Larry Summers isn’t the only one starting to recognize the “slow growth forever” scenario I have been describing the past couple years. Today on Bloomberg, HSBC bond manager Steven Major cited demographics, debt and the income gap saying that “I sincerely believe we have low rates for a very long time. Structural problems are outweighing any kind of cyclical bounce.” For investors waiting for a resumption of the central bank induced bull market, that is bad news.
Today, we are seeing stock markets around the world continue to fall, albeit not as badly as Friday, but with more of a tone of recognition that Brexit might just have been a reaction to other negative economic factors, as I described in my last piece. The next reaction could be worse.
Subscribers to Fundamental Trends know that this is not just a tip sheet. We are using macro analysis to find micro opportunities. The prevailing macro theme, likely to last for the better part of a decade, is that economic growth will cause equity markets to be very challenged.
Opportunities will only be found in certain parts of the stock market. We have four core themes that we are focused on:
- Companies, regional markets and sectors that benefit from secular trends.
- Companies and sectors that offer truly disruptive change to traditional markets.
- Companies and sectors that benefit from government and/or central bank support.
- Companies that are truly undervalued relative to their current and future intrinsic value.
In addition, bond markets will also be challenged. With coupon yields near, at or below zero, there is virtually no opportunity left in bonds and risks are high due to a misconception that central banks can go on forever. At some point, I don’t know when, but I suspect within the next five years, the long forgotten “bond vigilantes” will make reemergence.
It is just not reasonable to think that people and institutions will accept no return on their money forever. Ultimately, they will demand a better return on their money. I’m not sure what will trigger that change, however, it will have something to do with them gaining leverage over governments and central banks. One such event could be the majority of baby boomers in the U.S. getting onto Medicare. Somehow, the U.S. will have to finance that. There are similar and more severe circumstances of aging dependency in other nations, particularly Japan and throughout Europe.
When large investors finally have the ability to demand higher rates of return, then should expect a forced “austerity” or the creation of even more vast amounts of money. In a world with “slow growth forever,” if we see even more money creation, likely through the so-called “helicopter money,” then we will be on our way to stagflation in the general economy.
When stagflation hits (I say when because until central banks prove they are going to do something different, I presume they will continue on their path of printing money to solve problems), people with savings will need to be invested in inflation sensitive assets that benefit from the factors listed – it is a relatively short list. Folks who have recently drank the Kool-aid of index investing will experience a very long period of very low rates of return within a higher volatility period – the opposite of the low volatility post-crisis time period. The current volatility and correction is foreshadowing the intermediate term future. The period of low equity index returns and higher volatility probably just started.