Absolute Return Partners: Snail Trail Vortex

“The single most robust and striking fact about cross-national growth is regression to the mean.” –  Lawrence Summers and Lant Pritchett

Absolute Return Partners: Low growth is printed on the wall

When financial markets capitulate, many investors lose the ability to keep things in perspective. That is a fact of life. Instead the little things take over and begin to drive decision-making. The last few weeks provide an example of this behavioural pattern. We have a bit of a wobble in global equity and commodity markets and – lo and behold – the next 2008-like meltdown is literally around the corner, or so many seem to think. I think otherwise. In last month’s Absolute Return Letter I wrote:

“… there are good reasons to believe that the prolonged rally can continue for a little longer…”

The markets have an amazing ability to make a mockery of predictions. Literally days after going public with this statement, equity markets tanked, but I am not quite ready yet to throw the towel in to the ring. I continue to see positive economic growth on the horizon, at least in some of the bigger, and hence more important, markets but, at the same time, I also see low economic growth (as in lower than average) for several more years to come, and in the following I will give you my reasons for this. Importantly, markets do not normally collapse when economic growth remains positive.

At this early stage, I ought to point out that I could be overly optimistic on economic growth and still be just about right on my expectations for equity returns. Economic head winds do not necessarily imply negative equity markets. After all, the correlation between the two isn’t very high.

This month’s Absolute Return Letter is in effect a continuation of last month’s letter. If you didn’t read it, I recommend that you do so before going any further with this month’s letter. However, whereas the overall investor mood was gung-ho last month, a great deal of skepticism has crept in only a few weeks later.

First the negatives. Why do I expect economic growth to be lower than average for a prolonged period of time? That is what this Absolute Return Letter is about. Even the U.S. economy, which has now been out of recession for 5 years, is undergoing a remarkably weak recovery (chart 1) even if the last quarter was robust. For the record, other economies are faring even worse.

Absolute Return

Meanwhile, many investors and/or commentators, whilst negative in the short term, are currently trying to predict when economic conditions will return to levels experienced in the past. Whilst we are approaching Christmas, and it is almost time to collect wish lists, I don’t think GDP growth at an aggregate level will return to levels experienced in the past anytime soon. Having said that, some countries will surprise on the upside, whilst other will fail miserably.

Even though it is now quite a few years since I graduated from university, I don’t think economic growth theory has changed meaningfully in the interim. Two fundamental factors back then would be, and are still, considered the most important drivers of economic growth over the longer term – population growth and productivity enhancements.

Having said that, there are a number of other factors in play at the moment which are likely to drive economic growth down over the short to medium, and maybe even longer, term. These are:

  1. Demographics
  2. Continued high debts in the western world
  3. A sizeable output gap
  4. Skyrocketing use of debt in China
  5. Irresponsible corporate policies
  6. Weak global trade growth
  7. Poor credit conditions
  8. Deflation

See full PDF here.