Structural changes in economic cycles favor developing markets
03 June 2013
Wayne McCurrie, Momentum Wealth
Markets and economies are cyclical animals most of the time. These cycles vary in duration, but they normally are fairly regular in their characteristics. However, every now and again there are structural changes. These are actually few and far between but it is essential that investors recognize these structural changes and make the necessary adjustments to their investment philosophy and portfolios.
Unfortunately, most of the time normal cycles are interpreted as structural changes by the market in general, and by the proponents of that particular cycle in particular. You hear talk of a "new age”, "this time it’s different” etc. Examples of this are the IT/TMT bubble, the property bubble, gold, construction shares, small caps and the list goes on and on.
Structural changes
The fall of inflation globally (which began in the 1980’s globally and in the late 1990’s in South Africa) the rise of China (and other emerging markets) as an economic power block and the consequent structural rise in commodity prices, the negative adjustment in the value of the Rand post 1994 and the recent global financial crisis are good examples of a structural change and not a cyclical change.
Global financial crisis – what is this structural change and is it a "new normal”
The global financial crisis occurred as a result of excessive debt, primarily in the developed world. The foundation of this debt crisis was the housing market, specifically in the USA. The results of the bubble bursting are numerous and complex, but can be simplified as:
- Significantly lower growth in the developed world.
- Massive pressure on government finances in the developed world.
- Excessive liquidity pumped into the economic system by central banks and governments.
- Very low interest rates for a sustained period.
- Excess equity returns, as experienced from the early 1980’s to 2002, are unlikely to occur over the next two decades in the developed world.
Developing economies are affected by the crisis, but to a far lower extent. Nobody knows what the ultimate affect will be when the excessive liquidity that was pumped into the system during the crisis, is withdrawn. This event is however unlikely to occur soon and investment markets are not even thinking of this eventuality. Keep your eyes open for this, but not yet.
Economic cycle
The world’s economy is a far better place that a few years ago. This does not imply that it is a good place only that it is better than what is was.
Growth, which will occur at a slower pace in developed economies and a reasonable pace in developing economies, will continue without the normal associated rise in inflation and interest rates that would normally be anticipated at this stage of the cycle. Rising interest rates on the back of rising inflation most likely will occur, but this even is not within the current investment horizon.
So where are we going?
Over the next few years, the economic backdrop will remain similar: good growth which has excessive liquidity which makes it more risk tolerance. Therefore, there will be no change in the economic cycle within the current investment horizon.
The difference is that bond yields have already dropped to unrealistic levels and equity markets are essentially already at record highs.
Unfortunately then the outlook is not good for high portfolio returns. Global equity could give a fair return, resource shares may recover, but bonds, listed property and some industrial shares are expensive.
The only good news is that the liquidity will still be around and we are very unlikely to have another crisis in investment markets.
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