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» Articles - The New Normal
The New Normal
In his latest investor letter, Bill Gross, founder and managing director of the largest bond-fund in the world PIMCO, considers the following:
"With the bursting of the great credit bubble of the last decade, will we have a New Normal global economy (and investment market)?"
Bill's 30+ yeas of investment experience and insightful views on investment markets have significant implications for how we approach the preservation and growth of our investment capital in the future.
Below, we provide an extract of the key points and themes raised.
Children of the Bull Market
During a Bloomberg Radio interview in early 2009, Barton Biggs (hedge fund manager and former chief global investment strategist for Morgan Stanley) described himself as a "child of the bull market."
He went on to say that for as long as he's been in the business - and that's a long time - it has paid to buy the dips, because markets, economies, profits, and assets always rebounded and went to higher levels. That is not only the way that he learned it, but that is the way, basically, that capitalism is supposed to work. Economies grow and profits grow, just like children do.
With the bursting of the credit bubble however there's been a significant break in that growth pattern, because of delevering, deglobalisation, and re-regulation.
... "if you are a child of the bull market, it's time to grow up and become a chastened adult; it's time to recognise that things have changed and that they will continue to change for the next 10 years and maybe even the next 20 years." - Bill Gross, PIMCO Investments
Heading into the New Normal
The New Normal We are heading into what could be called "the New Normal", which is a period of time in which economies grow very slowly as opposed to growing like weeds; in which profits are relatively static; in which the government plays a significant role in terms of deficits and re-regulation and control of the economy; in which the consumer stops shopping until he drops and begins, as they do in Japan, to start saving to the grave.
Delevering, deglobalisation, and reregulation may be conceptually understandable, but nevertheless still a little hard to get one's arms around. Why would they necessarily lead to a new, slower growth normal?
At a high-level this new environment renders some of the old business and economic models defunct. The following examples are provided:
American-style capitalism and the making of paper instead of things
Inherent in the "great modernisation" of the past 25 years was the acceptance that America (and other large developed western nations) would consume (binge), then print paper assets and debt in order to pay for it. Developing (and many developed) countries would make things, and accept America's securities in return. This game is over, and unless developing countries (China, Brazil) step up and generate consumer-centric economies of their own, the world will grow at a slower pace.
Global economic leadership
It is premature to award the 21st century to the Chinese as opposed to the United States, but if the last six months have been any example, China is sort of lookin' like Muhammad Ali standing over Sonny Liston in 1964 yelling, "Get up, you big ugly bear!" Not only has China spent three times the amount of money (relaive to GDP) to revive its economy, but it has managed to grow at a "near normal" 8% pace vs. the United States' "big R" recessionary numbers. Its equity market, while volatile and lightly regulated, has almost doubled in twelve months, making the US look like that ugly bear instead of a raging bull.
Private vs. public-driven growth
The invisible hand of free enterprise is being replaced by the visible fist of government, a temporary necessity, but (if permanent) damnable condition in terms of future innovation, drive, growth and profits. The once successful "shadow banking system" (non-bank financiers) is being regulated and de-levered. Perhaps a fabled "110-pound weakling" may be an exaggeration of where our financial system is headed, but rest assured it will not be looking like Charles Atlas (or Arnold Schwarzenegger for those of us not old enough to remember Charles Atlas) anytime soon.
The financialisation of assets via the shadow banking system led to an era of consumerism because debt was available, interest rates were low, and the livin' became easy. Savings rates plunged from 10% to -1%, as many (if not most) assumed there was no reason to save -the credit card would pay for everything. Now things have perhaps irreversibly changed. Savings rates are headed up, consumer spending growth rates moving down. Get ready for the New Normal.
The issues that won't go away
Then there are the issues that will challenge us for the next 30 years - an aging boomer society not just in the US, but worldwide. Increased health care may be GDP positive, but it's only a plus from a "broken window" point of view. Far better to have a younger, healthier society than to spend trillions fixing up an aging, increasingly overweight and diabetic one. Same thing goes for energy. Far easier and more profitable to pump oil out of the Yates Field in Texas or even Prudhoe Bay than to spend trillions on a new "green" society. Our world, and the world"s world, is changing significantly, leading to slower growth accompanied by a redefined public/private partnership.
How to invest in "the New Normal"
The investment implications of this New Normal evolution cannot easily be modelled econometrically, quantitatively, or statistically. The applicable word in New Normal is, of course, "new".
The successful investor during this transition will be one with common sense and importantly the powers of intuition, observation, and the willingness to accept uncertain outcomes. As of now, PIMCO observes that the highest probabilities favour the following strategic conclusions:
* Global policy rates will remain low for extended periods of time.
* The extent and duration of quantitative easing, term financing and fiscal stimulation efforts are keys to future investment returns across a multitude of asset categories, both domestically and globally.
* Investors should continue to anticipate and, if necessary, shake hands with government policies, utilising leverage and/or guarantees to their benefit.
* Asia and Asian-connected economies (Australia, Brazil) will dominate future global growth.
* The US dollar is vulnerable on a long-term basis.
* Like playing in an Open Championship, future golfers/investors need to play conservatively and avoid critical mistakes. An 'even par' scorecard (plus some hard earned value-add) may be enough to hoist the trophy in a New Normal world.
An Australian Perspective
While Bill was talking from a US-Centric perspective, his views have direct implications for investors around the world and particularly in countries such as Australia that have so closely embraced the consumer-driven economic model of spending funded by debt.
Yes, as Bill mentioned, Australia is still the "lucky country" and poised to benefit from the rise of Asia as a global economic force. We have also lived and prospered in a far more "government regulated" financial system than exists in the US - in some respects we will adapt more readily to the "New Normal".
As far as we can see, the "New Normal" will impact, or re-enforce, the following investment principles:
* Patient "counter cyclical (contrarian)", while more challenging (due to greater volatility and lack of clear trend), will be absolutely essential to preserve and grow capital.
* Sustained linear, debt-fuelled, market recoveries will be rare - volatility will be the norm - requiring a more selective approach to investment entry and exit.
* The expectation of sustained double-digit investment returns will not be reasonable - for the most part. We can see an emerging trend toward holding a 'core investment portfolio" that aims for sustained conservative growth and cashflow generation, complimented by satellite investment portfolios that add value by taking shorter term event-driven opportunities. The prudent allocation of capital between special purpose portfolios will be critical.
The Eden Investment Committee is carefully considering current and future investment approaches with the anticipation that careful portfolio re-structuring will be required over the coming months/years to prosper in the changing economic and financial landscape.
For more information, or to discuss your specific situation, please contact me directly.
Robert Palma
Eden Wealth Management and Eden Tax Accounting
Now that you have read this, what do you think? Do you have other ideas? Please share you views with other members (eg by blog or discussion form) and/or request professional member(s) to contact you directly.
