Some of the investing world’s leading minds have concluded that the U.S. and much of the rest of the developed economies are circling the drain and that there is no chance of a sustained recovery for as far as most investment horizons can stretch.
We’re not just talking about favourite permabears like Nouriel Roubini, who warned again last month that “the downside risks to the global economy are gathering force.”
In a missive to investors in December, influential Pimco bond manager Bill Gross noted that industrial economies “have too much debt – pure and simple – and as we attempt to resolve the dilemma, the resultant austerity should lower real growth for years to come.” Mr. Gross is thinking growth of 2 per cent or less, annually. But that almost qualifies as irrational exuberance, when stacked against the dark forebodings of even more bearish voices.
In a National Bureau of Economic Research study last summer titled “Is U.S. Economic Growth Over?” star economist Richard Gordon answered the question with a resounding yes. His bleak vision: The world’s biggest economy faces significant headwinds –including sky-high public debt, unfavourable demographics, inequality and the demise of innovation – “that are in the process of dragging long-term growth to half or less of the 1.9 per cent annual rate [adjusted for inflation and population change] experienced between 1860 and 2007.”
Famed investment adviser Jeremy Grantham, chairman of global asset manager GMO, warned bluntly in his quarterly investment letter last November that the U.S. is “on the road to zero growth.” The old, accustomed expansion rate “is not just hiding behind temporary setbacks. It is gone forever.”
Such bleak assessments were bound to provoke challenges from less gloomy crystal-ball gazers. After all, if everyone shared the same view of where economies and markets were heading, no one would make any money. Which is where the rational optimist comes in.
That would be Laurence Siegel, director at the Research Foundation of the CFA Institute, who acknowledges some of the weaknesses and risks outlined by Prof. Gordon and Mr. Grantham, but disputes their long-term prognosis, particularly for the U.S. economy. Prospects have been muddied by the current fiscal problems, “but that will go away,” Mr. Siegel tells me confidently. “Not without a cost, but it will go away. And investments should be made for the long term.”
The “short-term trend is indeed disquieting,” he wrote in a response published in late November. “Growth has been close to zero over the last decade in advanced countries. But the most likely outcome is that per capita GDP growth going forward will approximate its U.S. historical average … and it will grow faster in developing markets.”
But what does all this mean for the markets, where people are betting real money on the outcomes?
“There’s no special evidence tying stock market returns to economic growth,” says Mr. Siegel, formerly the long-time head of research with the investment division of the Ford Foundation. “The future performance of the stock market seems to be mostly dependent on the starting point, in terms of the price-earnings ratio.”
The average P/E for the S&P 500 has returned to a traditional level of about 15, which suggests a “normal” rate of return, he says. “The question is what does normal mean? The historical rate of return is probably too high, because it contains some upward biases.”
Specifically, he’s referring to the survivor bias. Historical records are skewed by the fact markets that blow up, as in Czarist Russia, disappear from the averages. He likens it to trying to forecast how fast a bunch of randomly selected people can run by timing athletes on their training runs. “You see that the average runner is travelling at about six miles per hour. So that becomes the historical mark. But the average person can’t run that fast. The successes can achieve it, the others won’t.”
By the way, he is not related to the better known and much more bullish Jeremy Siegel, the Wharton professor who has famously stuck to his belief that equities remain by far the best place to sock away money for the long run. “When people ask me what I think about Jeremy’s views on this or that, I tell them: “My brother’s always been crazy, but he knows how to make money. It’s an ongoing joke between us.”
In fact, Laurence Siegel believes investors should be broadly diversified across available asset classes. “The higher the [stock] market gets, the better people feel. But a stock is like anything else. You’re buying a bundle of attributes, and the price keeps changing. An increase in the price might be indicative of the fact that the bundle of attributes has gotten better and is worth more. But there’s absolutely no guarantee of it. So I would think that you would want to become more pessimistic as the market rises.”