It is not possible to understand how the stock market and economy works without understanding long-term business cycles.
The world is constantly changing over the medium to long-term but for the short-term focused financial markets, extrapolation of the recent past is usually all it takes to put together a long-term forecast. The downfall of Long Term Capital Management should serve as a warning to all of those active in the field of finance who overly depend on short-term forecasts to make long-term predictions. Using short-term figures which have been extrapolated into a long-term forecast exposes the user to a major underestimation of the huge changes that happen through secular and long-term cycles.
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Unfortunately, in today’s short-term focused financial world there are few analysts out there who consider more than a few years worth of data.
However, Credit Suisse and Deutsche Bank are the two long-term stalwarts in a short-term focused world. Both banks put out an annual research report, looking at some long-term economic and market trends. Credit Sussie’s report takes a look at the annual returns of various asset classes in different countries over the past 100+ years, which is fascinating, especially concerning those European countries devastated by the first and second world wars.
This year’s report on long-term trends from Deutsche Bank looks at long-term economic cycles and reaches the conclusion that we are currently reaching the end of a 35-year long cycle which started in the 1980s.
35-year economic cycle
Since the beginning of the 1980s the global economy has been dominated by globalisation and also a complimentary and massive change in demographics. This has had a profound impact on the global economy at a macro and micro level. It’s also had a huge impact on asset performance.
According to Deutsche’s research, these trends appear to be coming to an end. Demographics are now changing as populations around the world age, and the number of people in work starts to decline. Further, many countries are starting to turn their back on globalisation.
Protectionist rhetoric from the United States, China and European nations, as well as a rising movement against inequality, appears to mark the end of the globalisation trend that has yielded so much growth for the world during the past three and half decades.
The recent UK ‘Brexit’ vote is one such act of rebellion from the disenfranchised, but populism is on the rise across the developed world. Whether its globalisation, immigration, inequality, poor economic growth or a combination of these, it’s quite clear from this and other anti-establishment movements that the status quo can’t last in a democracy without compensating policies: eventually you’ll have a reaction.
The economy is set for three decades of sluggish growth
All of these changes hint at the idea that the next cycle will be a low growth cycle. Deutsch Bank explains:
“With demographics deteriorating it seems highly unlikely that the next couple of decades (possibly longer) will see real growth rates returning close to their pre-crisis, pre-leverage era levels. Obviously if there is a sustainable exogenous boost to productivity then a more optimistic scenario (relative to the one below) can be painted. At this stage it is hard to see where such a boost comes from – and even if it does, time is running out for it to prevent economic and political regime change given the existing stresses in the system.”
“So we are likely stuck with the challenge of how to deal with prolonged low real growth and high (and largely increasing) overall debt levels. Although this will persist we do think that this current era is drawing to a close with a muddle through the least likely option due to various economic, political and social pressure points that have been reached.”
“We think that these will be the some common themes of the next 35 years. n Lower real GDP growth n Higher real wages n Higher inflation n Higher nominal GDP for most n Higher yields n Negative real returns in bonds n Lower corporate profits/GDP n Higher taxes for the wealthy and corporates n Less international trade n More controlled migration n More financial repression n Equities outpace bonds but lag long-term returns n Property under performs real wages and inflation n Lower than average defaults”