I have previously written about a future of low growth and low investment returns and how all investment managers will struggle to generate good returns.
The important point here – is that the portfolio’s that we construct use the funds we know are exercising the right balance between generating income and growth from today’s economy while also maintaining an eye on the big picture regarding long term economic growth and where that growth may or may not come from in the future.
Investment Bank Morgan Stanley anticipates that in the next 50 years of global growth will be half the rate of the last 50 years – and that includes an allowance for the new emerging economies growing.
There are a number of signs that we are now seeing this effect taking place in 2016 as a precursor to the future. As a series of bullet points below, I will simplify the reasons and rationale behind this.
- Low interest rates around the world have pushed up asset prices.
As a means to generate growth in the post GFC economy reserve banks around the world have reduced interest rates to levels never before seen. The Bank of England – with the longest running financial history in the world has interest rates lower than at any time in its history. Even in the 1700’s interest rates (pre the official Bank of England) were higher than now.
This has pushed up the price of assets in many areas – most notably in Australia in property prices, but elsewhere as well. Government bonds, corporate bonds, even high rise commercial buildings. A skyscraper in New York is priced so high than the rental return is now typically only 2%.
In the good old days rental returns were on average 7-10%. But once the prices have risen substantially, the capital growth tapers to 0 and you are then left with a small income return only. Property in Sydney and Melbourne may now be seeing the same effect, finalising the end of the Australian property boom.
- There is a Glut of almost everything – reinforcing low inflation. Despite the past threat of shortages of oil (amongst other things) we now have a global oil surplus from a variety of sources – including new countries with oil supplies and the US with new low cost shale oil technology.
China in the past 5 year ramped up steel production capacity and has flooded the world with cheap steel. Steel works in the UK (Wales) and South Australia ( Arrium in Whyalla) are going to the wall – other countries are in similar difficult situations.
There is also a flood of money from wealthy nations that seek out investments. China, oil rich middle east and the high debt nations have created a surplus of funds looking for investment returns. The glut of money pushes up the price of the investment and then pushes down the income return. (eg Housing and rents)
There is typically also technological revolution that is affecting our most commonly bought products – such as phones, tvs, computers, cars where the cost per item has dropped substantially and they are becoming almost “disposable” items. A glut of stuff.
- What was once a joke – may now be real – but has consumption consequences.
There use to be a joke that went as follows: . . “We slave away to buy big houses – to fill with stuff – to impress people we don’t like that much.”
What happens when every room is full? Retail spending in many established countries is lacklustre as people find that while they might fancy a new item, they must throw out an old item first – that may not be that old. Guilty feelings abound and a purchase isn’t made.
The term “Peak Stuff” was coined by IKEA to describe the above situation and they have set up experimental trade in arrangement for their old furniture which was previously bought and resold to needy households. It is meant to unclog the path to selling newer items. While it may be just a trendy new name / sales concept it may also have wider reaching implications across western society as most homes struggle with household capacity.
We used to have plenty of second hand shops that had mostly old solid quality / (pricey when new) furniture – but will we see an equivalent for low cost disposable furniture?
Anecdotally - a review of the Gumtree website recently revealed that within the 10km radius of Sydney CBD there was approx.1000 advertisements for second hand dining tables and chairs. Most in good condition, most for sale at only nominal cost but quite a few for free. In theory you could furnish a whole house for next to no cost with decent second hand items.
- Lower interest rates – as outlined above have a couple of counterproductive influences.
For example as the population ages the retirees and the pre retirees become more sensitive to interest rates and their savings increase – to preserve their funds. Since income from investments reduces.
For those that are pre occupied with the more conservative investments options such as bank savings and term deposits (which is a significant proportion of the over 50’s segment) the rate of returns have sunk dramatically over the past few years.
The natural reaction is to spend less and save more. While this may have affected a small segment of the population years ago, we now see the age group of the over 50’s has grown substantially. It now represents a very large portion of society in Europe, the USA and other western nations.
For example in the USA the over 50 age group increase in size as a proportion of the total population is shown as follows:
Europe tends to be older and other parts of the OECD tend to be younger – but the cumulative effect of lower interest rates for investing – affect how people save and spend as many get closer to retirement and can have a significant effect on the global economy.
- The Measurement of GDP is changing – slow economic growth may be the norm but the method of measure may also be affected, which we haven’t fully accounted for yet. The GDP of a country is measured by the dollar value of outputs that are consumed.
If the dollar value drops the GDP is affected. A dramatic drop can generate a negative GDP for a quarter or a year. Is that negative figure a reflection of what is really happening?
Technology can lead to cheaper goods which can benefit the community – but appear to also slow the apparent GDP activity.
Now consider the dramatic change in the past decade of whole industries which have succumbed to the internet. These industries no longer contribute in dollar terms anywhere near what they did a decade or two ago… and their reduction is reflected in the GDP of each economy affected.
- Encyclopaedia at $1000 a set or more – replaced by Google and Wikipedia for free.
- Music CD’s at $30 a disc (typically $3 per song) – replaced by streaming – i tunes – pirated songs – at very low cost or no cost.
- Newspapers, Books and magazines – have sales dropping dramatically and replaced by lower cost online papers, e-books or online magazines.
Usually at much lower costs or nearly at no cost in some cases.
- Travel Industry – travel agents – now a severely downsized and consolidated industry that exists on the slimmest of profit margins – replaced by travel booking websites and direct booking facilities with airlines and hotels.
- Accommodation – Airbnb becoming a “black market” hotel substitute and Uber taxis significantly cheaper often at the expense of the current taxi industry in every country.
The list could go on – but you can see the collective impact on measurement of the economic outputs of an economy. If measured in dollars – it’s all lower than it used to be. Actual consumption may increase – but not enough to offset the value of the price effect.
But if the costs drop across the economy and inflation “doesn’t exist” and the normal interest rates drop to reflect the inflation plus a rate of return. Does it matter?
The immediate probable future:
The Economic think tank Gavekal Economics – which I have referred to on other articles – have previously written about the prospect of a sustained growth spurt following years of stagnation in terms of investment market growth.
(see the 2015 Update in the menu list above)
They previously posted the following chart which has been made up from a composite of the S&P 500 dating back to 1900.
With the exception of the end 1920’s, each of the other 2 breakouts in the 1950’s and 70’s showed an initial pullback / stalling of the rise before resuming the growth.
Under the current long list of headwinds outlined above it would seem logical that world GDP and investment markets would experience the same pattern of initial resistance.
Since a number of respected industry analysts such as Perpetual’s Matt Sherwood expect that the “market will trade sideways” for a period – it would be reasonable to expect that the markets will in fact oscillate for between 6 – 18 months, without going anywhere.
- The S&P500 will probably bounce around between 1700 – 2100
- The Australian markets may benefit from a falling Australian dollar and further falls in interest rates but similarly bounce around 5000 – 5600. There is some scope that it could rise closer to its previous high of 6000 if everything goes well, but that would be later in 2017, if it happens.
- Falls in interest rates in Australia – while gently rising in the US should eventually bring the $A down below $US0.70, possibly under $US0.65. But it has taken forever for this to take place.
The better fund managers will be able to squeeze out some positive results from this, but will not reproduce the same strong growth of the period 2011 – 2015.
These above issues occupy the minds of the best economists and we regularly review the situation and seek to find the best investment solutions in amongst the myriad of issues that present themselves in 2016 and beyond.
Investment decisions increasingly will focus on funds that seek out various new technologies and approaches that offer viable income returns and growth in what is dubbed a low growth future. The portfolios that we propose are designed to reflect the funds that have the better track records with an eye to the issues outlined above.
You may wish to pass this onto some friends – who may have superannuation or investments which is not performing the way they think it should. Passive index investing would tend to be focused more on the past and present – with little exposure to forward thinking investments.