The next 15 years Is there a New Normal ahead? Delaware Investments Presentation. Richard C Marston Wharton School, University of Pennsylvania

Transcription

1 The next 15 years Is there a New Normal ahead? Delaware Investments Presentation Richard C Marston Wharton School, University of Pennsylvania

2 Outline 1. Is there a New Normal ahead for stocks? 2. Is the thirty-year bull market in bonds finally over? 3. Is it possible to avoid the New Normal by diversifying beyond U.S. stocks and bonds? Diversifying into fast growing economies Diversifying into alternative investments

3 Bill Gross introduced the New Normal too soon in May 2009 S&P 500 reached its bottom on March 9, 2009 just six months after Lehman failed. It has been a great cyclical rally ever since then. Through September 2016, the S&P 500 is up by 220% After a recession, we always experience a sharp cyclical rally

4 S&P 500 Index S&P 500 in Last 15 Years, Source: S&P

5 Dates of Recession Returns after Recession: S&P 500 return in 1 st 12 months Source: Investing for a Lifetime (2014), Table 3.3 Dec 07-Jun % Mar 01-Nov 01 Jul 90-Mar % 38.5% Jul 81-Nov % Nov 73-Mar 75 Dec 69-Nov 70 Apr 60-Feb 61 Aug 57-Apr 58 Jul 53-May % 41.9% 32.6% 43.4% 46.0% 0% 10% 20% 30% 40% 50% 60% 70%

6 The true New Normal Yet Bill Gross may be right that stock returns in the future will not what they have been in the past. Future stock returns may not be as high as in the past because growth in the industrial world has slowed down.

7 Real GDP Growth in Japan Source: IMF, international Financial Statistics 6% The collapse in growth occurred in Japan 25 years ago 4.6% 4.7% 4% BRICs 2% 1.0% 0.7% 0%

8 Growth per Annum Real GDP Growth in Europe Source: IMF, International Financial Statistics 4% France Germany 3.2% 3% 2% 2.7% 2.5% 2.3% 2.1% 2.9% 1% 1.0% 1.1% 0%

9 Growth per Annum 4% Real GDP Growth in United States Source: Bureau of Economic Analysis 3.2% 3.4% 3.4% 3% 2% 1.8% 1% 0%

10 Long view of U.S. growth U.S. economy grew rapidly in the 19 th century but never as fast as China! Slowdown in 1930s depression, then postwar boom that extended until 2000.

11 Percent per annum U.S. GDP growth since 1870 Source: NIPA, Table and F % 4.2% 4% Postwar boom 3% 3.1% 3.2% 3.2% 2% 1.7% 1.8% 1% 0%

12 Long view of U.S. growth Growth in industrial countries is slowing partly because productivity growth is slowing. A major reason for the slowdown in the growth in output per hour is the shift of the economy towards services and away from manufacturing. Productivity in most service sectors is way below that in manufacturing or agriculture or mining

13 Annual Growth in Productivity in Services, Source: Brookings Institution (WSJ, ) Accomodation/Hospitality Administrative Services Computer Systems/Services Food Services Social Assistance Eduational Services Hospitals/Residential Care Legal Services -1.0% -0.5% 0.0% 0.5% 1.0% 1.5%

14 Two Trends in Manufacturing Will examine two trends in manufacturing since 1980: 1. Growth in manufacturing output (adjusted for inflation) 2. Growth in employment in manufacturing

15 Index (1980 = 100) Production and Employment in Manufacturing Manufacturing Output million jobs million jobs Manufacturing Jobs Bureau of Labor Statistics and Council of Economic Advisors

16 The true New Normal Another reason growth is slowing is that the industrial countries are aging. That s particularly true of Japan, Germany and Italy. Look at share of population that is 65 years or older.

17 Share of Population 65 Years or Older Source: Pew Research Center using United Nations data Japan Germany Italy France U.K. U.S. 0% 10% 20% 30% 40%

18 Stock returns in developed markets Stock returns in the developed (or industrial) countries over the last 45 years or the last 30 years have been quite impressive. But the last 15 years have been a different story. Let s divide developed markets into three sets of markets: 1. U.S. market represented by the S&P 500 index 2. European portion of the MSCI EAFE index 3. Pacific portion of the EAFE index (Japan, Australasia, Hong Kong, and Singapore)

19 Return per annum Stocks in developed markets Sources: S&P and MSCI 14% 12% 10% S&P 500 EAFE Europe Pacific Last 30 years 11.4% 11.5% 10.3% 10.0% 9.5% 9.2% 9.4% 8% 6% 4% 2% 6.9% Last Last years years 4.3% 3.4% 2.9% 1.9% 0%

20 Stock returns in real terms Investors in the long run are interested in real (or inflation-adjusted) returns. Let s look at the same returns adjusted by the U.S. inflation rate (since the returns are measured in dollars). This chart shows how miserable stock returns have been over the last 15 years.

21 Return per annum Stocks in developed markets: real returns Sources: S&P and MSCI 10% S&P 500 EAFE Europe Pacific 8% 8.4% 8.5% 6% 4% 5.9% 5.7% 5.2% 4.9% 6.5% 4.0% Last Last years years 2% 2.0% 1.1% 0.6% 0% % -2%

22 2) A New Normal for bonds? Bill Gross talked about a New Normal for stocks. But what about bonds? Surely, there is a New Normal ahead for bonds. The bull market for bonds has lasted for 30 years.

23 Per Annum Figure 3-3 U.S. Inflation and Bond Yields, Data Source: IMF, International Financial Statistics and Bureau of Labor Statistics CPI Inflation 10 yr Treas Yield 16% 14% 12% 10% 8% 6% 4% 2% 0% %

24 Factors influencing interest rates A. Fiscal deficits B. Monetary overhang Fiscal deficits have been reduced dramatically in last few years.

25 Percent of GDP Federal Expenditure as Percent of GDP, Economic Report of the President (Feb 2016) 26% 24% 20.7% down from high of 24.4% of GDP 22% 20% 18% 16%

26 Percent of GDP U.S. Tax Receipts as Percent of GDP, Economic Report of the President (Feb 2016) 22% 20% 18.3% up from low of 14.6% of GDP 18% 16% 14%

27 Percent of GDP U.S. Fiscal Deficit as Percent of GDP, Economic Report of the President (Feb 2016) 4% 2% 0% -2% -4% -6% -8% -10% -2.5% up from low of -9.8% of GDP -12%

28 Factors influencing interest rates The election results promise that this favorable trend will not continue. Infrastructure spending Large tax cuts

29 B. Monetary overhang Federal reserve did heroic work during the financial system providing massive liquidity to save banking system and bolster economy. But legacies: 1. Fed balance sheet has ballooned. 2. So has cash at commercial banks.

30 $ Billions Assets on Fed s Balance Sheet Source: Federal Reserve Board $5,000 $4,000 Start of QE3 Start of QE2 $3,000 $2,000 Start of QE1 QE1 QE2 QE3 Other Assets Loans Other Securities U.S. Treasuries $1,000 Federal Reserve H.4.1 Release $0 1/5/2005 1/5/2008 1/5/2011 1/5/2014

31 $ Billions $3,000 Cash assets at commercial banks $2,000 Start of QE3 Start of QE3 Start of QE2 Start of QE2 $1,000 Start of QE1 Start of QE1 $- Jan-05 Jan-07 Jan-09 Jan-11 Jan-13 Jan-15 Source: FRB H8 Series

32 Now what? A New Normal for bonds Does anyone at the Fed know how to get back to normal? Two scenarios for bonds: 1. Good scenario: Interest rates stay low forever. (In that case, real yields stay close to zero). 2. Bad scenario: interest rates rise. That surely is a New Normal for bonds

33 3. Is it possible to escape the New Normal by diversifying? If U.S. stock and bond markets promise lower returns, will diversification help? 1. One possibility is to diversify into countries that are growing much faster than the United States the emerging markets. 2. Another possibility is to diversify into alternative investments. Let s explore each possibility.

34 A. Diversifying into emerging markets Since 2001, emerging markets have earned the highest stock returns, easily beating the U.S. and other developed stock markets. Maybe emerging markets will help investors to escape the New Normal. In November 2001, Jim O Neill of Goldman Sachs introduced the BRICs Heralded an impressive decade of high stock returns not only in the BRICs, but emerging markets as a whole.

35 Figure 9-6 Returns in the BRIC Countries and Emerging Markets as a Whole Data Source: MSCI Return/Annum 20% % 14.1% 12.6% 10% 8.2% 6.7% 9.7% 0% 1.2% -5.0% -4.1% -10% -20% -16.8% Brazil Russia India China MSCI EM

36 Decade of the BRICs But then in December 2013, Goldman Sachs published Emerging Markets: As the Tide Goes Out which forecast a prolonged slowdown in stock returns in the emerging markets. Is it wise to look for salvation there?

37 Emerging markets have faltered over last 5 years Stock Returns in Emerging Markets Source: MSCI EM Index Return per Annum 18% 14% 16.2% 10% 6% 8.3% 2% -2% -6% -4.5% -10%

38 China has led all emerging markets in growth China has grown rapidly for over three and ½ decades.

39 Growth Per Annum Real GDP Growth in China, Source: IMF, international Financial Statistics 12% 10% 9.9% 9.0% 10.4% 10.0% 9.7% 8% 6% BRICs 4% 2% 0%

40 Employment in Sector (% of GDP) Key: lots of labor available Share of Employment by Sector in China Source: China Statistical Yearbook, % 60% 30% Agriculture Industry Services 0%

41 But now wages are rising rapidly Wage Increases in China Source: China Statistical Yearbook, ,000 60,000 Average wage increase = 13.6% per annum 40,000 Total Wage Bill Average Wage 20,

42 Will China slow down? China also confronts an aging problem almost as bad as in Japan, Germany and Italy. Consider United Nations projections through 2050.

43 Working Age/Non Working Age China s Working Age Population Relative to Non-Working Age Population Source: United Nations

44 Will China slow down? China is beginning to slow down. That s bad news for everyone. China has been the growth engine for the world. With China slowing, two other BRICs are in even worse shape, Brazil and Russia.

45 Three of the BRICs have slowed down Economic forecasts for emerging markets Source: IMF, July f 2017f China 6.9% 6.6% 6.2% India 7.6% 7.5% 7.4% Brazil -3.8% -3.3% 0.5% Russia -3.7% -1.2% 1.0%

46 B. Diversifying into alternative investments Hedge funds: Surely hedge funds provide an escape from the low returns offered by U.S. stock and bonds. Let s consider how well they have performed in the last 15 years.

47 Return per Annum Hedge Fund Returns Too Many Cooks Spoiling the Returns? HFRI Fund Weighted Hedge Fund Index 20% 18.2% 18.3% 15% 10% Decline Decline in in average average Decline in average returns returns Decline over over in time average time returns over time returns over time 5% 7.1% 5.7% 3.6% 0%

48 Diversifying into alternative investments Hedge funds: The increasingly poor performance of hedge funds in last 15 years is perhaps expected. After all, the space has been flooded by the influx of new funds. Are there that many arbitrage opportunities to keep 10,000 managers in business?

49 Diversifying into alternative investments Real Estate: Over last 20+ years as well as over the last 40+ years, real estate has outperformed U.S. equity. Look at REIT index relative to the S&P 500

50 Table 12-1 NAREIT and stock returns compared Average Return Standard deviation NAREIT S&P % 10.3% 17.1% 15.2% NAREIT S&P % 9.0% 19.1% 14.4% Sources: NAREIT and Standard and Poor s.

51 Diversifying into alternative investments Two caveats about real estate: 1. Real estate is as cyclically sensitive as stocks are. It s true that in the recession, real estate did not fall with stocks. But in the financial crisis, the drop in REITs (65%) was more severe than in stocks (50%). 2. Current values in real estate ( Cap rates ) are high. It s not a great time to add to this sector. On other hand, the outlook is not great in any sector.

52 Index (Dec 1991 = 100) Crushed in financial crisis, but have come back fully Figure NAREIT and S&P 500 Returns, Data Sources: Ibbotson Associates and Zephyr Database NAREIT S&P Dec-91 Dec-97 Dec-03 Dec-09 Dec-15

53 Diversifying into alternative investments Private equity: Here we have an alternative investment that has proved itself time and again. Cambridge Associates has reported its private equity series since Returns have been consistently above those of the private equity markets. My advice to endowments (and wealthy families) wealthy enough to invest in PE: Take advantage of excess returns to buck the New Normal in public markets

54 Return Per Annum Private Equity Twenty Years of Superior Returns Source: Cambridge Associates 20% Private Equity S&P % 15% 12.2% 13.7% 11.1% 10% 9.1% 7.3% 5% 0% 1986II I

55 Diversifying into alternative investments So private equity provides an alternative to the New Normal only for large endowments not for the rest of us.

56 The bottom line Investors face a New Normal of diminished returns. Economic growth has slowed throughout much of the world, so investment returns are likely to be lower than in the past.

57 My latest book published by Wiley Investing for a Lifetime Managing Wealth for the New Normal 1) Saving and Investing 2) Choosing a Portfolio 3) Wealth Management Also see my website richardcmarston.com