2018_09_26 — “The Power of Ten”
September 29, 2018
The Power of Ten
The Power of Ten
GFC + 10: Ten years ago, when the great financial crisis (GFC) struck, investor, political, and economic chaos was so great and market volatility so high, that investors tended to overemphasize short-term scenarios and fear of economic Armageddon over long-term outlooks. Ten years after the GFC, much has changed, a lot of it for the better.
- Deleveraging: Household debt to disposable income has fallen appreciably in the U.S. and Europe.
- Banking: Banking and brokerage leverage has also fallen precipitously as regulation reined in financial industry risk.
- Growth: As good as economic growth seems in 2018, average U.S. GDP growth has declined from around 3.5% prior to the GFC to near 2% for the past decade (this was dubbed by some to be the new normal). Europe’s growth is averaging 1.6%. China’s growth has slid from approximately 9.5% to 6.5% and emerging market (EM) growth overall has halved.
- Trade: U.S. administrative rhetoric aside, global trade imbalances are narrower now than in 2006. The U.S. current account deficit has fallen in half over the last ten years, and China’s current account surplus has declined from a heady 10% of GDP to almost nothing. The big picture is that borrowing countries are borrowing less from foreign entities, and creditor nations (like China) are spending more domestically.
- Supply & Demand: Since the crisis, the supply of goods and services seems to have outpaced demand as savings continue to stockpile, capital expenditure (capex) has decelerated, and technology has made digital replicability seamless. Low commodity prices, low inflation, and China’s governmental push to increase its own domestic consumer demand are just a couple symptoms of this excess supply problem.
- Asset prices: With decreased leverage and excess capacity, an economic text book might tell you that asset prices should be lower; but ten years on, most assets — stocks, bonds, real estate — are valued higher because interest rates are low and huge mountains of money, savings, and profits (looking for a home) have been plowed into investable assets.
At some point, some or all of these trends may level off or reverse, but thats to be seen.
Silver lining: So where is the silver lining in a low leveraged, low growth, and oversupplied world?
- Fed rates: The Fed can keep pushing up rates without worrying about investors fleeing bonds because demand for safe assets (or any asset for that matter) remains high
- Long vs late: Although we have been a long expansion phase and bull market, that does not necessarily mean we are late cycle. No capex boom and ho-hum leverage reduces the chance of a cyclical economic bust.
- Caution: Stocks could still see a 10% to 20% price correction — especially when analyst earnings projections for 2019 and 2020 start scaling back, as they should — but that probably won’t derail economic trajectories. Enough investors seem to be cautious regarding extended valuations and fearful of a recession by 2020 that contrarian signs of excessive risk taking and investor euphoria are lacking.
Change without resolution: Ten years after the great financial crisis, a lot has changed globally, and this is certainly not a comprehensive list of those changes. Government debt is higher than it has ever been, and rising interest rates will make the interest burden from that debt material. Although we haven’t seen much inflation in goods and services, we’ve definitely seen it in asset prices; but asset prices don’t significantly impact cost of living adjustments. Where will the next crisis come from? Probably from a war; whether that will be a traditional war, a war between technology and private equity, a battle between bond vigilantes and politicians, or some other imbalance remains to be seen.
Three months to 30 years: What this all means is that almost every investor needs to expect both good and bad behavior from the market, and thus needs their advisor to look out for them not just through the next three months or through a 20% correction, but also across the next 30 years and multiple up and down scenarios.
Michael Ashley Schulman, CFA
Disclosure: The opinions expressed are those of Michael Ashley Schulman, CFA and are subject to change without notice. The opinions referenced are as of the date of publication, may be modified due to changes in the market or economic conditions, and may not necessarily come to pass. Forward-looking statements cannot be guaranteed; neither can backward-looking nor current-looking statements. This material is provided for informational purposes only and does not constitute an offer or solicitation to purchase or sell any security or commodity or invest in any specific strategy. It is not intended as investment advice and does not take into account each investor’s unique circumstances. Information has been obtained from sources believed to be reliable, but its accuracy, completeness and interpretation cannot be guaranteed. Past performance is no guarantee of future results.