By Paul Veith, managing director, and Matthew Gelfand, Sr. Wealth Advisor, Rockefeller Financial
The renowned economist Herbert Stein once said, “… If something cannot go on forever it will stop.” That saying is particularly
important to remember now, as the global economy faces trends that are unsustainable while presenting other long-term investment opportunities.
First, the bad news. Most economists agree that government debt financing was necessary to keep the Great Recession of the 2000’s from turning into a worse monster. But monetary expansion in the U.S. and other developed countries has been huge. The Federal Reserve expanded its balance sheet by $1 trillion – that’s $1,000,000,000,000 – and the U.S. Treasury is financing annual deficits of like amounts.
Just recently, Europe financed a $1 trillion bailout for Greece and other Mediterranean countries. Japan, the world’s third-largest economy, carries a national debt in excess of its gross domestic product (GDP) and still runs high deficits. The U.S. government has debt outstanding of 50 percent of GDP, an amount forecast to peak at 80 percent within 10 years, and that’s without accounting for unfunded entitlement liabilities like Social Security and Medicare.
Developed nations will be faced with reducing spending, raising taxes, or both. The rest of the world may eventually refuse to buy their debt, likely forcing interest rates and inflation higher and/or their currencies lower. This could spell a lower standard of living for the big deficit spenders.
Currently, U.S. inflation, running at one to two percent per year, will likely accelerate with a trillion dollars of new debt each year. We believe prudent investors should begin considering some inflation protection in the form of commodity- and inflation-linked investments. Unfortunately, commodity prices are already quite high – gold recently set a record above $1,200 per ounce. Similarly, inflationindexed bonds issued by the U.S. and other governments now pay unattractively low interest rates. Now hardly seems the time to invest in these inflation hedges. Nonetheless, we think it is time to prepare for higher inflation and to buy these instruments when prices/rates are more attractive.
Now, the good news. China and India might enjoy double-digit growth rates this year. Their citizens are rapidly entering the middle class. and, as opposed to the West, they are traditionally savers, not borrowers. Faster growth, liberalizing economies, and improving legal protections suggest higher corporate earnings and stock prices. Growth-oriented investors who are comfortable with global markets and currency risk should consider emerging market securities.
The U.S. stock market is at last priced attractively. We’ve had a lost decade; stock prices are barely changed from 10 years ago, even though projected corporate earnings now are 50-60 percent higher per $1 than in 2000. Our ideas rely on longerterm trends that either must stop – excess deficit spending – or are likely to persist, such as the rise of the new middle class in emerging markets.