By Christopher W. Beale, CFP®
"The only function of economic forecasting is to make astrology look respectable ".
This quote is from one of my all-time favorite economists, John Kenneth Galbraith, 1908-2006.
After a quick, 36 hours trip to Kansas City two weeks ago I caught a cold on the return flight. This cold turned into a respiratory/sinus issue with double conjunctivitis. So, to the delight of my office, I did something that I have not done in the last 3 years---I called in sick! Spending time with my two friends, CNBC and CNN, made me want to get back to work as soon as possible. How depressing to listen to their negative take on everything! No wonder why so many people think “we’re going to hell in a handbasket”. I’d like to take you away from the negative messaging of the addictive 24/7 news cycle to give you my view of what I see for both the short and longer term economic view of the US and the rest of the world.
Let me start with a brief list of economic “realities” that I’ve heard both at client meetings and from the “expert” talking heads who fill cable TV air time: interest rates are too low making money too cheap, interest rates will be too high, the Chinese economy is slowing, the Chinese economy will take over the United States’, too much global unrest including instability in Russia, our dollar is too strong, our political system is a mess, the income disparity is too wide, there's too much debt in the world.
First, let's start with The United States. In 1945, the United States accounted for more than half of the world’s total gross domestic product (GDP) or total output of goods and services.
This means that half the world's economic output took place inside our borders. Today the United States economy makes up just fewer than 24% of the world’s GDP. Without further analysis we could conclude that the United States has been in a terrible decline over the last 70 years. But economic and financial growth is not a zero sum game. The leveling of the global playing field is not from us going down on one side but both sides going up, albeit at different rates. In other words, the US has absolutely enjoyed steady growth, but the rest of the world; including developing economies (somewhat due to a lower starting point) have essentially taken off like a rocket! In a recent client meeting, the client’s accountant questioned whether the 30% international stake allocated to the equity portion of our model was too high. Again I don’t expect the average accountant to understand why it is essential to have global diversification. Most accountants don’t understand that some international markets have faster growth rates and higher dividend yields than our US markets. The US tax code doesn’t show how global diversification can reduce risk and increase returns over time.
Other concerns I've heard from some of you during our client meetings is about the United Sates declining to the point that we will soon be irrelevant to the global economy. This reminds me of when I started as a financial advisor over 3 decades ago. The rhetoric today sounds strikingly similar to the 1980s when Japan was going to eat our lunch economically. The common belief was that we would quickly become a second rate economic power full of lazy workers. Although before my time, I would assume the National conversation was very similar after October 4, 1957 when the Soviet Union launched Sputnik and beat the United States in the global space race.
Let's take a look at what's really happening. Every year, the World Economic Forum ranks countries for global competitiveness. They rank factors such as labor market efficiency, the quality of primary education and higher education, infrastructure, strength of institutions, innovations, business sophistication, technological readiness, in the sophistication of financial markets. In the most recent survey, the US ranked third overall just behind Switzerland and Singapore. The superpower that most Americans are worried about, China ranked 28th, one rung above Estonia.
One last doom and gloom issue the “experts” love to discuss is the decline of US manufacturing. One of the untold stories is that the combination of wage increases in China and elsewhere, plus the availability of cheaper energy, has made it more attractive for American companies to bring their manufacturing plants back to US soil. Foreign companies have also relocated their plants here to be more convenient to the huge end market for the manufactured goods. This trend even has a name. It’s called “reshoring”. Two recent examples that never made it through the filter of the 24/7 news programming because they aren’t negative enough: General Electric moving the manufacturing of washing machines and heaters from China to a factory in Kentucky (the rumor that the Kentucky factory was closing did make the news); and Apple moved the production of its Macintosh lines from China to the U.S.
The bottom line is that the US economy is growing, tax revenues are increasing, the deficits have shrunk from post-crisis levels, we are politically stable and have had 46 straight months of job growth. The United States didn’t become a second or third world economy in the 1950’s or the 1980’s and I see no threat of this happening today.
What about the rest of the world?
The same two inherent, universal drivers of US economic growth are also drivers of world economic growth. The first is that all people strive for a better life for themselves and their families. The second driver is the new era of global innovation in which we live.
400,000 people per day will enter the middle class over the next decade. Nearly one billion people entered the middle class from extreme poverty in the last 17 years. By 2025 (just 10 years from now) 4.2 billion people of the 8 billion people are projected to be living above the poverty line. This will be the first time in human history that over half the world’s population will be living above the poverty line! This is beyond the feel good story. As an investor, this story has huge implications. What do you want when you leave extreme poverty?
This is a question that most of us, thankfully never have asked ourselves, so let me share the research. These people want better health care, better education for themselves and their families, and finally, travel and leisure opportunities. These basic goals will have great economic impact on well positioned companies. 15% of Mexicans earned $15,000 or more in 1995. Today 65% earn at least that much. Disposable income has gone up 149% in the last 17 years in Vietnam. On the way to earning $15,000 annually, we go from walking to purchasing a bike, to a scooter to a car, with the next purchase being a luxury car. Actually one of your first purchases after hitting $10,000 is a refrigerator. Then you purchase more and better food, better beer and better wine. Better is a relative term because you typically buy more animal based food. Again, all these predictable trends have economic opportunities.
What about travel and leisure? Many of the new global middle class will take their first trip on an airplane. US manufacturer, Boeing, predicts the world will need an additional (not replacement but additional) 35,000 jets costing $4.8 trillion over the next 20 years to meet this demand.
Research and development costs in health care totaled more than $145 billion last year alone. Please reread this again. We didn’t spend $145 billion for healthcare last year—this was just the research and development costs. $240 billion spent on e-commerce last year would be a big number. But that was not the industry sales last year. One company, Alibaba (the Chinese version of Amazon) had sales $240 billion in sales last year!! The income growth and wealth creation over the next decade will have a transformational impact on the world’s economy. In my office I often say “everyone likes progress, but no one likes change”. Without change there is no progress. Change is here. And change and progress are disruptive. I think of this every time I try to play one of my 8 tracks or cassettes. Strangely, vinyl records are having a bit of a comeback from hipsters and diehard audiophiles, but downloads are rapidly replacing the CD.
So armed with this knowledge, how do we position your portfolios? I think it is a mistake to just be in the US stock market or US bond market. It would also be a mistake to just be in the international stock or international bond market. This is why our portfolio models are diversified. At New England Capital, we will never share the view of short term traders who measure their time horizon by the second hand of their watch. Let them panic if they want when emotion causes market swings. We will enjoy the long term returns which come from our diversification. I tend to agree with Warren Buffett who said “when we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever”.
I hope you share my deeply held long term belief about diversification. Diversification is always my best friend on my worst day.
Finally, don’t interpret my rational optimism as a prediction of a future without economic challenges or market declines. Thankfully, there will always be challenges. Challenges force human beings to grow, to strive to be better. Markets and investments will always swing up and down. To which I say “great” because these swings, caused by emotion, create opportunities for the informed investors. There are times to be fearful. The current reality does not support the fear-mongering rhetoric however. The world and US economy may not be to our liking or coincide with all our beliefs, but it simply doesn’t portend economic doom. Hopefully the facts in this article have at least made you rethink your desire to take your gun to the cabin in the woods with your gold Krugerrands stuffed under the floorboards and a few years of bottled water and canned goods in the pantry. Now you can turn off the television and breathe easier.