In today’s newsletter we feature an article from Adrian Saville. How have we dealt with the crisis – what is the real debt situation and where are the places for investors in the future are just some of the issues Saville addresses.
A Changed Global Fabric: Investing in the Post-Crisis Era
Dr Adrian Saville, CIO of Cannon Asset Managers, assesses the post-crisis investment landscape and suggests the best investment avenues
Measured by economic and financial criteria, the global economic meltdown of the past two years is unprecedented. Commodity prices collapsed; international trade fell 10 percent between 2007 and 2009; and the world economy went into recession for the first time since the end of World War II.
Further, the financial mess has seen many firms disappear, including former icons such as Bear Stearns and Lehman Brothers. For many others, survivorship has required substantial adjustment by the firm. In this turbulent environment, the world’s equity markets lost $35 trillion in capitalisation over the 15 months to the end of March 2009.
Policy makers have responded to the meltdown by using three main tools.
First, aggressive easing of monetary policy actions have been undertaken to help thaw financial markets. Second, policy makers have tried to repair business sentiment by providing rescue packages for ailing firms. Third, to restore consumer sentiment and bolster real economic activity, governments have put in place generous fiscal packages, such as the $800 billion spending programme in the US.
Recently-released economic data reveal that these policies have had some positive impact. For instance, it appears that the Western European and US economies have troughed. Further, economies in other parts of the world, including Brazil, China and India, have taken solace from the forceful policy actions, managing to grow rapidly this year despite the global recession.
In turn, capital and commodity markets have been spurred on by the policy cocktail. The global equities, for instance, have recovered $20 trillion of the $35 trillion paper wealth that was lost. In similar fashion, commodity prices have rebounded, with oil prices 100 percent higher than earlier this year.
Read together, the recent economic data and the market price responses suggest that the world has seen off the worst of the global financial crisis. However, this view seems short sighted given the adopted policy cures are made of the same poison that caused the crisis, in particular, an abundance of easy money. For investors, then, the question becomes what lies beyond the short term policy and market reactions?
In part, the answer to this question resides in accepting that the financial crisis has caused debt mountains to grow instead of shrink, particularly in the case of advanced economies such as Japan and parts of Western Europe. The headline grabber, though, has to be the US economy, where the debt-to-GDP figure is in excess of 100%. If the US government’s off-balance sheet debt is added to the equation, national debt balloons to more than 500% of GDP. If a national debt-to-GDP figure of around 75% is considered to be a red line, and that these advanced economies have shrinking workforces, it follows that some of the biggest and most advanced economies are in debt traps.
To boot, debt has been monetised in many of these economies. For the US, this printing of money has resulted in money supply more than doubling between 2008 and 2009. Moreover, from history we know that excess debt and consumption is always followed by currency debasement. This poses a major risk to the stability of the US dollar, which has served as the world’s reserve currency since World War II.
In any event, it is evident that this cocktail is poisonous. If the principles of economics hold, there is a reasonable chance that the next crisis faced by investors will involve navigating the threat of sovereign debt default in some advanced economies whilst coping with the spectre of high consumer price inflation.
Experience shows us that some asset classes are reasonably well placed to deal with this tough environment. In particular, portfolios that hold physical and productive assets – which include commodities, especially gold, real estate investments and equities – are better equipped to deal with the debt, deficits and default than the purported safe haven asset classes of cash and government bonds.
Moreover, while it can be argued that investors can look to investments in equities, real estate and commodities to deliver the goods in this new environment, they should note that not all such investments are the same. In particular, investors should consider at least three structural factors when scanning the environment.
First, nations which are savers are better positioned than net consumers. This argument is a basic principle of economics: by definition, savings are produced where consumption is less than income, and savings are the fuel for investment. In turn, it is investment in its various forms – physical capital, human capital, infrastructure and research and development – that lead to economic growth and national wealth. No nation can achieve growth without access to savings.
Second, investors should consider national competitiveness in their investment decision. If a country’s production exceeds consumption, it follows that the country is a net exporter. Just as a firm’s market share is evidence of competitive strength, so a country’s share of world export markets is evidence of national competitiveness. Export-led growth has many advantages over other forms of growth, such as import-replacing growth. Amongst other things, export-led growth has greater sustainability and produces foreign sector surpluses that act as a store of national wealth.
Third, contrary to conventional wisdom, a growing population, and in particular a growing workforce, is a desirable attribute. This is particularly the case where countries have pay-as-you-go systems for funding retirement, unemployment and healthcare. Yet, a number of countries that have such systems currently border on, or are experiencing, negative population growth. Russia, Japan, Germany and Italy fall into this set. In other cases, countries still have population growth, but their working population is in decline. This set incorporates the US and, by 2014, will have China as a member. By contrast, emerging economies such as South Africa, Brazil and India enjoy growing working populations.
Drawing these arguments together, investors equip themselves to navigate the post-crisis environment by recognising the opportunities that present themselves, especially where they are underpinned by the three structural factors identified above, namely the savings-investment ingredient; export-led growth and global competitiveness; and favourable demographic attributes. In the same breath, key risks in this environment flow from the policy actions that have been taken to address the crisis. Specifically, the post-crisis world demands policy solutions that extend beyond short-term expediency. More of the same simply will not suffice to cure the world and its leading economies of the credit binge.
The opinion and comment in this newsletter is opinion and comment only and is not intended as financial advice and should not be construed as financial advice. For all financial and investment decisions please speak to a registered professional financial adviser.