mrbpartners Independent Investment Strategy

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1 MacroResearchBoard partners Independent Investment Strategy Misconceptions, Reality and Investment Strategy Presented by Peter Perkins Peter Perkins Partner, Global Strategy April 2017

2 Main Themes m Debt is elevated, but is misunderstood and likely won t be the catalyst for the next crisis (it s usually overestimating demand) m There are many unusual aspects to this cycle, as well as misconceptions m The global economy is rife with structural imbalances, with Switzerland being a prime example m Investors either appear too pessimistic about the future or too optimistic; somewhere in between is probable 2

3 Yes, Debt Levels Are High By Historical Standards 160 Global: Credit to Nonfinancial Institutions* (US$ tn) Share of GDP (%) MRB Partners Inc 04/2017 MRB Partners Inc 04/ * Source: Bank for International Settlements

4 But The Economy & Dollar Are Keys -5 Global: GDP* (%YoY, Inverted, LS Credit To Private Nonfinancial Institutions** (% of GDP, RS) Trade-Weighted Dollar*** (%YoY, Inverted, LS Credit To Private Nonfinancial Institutions** (% of GDP, RS) MRB Partners Inc 04/ * Source: IMF ** Source: Bank for International Settlements *** Major currencies; source: Federal Reserve 4

5 The Debt Problem m Too much debt might be a problem m But it is not the biggest problem m Nor the most immediate one m Who owes the debt is as important in determining risk as how much is owed m Solving the debt problem requires stronger nominal GDP, both now and in the future m As well as longer-term changes to our health care and pension systems m The latter without the former will not be enough m You can t cut your way out of your debt problem, or into health 5

6 Misconceptions About The Global Economy m Misconception: Debtor nations haven t adjusted much Reality: Greece s national saving rate has risen by 15% of GDP since 2007; Spain s by 12% m Misconception: Rise in total debt has jeopardized the global economy Reality: It prevented a depression and allowed a recovery m Misconception: Hyper-accommodative monetary policy has created major risks Reality: It has prevented misguided fiscal policies from exacerbating economic problems m Misconception: Economic adjustment is primarily the responsibility of debtors; Reality: Debtors can t adjust if creditors don t 6

7 Many Debtor Countries Have Adjusted A Lot Change In Saving Rate (% Of GDP) Private Sector Public Sector National Private Sector Public Sector National Private Sector Public Sector National Germany Greece Ireland* Italy Portugal Spain Switzerland U.K U.S * Reflects government bailout of banks 7

8 De-Synchronized Cycles m The capital markets cycle is advanced relative to the economic cycle m Economic cycles have been more desynchronized across countries/regions than normal m The policy cycle has lagged the economic cycle by an abnormal amount to offset household de-leveraging, fiscal drag 8

9 Easy Fed Policy Has Brought Forward Capital Markets Cycle 8 U.S.: Federal Funds Rate (%) Talyor Rule* (%) Nominal GDP (%YoY) Minus Federal Funds Rate (%) 0-4 MRB Partners Inc 04/ * MRB calculation 9

10 The Government Has Been A Drag On U.S. Growth U.S. Real Government Consumption & Investment (% 5-Year CAGR) 4 3 Usually a source of growth MRB Partners Inc 04/ Note: Compound annual growth rate 10

11 Economic Realities & Problems m There are chronic current account surplus and deficit countries, reflecting structural problems and lack of adjustment m Free capital flows appear incompatible with stable exchange rates, yet most countries want both (impossible trinity) m Central banks have multiple targets, with too few tools m EM countries are net global lenders, yet with higher domestic growth rates m EM countries have built a massive FX war chest, but are punished if they use them m There are debtor prisons (e.g Greece) 11

12 Chronic, Large Trade Imbalances Signal Structural Problems m Large current account deficits Australia (4.4% of GDP avg since 2000), Greece (7.5% avg). U.K. (3%), U.S. (3.7%) m Large current account surpluses Singapore (19% avg!), Norway (12%), Switzerland (11% avg!), Taiwan (9% avg), Germany (5% avg), China (4%), Japan (3% avg) Switzerland has had a current account surplus each of the past 35 years! m Policies and prices are not adjusting to correct global trade imbalances 12

13 Singapore & Switzerland: Structural Surpluses Current Account Balance* (% of GDP): Switzerland Singapore MRB Partners Inc 04/ * Source: IMF 13

14 Is Secular Stagnation The Right Diagnosis? m U.S. de-leveraging dampened growth, but appears over m Euro area debt crisis/recession in was a political choice, not a secular force m Government has subtracted from growth this cycle, having boosted growth in the past (again, this was a political choice) m Depressed animal spirits rather than cost of capital, profitability or other factors is inhibiting private investment; there is no definitive shortage of potential investment opportunities m Low productivity growth is a measured fact, but few if any know what will drive it 14

15 Who s Adam Smith? Cost & Return On Capital Are Out Of Whack Global Return On Equity* (%) 16 U.S. 10-Year Government Bond Yield (%) 16 Rent extractors MRB Partners Inc 04/ * Source: MSCI 15

16 Earnings, Not Just The Fed Is Driving Stocks S&P 500: 12-Month Forward Earnings* 12-Month Trailing Earnings* Strong earnings performance U.S. Nonfinancial Corporate Profits** MRB Partners Inc 04/ * Rebased; smoothed; source: Thomson Financial / IBES ** Includes IVA & CCADJ; rebased; source: U.S. Bureau of Economic Analysis

17 The Equity Risk Premium Is High 6 MRB Global Cyclically-Adjusted Equity Risk Premium* (%) Valuation cushion for stocks MRB Partners Inc 04/ * Cyclically-adjusted earnings yield minus G7 10-year government bond yield; normalized for the ROE cycle 17

18 Moderately Positive Cyclical Outlook For Risk Assets m Firmer global growth, plus prospects for U.S. fiscal support m Rising corporate profits following profits recession m Valuations don t drive equity market performance on a 1-2 year horizon m Stocks have a valuation cushion versus bonds, although corrections likely as Fed hikes m Moderate returns on equities, losses on bonds imply poor aggregate portfolio returns m Commodities, alternatives unlikely to significantly enhance performance 18

19 Capital Markets Cycle: More Normal Than Believed 200 Global Stock / Bond Ratio* Peaks just ahead of recessions 100 Real Stock Total Return** Real Bond Total Return** MRB Partners Inc 04/ * Global MSCI stock market total return index divided by 10-year global government bond total return index; rebased ** Deflated by OECD G7 CPI; rebased Note: Shaded for NBER-designated U.S. recessions 19

20 Gold For The Long Run? Global Stock* / Gold Total Return Gold / Crude Oil** Total Return MRB Partners Inc 04/ * U.S. dollars; source: MSCI ** Equally-weighetd aggregate of Brent, OPEC, and WTI crude oil prices Note: All series rebased 20

21 Get Real About Investment Returns Country/Region Balanced Portfolio Returns* (% CAGR) Real Return Nominal Return Conservative Portfolio Returns** (% CAGR) Real Nominal Return Return Aggressive Portfolio Returns*** (% CAGR) Real Nominal Return Return U.S. Dollar Portfolio Stocks Fixed Income Gov t Bonds Risk Products Commodities Cash Euro Portfolio Sterling Portfolio % CAGR: Compound Annual Growth Rate From 2016 to 2026 MRB Partners Inc 04/2017 * Balanced portfolio is 50% global equities, 25% domestic 10-year government bonds,15% risk products, 5% global commodities, and 5% domestic cash, measured in local currency; rebalanced annually ** Conservative portfolio is 35% global equities, 45% domestic 10-year government bonds, 10% risk products, 5% global commodities, and 5% domestic cash, measured in local currency; rebalanced annually *** Aggressive portfolio is 70% global equities, 17.5% domestic 10-year government bonds, 12.5% risk products, 0% global commodities, and 0% domestic cash, measured in local currency; rebalanced annually 21

22 Conclusions m Our over-emphasis on debt has been misplaced attention should be focused on growth-boosting measures and longer-term re-balancing m The global economy has a number of structural problems, including the failure of creditor/surplus countries to allow adjustment m The capital markets cycle will only expire when the global economy is verging on recession, which is not on the immediate horizon m Long-term returns for major asset classes will be low, primarily because the 35-year decline in discount rates is behind us 22

23 Contact For more information regarding MRB -, please contact: Amy Smith Manager, Client Relations Telephone: +44 (0) Mobile: +44 (0) Peter Perkins Partner, Global Strategy Telephone: +44 (0)