In a sense, we are all children of the bull market, although some of us are more mature than others – a bull market of free-enterprise productivity and innovation, yes, but one fostered by a bull market in leverage, deregulation and globalisation that proved unsustainable in its excesses. We now must view ourselves as chastened adults, forced into acknowledging a new reality that is dependent upon bear-market delevering and debt liquidation to deliver us to our new and ultimate restructured destination – wherever it lies.
To me, this was the beginning of his — and Mohamed El-Erian‘s — talk of the “new normal.” He identified three major trends that he expected to dominate his investment thesis for the near to medium term. It started with the very future of the global economy where it
will likely be dominated by delevering, deglobalisation, and reregulating, yet if so, it is important to state at the outset that we do not envision a mean reversion, cyclically oriented future, but instead a new world where players assume different roles, and models relying on bell-shaped/thin-tailed outcomes based on historical data are less relevant.
He expected delevering to slow global economic growth — that “new normal” again. The globalizing trend to actually halt if not reverse somewhat as economies hunkered down in the policy-making equivalent of the fetal ball. While the politicians — egged on by a pitchfork wielding populace — would rediscover their populist souls and do what they do best: create more unintended consequences. He counseled that in this climate we [emphasis added]
stress the bird in the hand – as opposed to the one in the bush; stable and secure income – as opposed to uncertain capital gains; a government-regulated utility model – as opposed to innovative yet risky venture capital investments. At current price levels, to cite one example, the current income from corporate bonds is higher and certainly more secure than the dividend income from stocks. A return to an era reminiscent of the first half of the 20th century is not unimaginable where stocks were viewed as subordinated income producers with yields exceeding their senior bond companions on the liability ladder.
These comments came back — not readily, hence the re-read — when I noticed in Gillian Tett‘s October 7 piece how much further leverage needs to come down before we approach anything approaching normality. Even with the deleveraging that has already happened, things are nowhere near returning to normal. She believes that this is because
even as the private sector has delivered, public debt has exploded.
Thus the total scale of leverage in the system – namely the sum of both non-financial public and private debt – has not fallen markedly in the last two years (in America, for example, it is now running at around 220 per cent, compared to 170 per cent at the start of the decade.). Hence, Citi argues, investors cannot expect a “normal cycle”; companies and consumers alike are too shell-shocked by the recent past – and so uncertain about how governments will deal with all that public debt in the future. The most likely path for the next few years therefore is one of sluggish growth at best.
That dreaded “new normal” again. So how do we make money in this changed investment landscape? We could lobby (another word for bribe and cajole) the policymakers into give us more free money — as Goldman Sachs has done so adroitly — or we could do it the “old-fashioned” way. That’s a theme Gross returned to in October 2010
The hard cold reality from Stan Druckenmiller’s “old normal” is that prosperity and overconsumption was driven by asset inflation that in turn was leverage and interest rate correlated. With deleveraging the fashion du jour, and yields about as low as they are going to go, prosperity requires another foundation.
What might that be? Well, let me be the first to acknowledge that the best route to prosperity is the good old-fashioned route (no, not the dated Paine Webber road map utilizing hoped for paper gains of 12%+) but good old-fashioned investment in production. If we are to EARN IT – the best way is to utilize technology and elbow grease to make products that the rest of the world wants to buy.
That thinking explains why an investor like Michael Burry is investing in productive agricultural land or Galtere International’s Renee Haugeruud is betting on inverse stagflation entailing, with inflation and deflation co-existing,
little or moderate economic growth and the underperformance of traditional paper assets like stocks and bonds. Commodity prices, however, would soar, along with real asset values. Agricultural commodities and farmland would do well in such a scenario, while U.S. stock and bond returns would lag. This is a structural shift away from the regime of the past 30 years, in which paper assets have outpaced real assets five times over.
It’s the same thinking that’s got Warren Buffett licking his chops at buying up a US railroad or Abu Dhabi’s Aabar investment fund freeing up EUR 2 billion of cash to invest in European infrastructure, western telecoms companies and agricultural assets.
It’s not “the economy, stupid” but “the real economy, stupid!” Of course, investing in real assets in the real economy requires real skills in assessing the viability of economic models, business models, and teams. That is if you’ve already figured out which way the world is going to go so you can invest before the suits get there. Good luck then!