Since the market began its recovery following the 2008 financial crisis, a number of trends have dominated the landscape. Many of them have gone on way longer than expected, and have scaled heights never seen before. Some looked to be on their last legs two or three years ago, but are still going strong. They’re the Rolling Stones of investing.
To make sense of what’s going on in the economy and capital markets, I separated these trends into two lists – sustainable and unsustainable. In other words, which ones are early in the concert and which are on their second encore.
Running on Empty
- Interest rates – It’s hard to see why rates will go up any time soon, but the laws of capitalism are pretty compelling. Over the long term, bondholders require a yield that is well in excess of inflation. Today, we’re two to three percentage points below that.
- Borrowing – Near-zero interest rates have allowed us to postpone the day of reckoning. To date, the solution to our debt problem has been to issue more debt. Government and consumer borrowing continues to grow at a faster pace than the economy.
- Central bank intervention – The trend toward central bank micro-management began in the era of George W. Bush/Alan Greenspan, but became a broad-based theme following the financial crisis. As any profligate lender discovers, the game eventually comes to an end.
- Chinese investment spending – Staying on the debt theme, China has been propping up its economy since 2008 through unprecedented investment spending. As a result, debt levels have skyrocketed and the state of infrastructure (planes, trains and automobiles) is now beyond what their economy requires.
- U.S. corporate profits – They’ve been nothing short of stunning (even after a flattening of the trend in the past two years). On the backs of labour and share buybacks, Corporate America is on a roll.
- Growth beating value – Over decades, buying value stocks (low price-to-earnings and price-to-book value ratios) proved to be a reliable way to beat the market. Since 2009, however, growth stocks have consistently outperformed value such that the valuation gap between the two is now extremely wide.
Time On My Side
The trends on the other side of the page have also been going on for a while, but in my view, are still in their early days.
- Cheap energy – Conservation. Technological change. Improving economics for alternative sources. The world economy will continue to enjoy an energy dividend.
- Climate change – I’m optimistic that the right steps are being taken to end this powerful trend, but it will take years and significantly more attention and capital to stop it.
- Online everything – The Amazon effect is just getting rolling. How we consume goods and services is going through a paradigm shift.
- Technology impact – More broadly, the Internet, big data, mobile, GPS, social networks and the Internet of Things are changing how we operate businesses, administer governments and manage our households. The impact and velocity of that change is accelerating, not waning.
- Aging boomers – I’m sorry to say, but we’re getting older. The baby boomers will reshape retirement living, just as they have so many other things (housing, vacations and music). For instance, this demographic trend, when paired with medical innovation, virtually guarantees that health-care products and services will continue to be a high-growth part of the economy.
- Emerging markets growth – The emergence of the middle class in countries like China and India has the potential to overwhelm the poor demographic trends in Western countries.
- ETFs – Canada is far behind the United States when it comes to using exchange-traded funds to build index portfolios. With new client reporting rules coming into effect next year, and the potential elimination of trailer commissions on mutual funds, ETFs have years of catch-up ahead of them.
Both Sides, Now
Beyond sparking debate, this simple categorization provides a useful check and balance for investors. Is your portfolio stacked heavily toward the unsustainables? Are there lots of commodities and no health care? Does it rely on the indebted Canadian consumer and have little exposure to China and India’s emerging middle class? And, as most portfolios are, is it strictly designed for declining interest rates and easy credit?
A well-diversified portfolio should be represented on both sides of the ledger. Otherwise, you can’t get no satisfaction.
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