As we leave the year of the "Great Recession" behind, knowing four likely financial outcomes will show us how to position ourselves for financial prosperity in the coming decade.
FOUR FINANCIAL PREDICTIONS
1) Global growth
Emerging economies were economically superior in the last decade. Without the effect of the tech and housing bubbles in their past, their demand is not hampered by enormous public (and private) debt. The better run of these economies will prosper in the coming decade, and provide markets for economies weakened by the lingering effects of the recent recession.
2) Inflation
As we emerge from the Great Recession, the reality of the damage is becoming more clear. Without government support, we'd be in a Depression. While the steps taken by G-20 nations were inarguably necessary, it effectively covered old problems with borrowed dollars, while keeping interest rates artifically low in order to give life to a near-death economy.
As more countries take on huge amounts of debt, the numbers of lenders who have the money and motivation to lend decrease. It's a simple formula that we all know: less demand for a commodity causes the price of that commodity to fall. If nobody is buying the farmer's apples, the farmer lowers her prices.
In the case of our debt (in the form of bonds), when bond prices fall, yields go up. Here's an example
Maturity Date - One Year. Price of bond - $1000. Interest paid by borrower - 4% Yield to lender - 4%
If the price of that $1000 bond falls to $980,
Maturity Date - One Year. Price of bond - $980. Interest paid by borrower - 4% Yield to lender - 6.1%
Higher interest rates mean higher inflation. The Fed can't keep rates artificially low forever.
3) The mortgage market
We have just seen the effect of lending to less-than-qualified-borrowers in the recent mortgage meltdown. You may be able to cut mortgages into little pieces and sell them to Iceland, but in the end, the mortgages will still go bad if the borrower can't pay it back. Since the crisis, financial reform has stalled. Mega-banks are repaying taxpayers for the money we spent keeping them alive, and, while lending standards have tightened, the genie has been let out of the bottle.
Investment bankers now operate under commercial bank charters. Structure finance has diminished the barrier to entry to the mortgage market. This demand, together with stricter lending practices, will provide additional upward pressure on interest rates.
4) Wealth transfer
Over the last decade, emerging nations have produced good for the insatiable US consumer, who bought with abandon. Now debt laden, US consumer growth is diminishing. Emerging nations, however, have newfound wealth. Those nations now lend money to our government, and have a huge and growing middle class.
China is the most obvious example, but there are others. These nations, assuming that they avoid the pitfalls of asset bubbles, will provide the majority of global growth in the early part of this decade with their newly acquired wealth.
A SHIFT IN THE PORTFOLIO PARADIGM
Before the effects of globalization, all but those who ascribed to "Modern Portfolio Theory" (those who invested a set percentage of their money in various asset classes) were confident in keeping their money largely in US equities and bonds.
With future diminished US growth prospects, however, this investment strategy is unlikely to be as successful in the next decade. History has shown that this strategy has not been effective in the past, as well. Investment veteran Art Cashin, Director of Floor Operations at UBS, recently reiterated his "theory of the 17.6-year cycle." He pointed out that the periods 1966-1982 and 1929-1947 were "lean cycles," and predicts that we are entering another such cycle at this time.
Consequently, the old benchmark of "Subtract your age from 100, put that percentage of your portfolio in high quality US stocks, and the remainder in bonds" may well be over.
What now? If you agree with the four assumptions discussed above, Pimco's Emerging Market fund manager (and former Harvard Endowment fund manager) Mohamed Il-Erian proposes the following portfolio:
STOCK 15% US, 15% Non-US Advanced Economies, 12% Emerging Markets, 7% Private Equity.
BONDS 5% US, 9% International, 5% US Treasury Inflation Protection Securities.
REAL ASSETS 6% Real Estate, 11% Commodities, 5% Infrastructure.
SPECIAL OPPORTUNITIES 8%
With an increasing investment in fast-growing emerging markets, with an emphasis on TIPS and real assets, this portfolio seeks growth with protection against inflation. If you agree that inflation will cause rates to rise, you'll want to delay your US bond purchases until rates are higher, and wait until gold prices fall before investing in that commodity. Depressed real estate prices, other than commercial property, show good value now.
Of course, as we've learned through the painful correction in the last decade, this portfolio does not include cashflow you will need in the next five to ten years. That is best kept in short-term Treasury issues or insured savings. Yes, rates are low now. But, they're likely to rise, as inflation picks up, and for this money, you want return OF capital more than return ON capital.
Have a safe, happy, healthy and prosperous new decade.
Showing posts with label emerging markets. Show all posts
Showing posts with label emerging markets. Show all posts
Thursday, December 31, 2009
Sunday, July 26, 2009
WUVL - The Shape of Our Upcoming Recovery
W
NYU Economics Professor Dr. Nouriel Roubini, sometimes called "Dr. Doom" for his less than rosy economics predictions, says the US recovery from its current recession will be in the shape of a W. W's, for those who are sharpening up their penmanship skills in preparation for the oncoming Fall semester, go down, up, down, up. He says he thinks we'll have a "double dipper" recession. Did I mention he made his reputation as a gloomy guy? His current fear is that the weary consumer will fail come to the rescue after the effects of government spending start to pull us out of the recession, and back we'll fall. He, by the way, is a professor of economics at the Stern School of Business. Every adjective associated with this guy seems to be depressing, but I guess there's something to be said for consistency.
U
Others, less gloomy but none too optimistic, say that this recession will resemble a U. Down we'll fall, and stay at an elongated bottom, then, finally, we'll move up. This elongated bottom will be caused by extended unemployment and cautious spending. After an extended period where inventories are sold off, housing prices bottom, and liquidity is restored to the banking system, we will then turn the economic corner after the last optimist has thrown in her towel.
V
The V proponents are the rosy predictors, who say the economy has hit bottom and is due to bounce right back up again. Those who are out of work tend to disagree with these rosy predictions. The V's cheerily respond by saying that the beginning of such a recovery is "jobless," to which the jobless respond with expletives which have been deleted for purposes of keeping this discussion family-friendly.
L
Then, rivaling Dr. Roubini for the doomsday scenario, is the L shaped recovery. I don't actually understand how this is a recovery at all, as it illustrates falling, then moving sideways. I suppose that one could argue that the fact that it doesn't fall forever would account for some degree of positivity. The L's argue that we have a "new normal" that is slower growth, higher joblessness, a lengthy period of stagnant prices and other depressing economic predictions. L's are not fun at parties.
Numbers - Not Letters
I've chosen to describe the recovery without the use of an illustrative letter. My experience with economics presents a problem that causes me to avoid using neat lines to illustrate anything. Economics is messy.
GDP
One often overlooked fact in the current GDP projections is our international trading trends. From 1950 to 1980, Gross Domestic Product averaged almost 4%. From 1980 to now, it has been almost 3%.
Source: Bureau of Economic Analysis
Trade and the Weakening Dollar
Economist Jim Paulson of Wells Capital Management in Minneapolis points out that trade deficits, i.e., the excess of imports to exports, fueled by the US consumer since the 1980's has enriched emerging nations, who provided our voratious consumerism with relatively cheap imports during that period.
Now that we are cutting back and repaying our debt, demand from those newly rich emerging markets is likely to increase the amount we export, just as our demand decreases. Further, our "strong dollar policy" in the recent past made our exports more expensive to emerging markets. Now, our dollar's weakened position as we lower rates to fuel our economic recovery, will make our exports even cheaper for those newly rich markets.
Economist Edward Yardeni of Yardini Research agrees with Paulsen, noting that, as of May 2009, "US exports of goods and services had actually risen by $1.9 billion from the previous month. . . while US imports continued to slide."
Source: Barron's Magazine, July 20, 2009
So, conceding that the weary US consumer is unlikely to once again come to the rescue of the US economy, there is legitimate reason to see light at the end of the tunnel. The shape of things to come?
Perhaps not a WUVL, but an unexpected increase in a rarely followed sector of the economy - exports, from an unexpected consumer group - emerging countries. The sky may actually not be falling, and those who predict a "new normal" of GDP growth in the 1% - 2% range, may have overlooked a piece of economic data that could increase their predictions from 33% - 50%, and even better, silence the WUVL's and those who join them in using letters to describe economics.
Pardon me for sounding like a dinosaur, but economics is made up of numbers - not letters.
NYU Economics Professor Dr. Nouriel Roubini, sometimes called "Dr. Doom" for his less than rosy economics predictions, says the US recovery from its current recession will be in the shape of a W. W's, for those who are sharpening up their penmanship skills in preparation for the oncoming Fall semester, go down, up, down, up. He says he thinks we'll have a "double dipper" recession. Did I mention he made his reputation as a gloomy guy? His current fear is that the weary consumer will fail come to the rescue after the effects of government spending start to pull us out of the recession, and back we'll fall. He, by the way, is a professor of economics at the Stern School of Business. Every adjective associated with this guy seems to be depressing, but I guess there's something to be said for consistency.
U
Others, less gloomy but none too optimistic, say that this recession will resemble a U. Down we'll fall, and stay at an elongated bottom, then, finally, we'll move up. This elongated bottom will be caused by extended unemployment and cautious spending. After an extended period where inventories are sold off, housing prices bottom, and liquidity is restored to the banking system, we will then turn the economic corner after the last optimist has thrown in her towel.
V
The V proponents are the rosy predictors, who say the economy has hit bottom and is due to bounce right back up again. Those who are out of work tend to disagree with these rosy predictions. The V's cheerily respond by saying that the beginning of such a recovery is "jobless," to which the jobless respond with expletives which have been deleted for purposes of keeping this discussion family-friendly.
L
Then, rivaling Dr. Roubini for the doomsday scenario, is the L shaped recovery. I don't actually understand how this is a recovery at all, as it illustrates falling, then moving sideways. I suppose that one could argue that the fact that it doesn't fall forever would account for some degree of positivity. The L's argue that we have a "new normal" that is slower growth, higher joblessness, a lengthy period of stagnant prices and other depressing economic predictions. L's are not fun at parties.
Numbers - Not Letters
I've chosen to describe the recovery without the use of an illustrative letter. My experience with economics presents a problem that causes me to avoid using neat lines to illustrate anything. Economics is messy.
GDP
One often overlooked fact in the current GDP projections is our international trading trends. From 1950 to 1980, Gross Domestic Product averaged almost 4%. From 1980 to now, it has been almost 3%.
Source: Bureau of Economic Analysis
Trade and the Weakening Dollar
Economist Jim Paulson of Wells Capital Management in Minneapolis points out that trade deficits, i.e., the excess of imports to exports, fueled by the US consumer since the 1980's has enriched emerging nations, who provided our voratious consumerism with relatively cheap imports during that period.
Now that we are cutting back and repaying our debt, demand from those newly rich emerging markets is likely to increase the amount we export, just as our demand decreases. Further, our "strong dollar policy" in the recent past made our exports more expensive to emerging markets. Now, our dollar's weakened position as we lower rates to fuel our economic recovery, will make our exports even cheaper for those newly rich markets.
Economist Edward Yardeni of Yardini Research agrees with Paulsen, noting that, as of May 2009, "US exports of goods and services had actually risen by $1.9 billion from the previous month. . . while US imports continued to slide."
Source: Barron's Magazine, July 20, 2009
So, conceding that the weary US consumer is unlikely to once again come to the rescue of the US economy, there is legitimate reason to see light at the end of the tunnel. The shape of things to come?
Perhaps not a WUVL, but an unexpected increase in a rarely followed sector of the economy - exports, from an unexpected consumer group - emerging countries. The sky may actually not be falling, and those who predict a "new normal" of GDP growth in the 1% - 2% range, may have overlooked a piece of economic data that could increase their predictions from 33% - 50%, and even better, silence the WUVL's and those who join them in using letters to describe economics.
Pardon me for sounding like a dinosaur, but economics is made up of numbers - not letters.
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