By Shaun le Roux
The Credit Crisis was at the heart of the monumental collapse in global stock markets in 2008.
The credit-specific crisis has largely been averted by extraordinary government and central bank intervention, which has seen a massive expansion in the monetary base, and credit markets are now operating on pre-crisis terms. Now that we have that particularly ugly episode behind us, we can turn our attention to real world economics and try to assess what financial markets have in store for us over the years ahead.
We are of the view that no rational investment decision can be made today without first recognizing the major secular changes that are busy taking place in the world. In two key areas, the balance of power is in the process of shifting. We believe that you ignore these shifts at your peril.
Firstly, we believe that the world is becoming increasing dependant on the emerging world for growth. Emerging markets, on a combined basis, have grown at more than double the pace of developed markets over the past twenty years. It is, however, a foregone conclusion that few countries in the world will match their growth rates of the more recent years in the decade ahead. This is largely because key ingredients of the supercharged growth up until last year were cheap credit and financial leverage.
The world of massively leveraged financial institutions and over-extended western consumers has seen its demise, and we believe that the foreseeable future will unequivocally witness a return to generally higher levels of savings and much tighter credit standards. This means that most countries will need to revise their anticipated trend growth rates downwards. At this stage the South African Treasury’s anticipated trend growth rate of 4% and target of 6% now starts to look like a pipe dream.
Notwithstanding the above, recent months have made it clear that emerging markets as a whole do have the capacity to continue to out-perform in the future. Levels of foreign reserves are healthy, infrastructural development continues and a significant middle class has emerged. South Africans only need to drive around Johannesburg today and compare it to ten years ago to assess both the changes that have taken place and the development that is underway.
Emerging Markets have seen their contribution to the MSCI World Index rise from 2% in 1998 to over 13% today. We expect this relative growth trend to continue.
The second major shift we see in the balance of power is away from the financial sector to other real economy sectors. The chart below illustrates profits earned by the financial sector together with US total debt, both as a percentage of GDP. As can be seen, the rise of financial profits went hand-in-hand with an implosion of savings levels, to the degree that, in 2005, the savings rate in the US was negative.
We expect both trends to normalize in the decades ahead and anticipate it taking quite a while for global financial firms to match their level of profitability in 2007.
We expect both trends to normalize in the decades ahead and anticipate it taking quite a while for global financial firms to match their level of profitability in 2007.
We believe that investors need to carefully consider the implications that the shifts described above will have on their investments.
Firstly, investors will need to appreciate that lower growth rates and lower levels of leverage inevitably will mean lower real returns for equities. There will be many sectors that will take a long time to return to the levels of profitability of recent years, so stock selection in an equity portfolio will be very important.
We favour a core portfolio of high dividend payers where our analysis indicates growth and sustainability of those dividend payments.
Capital will be harder to come by and bond investors will require higher yields. Country allocation in global portfolios will have a massive bearing on returns. Long term investors should be over-weighting Emerging Markets. Stock selection will be critical to success.
Source: Shaun le Roux, Alphen Asset Management, July 3, 2009.
