’re financials, they’re manufacturing stocks. HSBC, BP, those are the biggest stocks in the European market. That isn’t really where the economy’s going in the future. So I think Europe, relative to the US, has been a value trap for the last two or three years and will continue to be so.

Silverstein: You say that technology is building in some deflation and that that’ll keep interest rates low?

McCaughan: I suspect that’s right. You know, it’s one of the puzzles, most economic commentators if they’d been shown four or five years ago what the US economy has done, they’d have said, ‘Woah, rates will be high, the 10-year will be 4% or 5%, the short rates will be 3%.’ You know, they’d have said that rates had to go up, because at the current sort of economy 20 years ago, they would have. What they’re missing is the fact that the prospective inflation is a lot less, because of the rapid adoption of technology. And I think that means that the valuations remain OK on equities. The same’s true of commercial real estate. It’s done very well, but it’s still not overly extended, given the likely outlook for interest rates.

Silverstein: So for 2018, you think that the economy can continue to expand and that US equities can continue to rise?

McCaughan: Here’s what I would say, which I hope is a helpful comment. There’s a 80% probability it continues to be pretty good; 80% probability you get 2% or 3% growth on the flawed GDP numbers that we’ve been talking about; that you see profit growth even after the acceleration caused by lower tax rates. So a 80% probability things are all pretty benign; inflation doesn’t really hit.So you’ve got bond yields around the current level, maybe up a bit at the short end. And as the Fed tightens further, you could see equities be a bit better. What’s the other 20%?

Silverstein: What is it?

McCaughan: The other 20% is the negative tail risk mostly from geopolitics. Something bad happening in Korea. It looks less likely at the moment, but you know military hostilities are still possible. Something bad happening in the Gulf; there’s a lot of change going on in Saudi Arabia that we hope goes well. But if it goes badly, it could interrupt oil supplies to a lot of the world.

A trade war, you know, it doesn’t look at the moment as if we’re going to pull out of NAFTA, but if we did, that would hurt supply chains. Any of those and a number of other things could cause the market to go down quite sharply, and could bring the next bear market forward, but I don’t think it’s the most likely outcome. That’s why I give it a 20% probability. I think that the real decline — absent policy errors — is two or three years away. If you like, in terms of the ’98, ’99 internet boom,we are still in early ’98;we’re not in late ’99. If that’s true, that’s quite a long way to go on the markets.