The Four Phenomena Which Will Determine Long Run Investment Performance in the Coming Years
Four phenomena will affect investment performance in the years to come. Unfortunately in all four cases they are new phenomena. We do not have a lot of history to go on and all forecasts are simply guesswork. And to make this more interesting—and more uncertain—all four are interrelated.
The first is the continuous movement towards government encroachment in virtually all advanced economies with the concomitant socialization of risk and increased bureaucratic intervention into markets. Keep an eye on one single statistic – general government as a percent of GDP. It’s been slowly rising over the last hundred years. This is the result of a fundamental tendency towards populism characteristic of universal suffrage democracies which I describe in my book (with contributor Michael C S Wong) Investing in the Age of Sovereign Defaults. Defaults will take various forms starting with outright legal defaults on sovereign debt obligations to bailouts to hyperinflation to reneging on the tsunami of entitlements that democratic governments have promised over the last hundred years. The default process has begun with weaker credits like Greece, Ireland, and Cyprus leading the way and now with US municipal entities like Detroit. Fortunately for investors the big guy – the United States federal government – will be the last domino to fall and could still reverse the process. The default of Detroit will provide a menu default choices. The courts – and perhaps President Obama and Congress – will decide the type of default, i.e., who is going to get screwed – the bondholders, the taxpayers, the pensioners or the Federal Government? Investors everywhere can expect an increase in taxes as governments everywhere try to stave off defaults.
The second phenomenon is the collapse in birth rates. Outside of Africa, birthrates have collapsed virtually everywhere and in the majority of countries are well below the 2.1 children per women which is the breakeven reproduction rate. The dramatic expansion of economic welfare in the last five hundred years has been accompanied by – some would say driven by – increases in population. The tsunami of entitlements on the intermediate term horizon would seem to require more, not fewer, children now. Does this mean we are condemned to a future of economic stagnation and presumably poor stock market performance? Or will the absence of large number of child dependents at least in the intermediate future make for a bigger spending consumer? And can investors profit from investing in “fogie” stocks, i.e., those which cater to the spending patterns of older citizens.
The third phenomenon is quantitative easing by so many of the central banks of advanced countries. We don’t have much history on this either. Will hyperinflation be the inevitable result or will the world economies go back into a global depression as QE is withdrawn. Or will nothing happen because most reserves created by QE have just sat in central banks and QE is overrated by the markets?
The fourth and perhaps the most interesting of the four phenomena is the acceleration of technology and one of its “children”, globalization. I know the respected economist Robert Gordon has opined that technological progress has slowed down. I think he is dead wrong. If investors are going to read one book (besides mine), they should pick up Ray Kurzweil’s Age of Spiritual Machines. You do not have to agree with Kurzweil that artificial intelligence entities will eventually replace humans. But the Kurzweil theme is human civilization is on an ever upward path towards higher intelligence. Accelerating technology has become the dominant force in human evolution, edging out Darwinian natural selection. Kurzweil, who is now Director of Engineering at Google and co-founder of the Singularity University, has proposed what he calls the law of accelerating returns which is based on the concept of exponential technological progress. I would argue that investors better get on the right side of this.
Technological Acceleration Isn’t Fair – The Rich Get Richer, Winners Win More, the Stars Clean Up
“Today there are three Americas. At one extreme are the brain hubs—cities with a well-educated labor force and a strong innovation sector. They are growing, adding good jobs and attracting even more skilled workers. At the other extreme are cities once dominated by traditional manufacturing, which are declining rapidly, losing jobs and residents. In the middle are a number of cities that could go either way. The three Americas are growing apart at an accelerating rate…the very success of the country’s engine of growth is generating a deep and growing inequality among American communities.”
– From The New Geography of Jobs, Enrico Moretti, p13-14.
If you grew up in a two parent family and you are white or Asian, the chances are you are well paid and work in a brain hub or as a professional (like a lawyer or doctor) servicing the brain hub. And it’s in the brain hubs where technology is accelerating.
Herein lies the reason why from a social perspective Detroit is the perfect storm. Overwhelmingly minority (African American), its traditional manufacturing industry lost to non-union locales and robots, its middle class departed and its union pension liabilities beyond imagination, Detroit is about as close to hopeless as you can get. Reportedly 47% of its adult citizens are functional illiterates. Bankruptcy is the logical solution. Good luck to the judge who has to decide which creditor has to get the worst treatment. And good luck to an America that is increasingly divided between whites and Asians from two parent families and (non-Asian) minorities and poor whites from one parent families.
There’s a curious proposal on the table from a group of investors who want to buy an island called Belle Isle from the city of Detroit and create “another Singapore.” Belle Isle is currently uninhabited and used as a park. That’s just great. Suppose this idea really came into being and it succeeded. Belle Isle would become kind of brain hub filled with over-achieving whites and Asians and sitting right next to America’s poorest, non-brain hub minority-dominated city. This is a proposal for a race war. Chinese dominated Singapore has had a hard enough time getting along with Malay dominated (and slightly slower) Malaysia. It is not for nothing that Singapore has compulsory military service for males. And Malaysia isn’t a basket case like Detroit. Detroit is probably too far gone even for the Obama Administration to consider a bail out. Let’s see what Obama does when someplace like Chicago needs a little help.
Meanwhile in the brain hubs the numbers just keep getting better. And top talent commands big bucks, as technology has made possible. Become a star, and now you’ve got a global market. As Facebook’s Mark Zuckerberg has said, “Someone who is exceptional in their role is not just a little better than someone who is pretty good… They are one hundred times better.” And Zuck and his fellow captains of the brain hubs will pay them one hundred times more. The stars really clean up and the near stars don’t do too badly either. Zuckerberg has reportedly given some $100 million for education in Newark. A generous act to be sure and one that is potentially exciting if some Silicon Valley innovation could infiltrate its way into the US public schools. But in the meanwhile, has Facebook hired anybody from Newark?
The sluggish pace of the recovery is at least in part due to accelerating technology. The comfy middle class jobs that used to exist and that Obama’s dreamlike speeches want to bring back are being eliminated by globalization and technology including your friendly industrial robot. This theme is being repeated not just in the United States but around the world. Accelerating technology is exciting and benefits all of humanity but it benefits some humans more than others.
There are winners and there are losers. And the losers are going to demand that their politicians expropriate the earnings of the winners. That is a given especially when governments are broke to start with. There is a curious thing going on here. MIT Professor Enrico Moretti, in his new book quoted from above, points out that, contrary to what some economists might predict, some of the brain hubs are in unlikely high tax places like New York and California. Not only that, but the brain hubs are inhabited in many cases by liberal younger people.
It’s good that they are so liberal. That way they will be delighted when their state, local and federal governments come to take their pound and half of flesh. But for older investors (like me) this situation is a potential disaster. The governments are after their hard earned money.
Investors have to get on the tech bandwagon. Clipping coupons on bonds is a dangerous and high risk longer term strategy even though in recent times it has worked pretty well. I wrote in the last piece that the real winners in the high tech investing world are the venture capitalists. They are legal possessors of inside information and they get there first.
But there’s still enough left over for everyone else. First a caution. Historically tech investing comes in boom and bust cycles of which 2000 was the latest example. Not only that but historically there have been lots of tech losers. Failure is a necessary part of the learning process. If you try to hit home runs and pick the next Apple you might just as easily pick the next Nokia.
If you are willing to settle for singles (sorry for the baseball analogy but I could not think of anything better), established global companies with sold brands and managements are another way to play tech. These companies are major users of technology and in a sense they are insiders in that they know, better than outsiders, the technologies they are buying. You cannot run a global corporation or a global bank without a heavy reliance on technology.
There is also the question of dividends. I am not a major enthusiast. In a perfect capital market where dividends are not subject to double taxation, dividends are the optimal use of a company’s excess capital. Return the capital to investors who will reinvest in other promising ventures. But in the real world where taxes and inflation (eventually) may be rising, dividends may not be so optimal. Let the tech using big global corporations invest your profits in a more tax efficient manner and watch that they do not waste too much in the process.