So, clearly, the scope and scale of Chinese economic activity is breathtaking, no less than its speed.
Some big numbers, but also numbers looking in the rear-view mirror.
Going forward, it makes no sense to project China's recent economic development into the future.
Tuesday, March 01, 2011
Other voices on the future of China, India and the US
Apparently, some senior economists at some pretty big banks, Citigroup, HSBC and UBS share my scepticism about the future of Asian economies, and like me, believe that the Jeremiads decrying the decline of the West suffer for want of analysis.
Maybe they have been reading the Strategic Investor? If so, I don't see any attribution....
Maybe they have been reading the Strategic Investor? If so, I don't see any attribution....
Follow up on Glassman's new book
As I said, I haven't read it, nor have I any intention of doing so, but apparently, it is something of an apologia for his monumentally bad call in 1999.
What I find amazing is that in spite of acknowledging lower growth going forward (according to the review), Glassman fails to believe that thtis will manifest itself in lower earnings growth and lower stock returns.
I always wonder about the conflicts between the authors of investment newsletters and their readers. I mean, who pays for the advertising in personal finance magazines? Asset managers. Asset managers have a vested interest in explaining why you should invest NOW. There is always a reason - usually it is compound interest and the argument that you can't time the market. So "no time like the present". But this means that real deep analysis, partiuclarly bearish analysis, must be frowned upon, since the last thing an asset manager wants is big redemptions.
Thus, projections about the future are generally rosy, so long as you "invest for the long term" and park your cash with that expensive manager.
What I find amazing is that in spite of acknowledging lower growth going forward (according to the review), Glassman fails to believe that thtis will manifest itself in lower earnings growth and lower stock returns.
I always wonder about the conflicts between the authors of investment newsletters and their readers. I mean, who pays for the advertising in personal finance magazines? Asset managers. Asset managers have a vested interest in explaining why you should invest NOW. There is always a reason - usually it is compound interest and the argument that you can't time the market. So "no time like the present". But this means that real deep analysis, partiuclarly bearish analysis, must be frowned upon, since the last thing an asset manager wants is big redemptions.
Thus, projections about the future are generally rosy, so long as you "invest for the long term" and park your cash with that expensive manager.
The Outlook for Equity Prices: It’s probably worse than you think
With recent tremors in global markets queued up by concerns about oil supplies, sovereign debt levels, government deficits and the tax increases and spending cuts required to get them under control, I think it is about time to look at Equity Prices in a more holistic – and to my mind, clearer - way. To strip away the noise, and think about what truly long term returns are likely to be.
The proximate cause of this exercise was an interview given by James Glassman, contributing editor to Kiplinger’s Personal Finance and author of the notoriously badly timed “Dow 36,000”, to Henry Blodgett of Tech Ticker. Glassman, it should be noted, is now peddling a new book – encouraging investors (individual investors) to reduce their overall stock exposure and instead to hedge against loss. This only took 10 years of dismal equity returns for him to acknowledge that markets sometimes go down and for long periods. I admit that I have not read either book, though I have read many of his columns over the years.
Blodgett and Glassman discussed the effect of a lower volatility portfolio on long term returns. Both used a 10% number as the long term compounded (geometric) average return to investors from equities. Glassman’s argument was that in saving for retirement, you should sacrifice some upside to ensure that you don’t experience a big, catastrophic drop – in his words “once of the worst things you can do is reach for extra return”. (I agree with this view. Warren Buffett also had some choice words on this in his annual letter). Blodgett countered – but what of the people who *need* 10% to make “the number” they need to retire? Glassman essentially said, you should settle for a lower return, which he estimated at around 8%. When challenged by Blodgett that this might also be optimistic, he conceded that 5-6% returns might be possible if things were “really bad”. Unsaid by both was that with lower investment return expectations, that investors must instead adjust either saving rates (up), working life (longer with a shorter retirement), or their accept a lower standard of living in retirement.
Glassman and Blodgett were talking about a version of this chart, which I confess had a huge impact on me as an undergraduate in the 1990s, and got me focused on saving and investing. But consider how different the chart looks if returns are much lower than 10%, or even Glassman’s 8%. The difference between 8% and 10% is 60% of the total account value for our “young and done” investor, and *only*45% of the account value for our later diligent. What if returns fall to 6%? That $1 million portfolio might now buy our “young and done” investor a small condo in Miami (at post bubble prices). Even our diligent saver has lost 67% of his projected nest egg.
Given the impact that different rates of return have on expected retirement assets and living standards, it makes sense to have a basis for expectation. All of the numbers I see are “rear view” projections. They make assumptions that the future will be like the past.
Instead, I would like to suggest that we face forward, and think about what is probable – not in the near term, but over the long term. The short answer is – we aren’t going to get historical returns.
Let’s start by unpacking the components of equity prices. Stock prices have two drivers – earnings (dividends, or free cash flows, technically, but over an infinite time horizon these converge), and investors’ appetite for earnings (that is the price investors are willing to pay for those earnings).
Earnings have two components, the current rate, and the rate of earnings growth over an infinite time horizon. This is what one might call “fundamental” or “intrinsic” value – the actual money the business would throw off.
Investor’s appetites (valuation) have three components - interest rates, volatility (risk) and expectations of earnings growth.
I want to begin our investigation by thinking earnings and – more importantly earnings growth. I start with a statement – over the long term, earnings cannot grow materially faster than GDP. This might shock you, but it is the GDP identity.
Without getting too technical, there are three methods of calculating GDP: the output method, the income method and the expenditure method. In theory, they should produce the same result. In actual practice, they differ slightly, but are close enough for our purposes. Since we are discussing income (earnings) we will apply the Income Method, which states:
GDP= Employee Compensation + Corporate Operating Surplus + Gross Mixed Income + Taxes – (Subsidies on production and net Imports)
This identity says that Employee net income, plus corporate net income, plus the income of unincorporated businesses, plus taxes (government income) less subsidies (which accrue to one of the other income sources) is the national income. This makes sense. From this identity it follows that for corporate profits to be larger than GDP, either employee compensation, proprietor income or taxes (less subsidies and imports) would have to be negative. In practice, no one component would ever be as large as GDP, even in a socialist country, because people have to eat.
If one component in growing faster than GDP, it is gaining share of the national income. Moreover, that over very long (infinite) time horizons, no component can grow significantly faster than the whole, since it would over time gain enough share to approach 100% of GDP, and either drive up GDP growth with it, or slow to a rate approximating GDP. Over shorter than infinite time horizons, however, individual components can grow faster than the whole, and gain share of the overall pie.
I suggest to you that people who throw 8, 9, 10, 11% growth as the “long run” return of equities are projecting a future in which corporate earnings permanently grow significantly faster than the underlying economy. If you ask these same people to estimate GDP growth you will usually get a number of either 3% or 6% depending on whether you mean nominal or real GDP. (Since earnings are a nominal measure nominal GDP is what counts here). I also suggest that they are likely to be disappointed.
It is true that looking backward over long time horizons, equities have earned 9-10% or so. So how has the market delivered this return “over the long term”? Well, consider two factors. First, earnings may have grown faster than GDP over measurable historical periods. Our information about markets and economics are really quite recent developments. The stock company is also a recent development. The first joint stock company was invented in 1600 when Elizabeth I chartered the East India Company. Stock exchanges are even newer, with the London Stock Exchange having its origins in 1698. Most of the “stock” traded was government paper, not equities and their profits were tiny compared with overall economic activity. Modern industrial firms were really created in the 19th century and have steadily increased their share of economic activity at the outset. Most people were unincorporated small proprietors working at subsistence farming, or small shopkeepers. Wartime cartelization and unionization meant that in the 1950s workers held a much larger share of national income So, looking BACKWARD, corporate profits have grown faster than the economy overall, and have gained share of output, but projecting that growth onto the future is asking for trouble because corporate profits are no longer working off of a low base.
Second - there is valuation: equity investors have simply been willing to pay more for earnings over time. This is particularly true in the period after 1994. A variety of factors contribute to this, including favorable macro conditions, which have driven higher all asset prices (as measured by earnings or interest yields) - and have reduced the realm of attractive alternatives, recent experience which has been for equity prices to increase much faster than overall economic activity and reduce the perceived risk of equities, wider equity ownership (with most of the growth coming from less sophisticated investors, who may be less scrutinizing of changes in underlying fundamentals), and the possibility that investors in early market stages were excessively cautious - that is, that equity prices were simply too low relative to the risks (thus some of the gains were simply a correction of undervaluation).
In short, when we look at equity returns, I believe we are taking as normative something that is in fact a historical anomaly. Like any new and successful technology or approach, corporations experienced significant growth, taking share from other market participants (otherwise, it would have died out. It is tantamount to projecting iPad sales, or Google revenue out into the future based on the first few years after introduction.
Even exceptional cases of long term performance, e.g. Berkshire Hathaway, have experienced diminished returns over time as the base on which high growth has to be earned, expands. At some point, corporation earnings will slow, because attractive investment opportunities will decline, because workers will gain more pricing power, or because governments will raise taxes, or all three. What is certain is that to earn the kind of returns investors expect, they must believe that corporate profits will come to represent 20-30% of economic activity within the course of an adult lifetime (up from 10% now). This is highly improbable, and should therefore not be used as a “conservative” or “reasonable” forecast of returns.
Moreover, the GDP range I have used above is also historic and may also be anomalous.
6% nominal growth seems high, given that inflation is running well below 3% and the primary inputs of real output – labor (in the form of hours worked) and output per hour, both look to be factors that will grow slower in the future than in the past. More people are working in the US than practically ever before. This is mostly due to demography – women’s labor force participation has increased dramatically, the dependency ratio (the number of people divided by the number who work) has hit a low and is projected to rise as Boomers retire. Labor hours worked is set to rise slowly from currently suppressed levels. Productivity growth may continue at 1.5% but with hours worked increasing only 0.5% - 1% per year, real growth will likely be closer to 2-2.5%. If inflation remains around 2%, then nominal output will grow 4-5%, not 6%, and we will see a corresponding decline in the rate of earnings growth.
Consider though that if the variation (the volatility) of the returns stays constant regardless of the mean expected return that we should expect to see many more years with negative stock returns. The standard deviation of returns is around 15%, which means that if mean returns are 11% most years will see positive stock markets. If the mean is 4%, however, there will likely be many more years where returns are negative. Worse, stock returns are heteroskedastic, which means that volatility changes with the time horizon (though I am not sure if it increases or decreases – this is important).
I think it more likely that taxes will increase as a share of the economy, and with it, subsidies. If unemployment remains high, it is possible that corporate taxes will rise, reducing corporate income (though most policy advocates on both the left and the right seem to want to reduce corporate income taxes, which would INCREASE income as a share of economic activity, all else equal). One positive factor, however, is that net imports may decline, particularly if consumption declines as well. Finally, over the next few years, unemployment is likely to improve, and with it consumer wages. Already, we see wages rising in both Eastern Europe and the Far East, places which have supplied the low cost labor that has enabled companies to keep a lid on wages and benefits and expand corporate share of income. With rising wages, overseas and slowly falling unemployment, it seems quite reasonable to believe that wages and benefits will rise, eroding corporate profitability. Thus it seems possible that corporate income could as likely fall as a share of output as rise.
With corporate profits already at high levels, and unlikely to sustain growth faster than the economy, and the economy likely to grow more slowly than in the past, the only hope we have for Glassman’s 8% returns seems to lie in higher valuations. Sadly, the news here is also rather dismal.
Stocks rocket from periods of high valuation to periods of low valuation. This table from John Mauldin, shows what happens when you invest in periods of high valuation – you tend to get returns of less than 4%. More accurately, attempting to live of 4% of your money leaves you in real risk of winding up bankrupt over 30 years.
Today, sadly, our valuation (measured over the 10 year business cycle) is high. Several factors influence this, interest rates (at which investors discount future growth) are quite low. Low rates lead to high valuation. Faced with low yields in other asset classes, such as bonds or cash, investors are turning to risk assets. Similarly, growth expectations are high, because people are still projecting the past onto the future. Further, equity valuation has been high for so long, people have come to see it as normal. Indeed, stocks may look cheap when compared to the astronomical valuations of the late 1990s.
Pity a poor Japanese who at age 50 has been working since 1985. If he has been a diligent saver, putting his money into the stock market in hope of high returns, he has watched his investments wither away as slow earnings growth and compressed valuations have left the market down 75% from its high, more than 20 years after the peak! Real estate returns are similarly bad. That is why he instead purchases assets with no risk of capital loss – government bonds – and earns essentially zero. He is just happy to know that he can get his money back someday.
What we know is that equities tend to rotate from high valuation to low valuation and back again. Despite coming down from very high levels 10 years ago, we are not near to a low valuation level. True, at market lows in 2009 we were near the normal valuation level. Beyond 2012, ten year corporate earnings will be able to escape the poor performance in the 2000-2002 period, and so be a bit higher.
But interest rates will also likely rise, and that will give competition to increasingly risk averse Boomers. Moreover, it will raise the discount rate on stocks. If valuations fall, even as earnings rise, the perception of risk in equities as a class may rise, and the return demanded from investors may rise as well. This will feed into yet lower valuations. But this is again to suggest what might happen to stocks over the next ten years.
What I am saying is that one has to be very selective in the stocks one picks – stocks as an asset class will have low returns, likely in the 4-6% range over time. This may come from a permanently 2nd gear growth rate in prices, but history suggests that stock returns are volatile, thus returns are likely to instead go through a period of negative returns. These may be sufficiently large to reduce valuation to such a point that returns from that point forward can grow faster than economic growth for an extended period. This is not the market we face.
In short, I believe we are looking at 4-6% returns for equities going forward. This result is the combination of an expectation of lower earnings growth coupled with a fall in valuation.
This will have profound impact on the level of savings required to have the standard of living in retirement that people expect. Paradoxically, if enough people attempt to save more – we will push valuations higher in the short term, but subsequent returns yet lower later, as underlying yields could fall to Japanese levels. Pity the guy who has to select from an investment universe in which all values are sky high. In the short term, of course, returns could easily exceed this level. But they could just as likely fall.
Such low rates mean that one has to question whether one is inclined to subject oneself to the volatility of stock returns. These will be negative far more often than investors have experienced over the past 30 years. I continue to recommend solid businesses that can pay steady dividends, fortified by a low payout rate. Stocks yielding 2-4% offer current yields not materially different from the expected return on the overall market with significantly less volatility that the overall market. These stocks will also hold value better during a decline, providing the investor with the option to acquire more volatile stocks at a moment when that volatility results in low valuation. In the event of inflation, they should also have pricing power and the ability to raise yields to protect investors.
Happily, many solid dividend paying stocks, such as CL, INTC, WMT, JNJ and other solid brand-name firms are relatively inexpensive. There are also a host of smaller firms which may be attractive takeover targets, particularly in a world where investors expect strong earnings growth but organic returns aren’t in the cards. Of course, once you sell, you face the same unattractive investment universe everyone else has, but at least you have some cash.
Finally, in a world of low returns, the optionality of cash should be attractive to most investors. You are unlikely to lose big sitting out (yes, I KNOW that stocks have rallied 95% since March 2009. I wish that I had bought more in the Q1 of 2009, but we are in March 2011 now, and have to look at the situation we now face). I confess that given relatively high valuations, I believe we remain in a secular bear market, and that March 2009 lows will be back, though it may be a few years yet.
Protect your downside and adjust your expectations and your plan.
The proximate cause of this exercise was an interview given by James Glassman, contributing editor to Kiplinger’s Personal Finance and author of the notoriously badly timed “Dow 36,000”, to Henry Blodgett of Tech Ticker. Glassman, it should be noted, is now peddling a new book – encouraging investors (individual investors) to reduce their overall stock exposure and instead to hedge against loss. This only took 10 years of dismal equity returns for him to acknowledge that markets sometimes go down and for long periods. I admit that I have not read either book, though I have read many of his columns over the years.
Blodgett and Glassman discussed the effect of a lower volatility portfolio on long term returns. Both used a 10% number as the long term compounded (geometric) average return to investors from equities. Glassman’s argument was that in saving for retirement, you should sacrifice some upside to ensure that you don’t experience a big, catastrophic drop – in his words “once of the worst things you can do is reach for extra return”. (I agree with this view. Warren Buffett also had some choice words on this in his annual letter). Blodgett countered – but what of the people who *need* 10% to make “the number” they need to retire? Glassman essentially said, you should settle for a lower return, which he estimated at around 8%. When challenged by Blodgett that this might also be optimistic, he conceded that 5-6% returns might be possible if things were “really bad”. Unsaid by both was that with lower investment return expectations, that investors must instead adjust either saving rates (up), working life (longer with a shorter retirement), or their accept a lower standard of living in retirement.
Glassman and Blodgett were talking about a version of this chart, which I confess had a huge impact on me as an undergraduate in the 1990s, and got me focused on saving and investing. But consider how different the chart looks if returns are much lower than 10%, or even Glassman’s 8%. The difference between 8% and 10% is 60% of the total account value for our “young and done” investor, and *only*45% of the account value for our later diligent. What if returns fall to 6%? That $1 million portfolio might now buy our “young and done” investor a small condo in Miami (at post bubble prices). Even our diligent saver has lost 67% of his projected nest egg.
Given the impact that different rates of return have on expected retirement assets and living standards, it makes sense to have a basis for expectation. All of the numbers I see are “rear view” projections. They make assumptions that the future will be like the past.
Instead, I would like to suggest that we face forward, and think about what is probable – not in the near term, but over the long term. The short answer is – we aren’t going to get historical returns.
Let’s start by unpacking the components of equity prices. Stock prices have two drivers – earnings (dividends, or free cash flows, technically, but over an infinite time horizon these converge), and investors’ appetite for earnings (that is the price investors are willing to pay for those earnings).
Earnings have two components, the current rate, and the rate of earnings growth over an infinite time horizon. This is what one might call “fundamental” or “intrinsic” value – the actual money the business would throw off.
Investor’s appetites (valuation) have three components - interest rates, volatility (risk) and expectations of earnings growth.
I want to begin our investigation by thinking earnings and – more importantly earnings growth. I start with a statement – over the long term, earnings cannot grow materially faster than GDP. This might shock you, but it is the GDP identity.
Without getting too technical, there are three methods of calculating GDP: the output method, the income method and the expenditure method. In theory, they should produce the same result. In actual practice, they differ slightly, but are close enough for our purposes. Since we are discussing income (earnings) we will apply the Income Method, which states:
GDP= Employee Compensation + Corporate Operating Surplus + Gross Mixed Income + Taxes – (Subsidies on production and net Imports)
This identity says that Employee net income, plus corporate net income, plus the income of unincorporated businesses, plus taxes (government income) less subsidies (which accrue to one of the other income sources) is the national income. This makes sense. From this identity it follows that for corporate profits to be larger than GDP, either employee compensation, proprietor income or taxes (less subsidies and imports) would have to be negative. In practice, no one component would ever be as large as GDP, even in a socialist country, because people have to eat.
If one component in growing faster than GDP, it is gaining share of the national income. Moreover, that over very long (infinite) time horizons, no component can grow significantly faster than the whole, since it would over time gain enough share to approach 100% of GDP, and either drive up GDP growth with it, or slow to a rate approximating GDP. Over shorter than infinite time horizons, however, individual components can grow faster than the whole, and gain share of the overall pie.
I suggest to you that people who throw 8, 9, 10, 11% growth as the “long run” return of equities are projecting a future in which corporate earnings permanently grow significantly faster than the underlying economy. If you ask these same people to estimate GDP growth you will usually get a number of either 3% or 6% depending on whether you mean nominal or real GDP. (Since earnings are a nominal measure nominal GDP is what counts here). I also suggest that they are likely to be disappointed.
It is true that looking backward over long time horizons, equities have earned 9-10% or so. So how has the market delivered this return “over the long term”? Well, consider two factors. First, earnings may have grown faster than GDP over measurable historical periods. Our information about markets and economics are really quite recent developments. The stock company is also a recent development. The first joint stock company was invented in 1600 when Elizabeth I chartered the East India Company. Stock exchanges are even newer, with the London Stock Exchange having its origins in 1698. Most of the “stock” traded was government paper, not equities and their profits were tiny compared with overall economic activity. Modern industrial firms were really created in the 19th century and have steadily increased their share of economic activity at the outset. Most people were unincorporated small proprietors working at subsistence farming, or small shopkeepers. Wartime cartelization and unionization meant that in the 1950s workers held a much larger share of national income So, looking BACKWARD, corporate profits have grown faster than the economy overall, and have gained share of output, but projecting that growth onto the future is asking for trouble because corporate profits are no longer working off of a low base.
Second - there is valuation: equity investors have simply been willing to pay more for earnings over time. This is particularly true in the period after 1994. A variety of factors contribute to this, including favorable macro conditions, which have driven higher all asset prices (as measured by earnings or interest yields) - and have reduced the realm of attractive alternatives, recent experience which has been for equity prices to increase much faster than overall economic activity and reduce the perceived risk of equities, wider equity ownership (with most of the growth coming from less sophisticated investors, who may be less scrutinizing of changes in underlying fundamentals), and the possibility that investors in early market stages were excessively cautious - that is, that equity prices were simply too low relative to the risks (thus some of the gains were simply a correction of undervaluation).
In short, when we look at equity returns, I believe we are taking as normative something that is in fact a historical anomaly. Like any new and successful technology or approach, corporations experienced significant growth, taking share from other market participants (otherwise, it would have died out. It is tantamount to projecting iPad sales, or Google revenue out into the future based on the first few years after introduction.
Even exceptional cases of long term performance, e.g. Berkshire Hathaway, have experienced diminished returns over time as the base on which high growth has to be earned, expands. At some point, corporation earnings will slow, because attractive investment opportunities will decline, because workers will gain more pricing power, or because governments will raise taxes, or all three. What is certain is that to earn the kind of returns investors expect, they must believe that corporate profits will come to represent 20-30% of economic activity within the course of an adult lifetime (up from 10% now). This is highly improbable, and should therefore not be used as a “conservative” or “reasonable” forecast of returns.
Moreover, the GDP range I have used above is also historic and may also be anomalous.
6% nominal growth seems high, given that inflation is running well below 3% and the primary inputs of real output – labor (in the form of hours worked) and output per hour, both look to be factors that will grow slower in the future than in the past. More people are working in the US than practically ever before. This is mostly due to demography – women’s labor force participation has increased dramatically, the dependency ratio (the number of people divided by the number who work) has hit a low and is projected to rise as Boomers retire. Labor hours worked is set to rise slowly from currently suppressed levels. Productivity growth may continue at 1.5% but with hours worked increasing only 0.5% - 1% per year, real growth will likely be closer to 2-2.5%. If inflation remains around 2%, then nominal output will grow 4-5%, not 6%, and we will see a corresponding decline in the rate of earnings growth.
Consider though that if the variation (the volatility) of the returns stays constant regardless of the mean expected return that we should expect to see many more years with negative stock returns. The standard deviation of returns is around 15%, which means that if mean returns are 11% most years will see positive stock markets. If the mean is 4%, however, there will likely be many more years where returns are negative. Worse, stock returns are heteroskedastic, which means that volatility changes with the time horizon (though I am not sure if it increases or decreases – this is important).
I think it more likely that taxes will increase as a share of the economy, and with it, subsidies. If unemployment remains high, it is possible that corporate taxes will rise, reducing corporate income (though most policy advocates on both the left and the right seem to want to reduce corporate income taxes, which would INCREASE income as a share of economic activity, all else equal). One positive factor, however, is that net imports may decline, particularly if consumption declines as well. Finally, over the next few years, unemployment is likely to improve, and with it consumer wages. Already, we see wages rising in both Eastern Europe and the Far East, places which have supplied the low cost labor that has enabled companies to keep a lid on wages and benefits and expand corporate share of income. With rising wages, overseas and slowly falling unemployment, it seems quite reasonable to believe that wages and benefits will rise, eroding corporate profitability. Thus it seems possible that corporate income could as likely fall as a share of output as rise.
With corporate profits already at high levels, and unlikely to sustain growth faster than the economy, and the economy likely to grow more slowly than in the past, the only hope we have for Glassman’s 8% returns seems to lie in higher valuations. Sadly, the news here is also rather dismal.
Stocks rocket from periods of high valuation to periods of low valuation. This table from John Mauldin, shows what happens when you invest in periods of high valuation – you tend to get returns of less than 4%. More accurately, attempting to live of 4% of your money leaves you in real risk of winding up bankrupt over 30 years.
Today, sadly, our valuation (measured over the 10 year business cycle) is high. Several factors influence this, interest rates (at which investors discount future growth) are quite low. Low rates lead to high valuation. Faced with low yields in other asset classes, such as bonds or cash, investors are turning to risk assets. Similarly, growth expectations are high, because people are still projecting the past onto the future. Further, equity valuation has been high for so long, people have come to see it as normal. Indeed, stocks may look cheap when compared to the astronomical valuations of the late 1990s.
Pity a poor Japanese who at age 50 has been working since 1985. If he has been a diligent saver, putting his money into the stock market in hope of high returns, he has watched his investments wither away as slow earnings growth and compressed valuations have left the market down 75% from its high, more than 20 years after the peak! Real estate returns are similarly bad. That is why he instead purchases assets with no risk of capital loss – government bonds – and earns essentially zero. He is just happy to know that he can get his money back someday.
What we know is that equities tend to rotate from high valuation to low valuation and back again. Despite coming down from very high levels 10 years ago, we are not near to a low valuation level. True, at market lows in 2009 we were near the normal valuation level. Beyond 2012, ten year corporate earnings will be able to escape the poor performance in the 2000-2002 period, and so be a bit higher.
But interest rates will also likely rise, and that will give competition to increasingly risk averse Boomers. Moreover, it will raise the discount rate on stocks. If valuations fall, even as earnings rise, the perception of risk in equities as a class may rise, and the return demanded from investors may rise as well. This will feed into yet lower valuations. But this is again to suggest what might happen to stocks over the next ten years.
What I am saying is that one has to be very selective in the stocks one picks – stocks as an asset class will have low returns, likely in the 4-6% range over time. This may come from a permanently 2nd gear growth rate in prices, but history suggests that stock returns are volatile, thus returns are likely to instead go through a period of negative returns. These may be sufficiently large to reduce valuation to such a point that returns from that point forward can grow faster than economic growth for an extended period. This is not the market we face.
In short, I believe we are looking at 4-6% returns for equities going forward. This result is the combination of an expectation of lower earnings growth coupled with a fall in valuation.
This will have profound impact on the level of savings required to have the standard of living in retirement that people expect. Paradoxically, if enough people attempt to save more – we will push valuations higher in the short term, but subsequent returns yet lower later, as underlying yields could fall to Japanese levels. Pity the guy who has to select from an investment universe in which all values are sky high. In the short term, of course, returns could easily exceed this level. But they could just as likely fall.
Such low rates mean that one has to question whether one is inclined to subject oneself to the volatility of stock returns. These will be negative far more often than investors have experienced over the past 30 years. I continue to recommend solid businesses that can pay steady dividends, fortified by a low payout rate. Stocks yielding 2-4% offer current yields not materially different from the expected return on the overall market with significantly less volatility that the overall market. These stocks will also hold value better during a decline, providing the investor with the option to acquire more volatile stocks at a moment when that volatility results in low valuation. In the event of inflation, they should also have pricing power and the ability to raise yields to protect investors.
Happily, many solid dividend paying stocks, such as CL, INTC, WMT, JNJ and other solid brand-name firms are relatively inexpensive. There are also a host of smaller firms which may be attractive takeover targets, particularly in a world where investors expect strong earnings growth but organic returns aren’t in the cards. Of course, once you sell, you face the same unattractive investment universe everyone else has, but at least you have some cash.
Finally, in a world of low returns, the optionality of cash should be attractive to most investors. You are unlikely to lose big sitting out (yes, I KNOW that stocks have rallied 95% since March 2009. I wish that I had bought more in the Q1 of 2009, but we are in March 2011 now, and have to look at the situation we now face). I confess that given relatively high valuations, I believe we remain in a secular bear market, and that March 2009 lows will be back, though it may be a few years yet.
Protect your downside and adjust your expectations and your plan.
Friday, February 25, 2011
Why do investors hate MSFT ?
I cannot understand the market's valuation of Microsoft (MSFT). The market has consistently treated this stock badly since the collapse of it's insane overvaluation in the dotcom bubble.
But it has languished around the mid 20's for some time, even as the rest of the market has continued to climb. Management has continued a series of very shareholder friendly activities: ending equity derivative compensation, buying back large amounts of stock and raising the quarterly dividend, doing so again recently, from 13 to 16 cents. A substantial increase.
As a result, the stock yields an attractive 2.4%, with seemingly large amounts of upside potential.
I just ran the stock through my DCF model and had difficulty engineering a price below $30. Based on my forecasts for modest sales growth and continued solid margins (I find a price of $34 quite reasonable). In fact, using my operating assumptions, the discount rate required to reach the market's price is 14%, and that is too high for a business with a tremendous franchise, strong cash flows and a dividend.
I tried so assume that competition going forward would erode margins, and that tax policy would mean higher rates, but it is still hard to see how the stock does this badly, unless you assume no growth. MSFT should be able to lift volumes in it's most importnat segments in line with overall PC shipments, growing around 3% per year, and grow much faster in it's less mature product lines.
One cause for concern, though is the fact that R&D spending is currently less than depreciation, suggesting that the company may be underinvesting - in technology this means death (though software assets can be sweated more than hardware). Even so, I raised R&D spending above traditional rates of depreciation, assuming that to grow, the business will have to be a net acquirer of fixed assets. The $34 I derive already accounts for this.
So, what am I missing (other than an online order at my broker?)
But it has languished around the mid 20's for some time, even as the rest of the market has continued to climb. Management has continued a series of very shareholder friendly activities: ending equity derivative compensation, buying back large amounts of stock and raising the quarterly dividend, doing so again recently, from 13 to 16 cents. A substantial increase.
As a result, the stock yields an attractive 2.4%, with seemingly large amounts of upside potential.
I just ran the stock through my DCF model and had difficulty engineering a price below $30. Based on my forecasts for modest sales growth and continued solid margins (I find a price of $34 quite reasonable). In fact, using my operating assumptions, the discount rate required to reach the market's price is 14%, and that is too high for a business with a tremendous franchise, strong cash flows and a dividend.
I tried so assume that competition going forward would erode margins, and that tax policy would mean higher rates, but it is still hard to see how the stock does this badly, unless you assume no growth. MSFT should be able to lift volumes in it's most importnat segments in line with overall PC shipments, growing around 3% per year, and grow much faster in it's less mature product lines.
One cause for concern, though is the fact that R&D spending is currently less than depreciation, suggesting that the company may be underinvesting - in technology this means death (though software assets can be sweated more than hardware). Even so, I raised R&D spending above traditional rates of depreciation, assuming that to grow, the business will have to be a net acquirer of fixed assets. The $34 I derive already accounts for this.
So, what am I missing (other than an online order at my broker?)
Thursday, January 27, 2011
Three China Predictions
I just came across the following link, that suggests that many investors are now seeing an abrupt end to China's rapidly expanding economy, a view the TSI has held for years.
As a bonus link, I include the Economist website that has moved forward the date of China's ascendancy to the world's largest economy. In essence, the Economist assumes that China's nominal GDP will grow strongly, even as real GDP growth begins to decline (due to inflation running at 4%), but that since the Yuan will continue to appreciate against the dollar, high inflation will actually serve to help make China richer, faster.
I promised you 3 predictions about China, though, and here they are:
1) China will become the largest economy in the world in the 2020s
2) By 2050, it will have fallen back to third.
3) Slower economic growth will provoke a political crisis in China, and this will lead to a major recession and a fall in China's output.
My rationale:
1) China's continued growth coupled with inflation and a slow but steady increase in the value of the Yuan, will enable China to overtake the US sometime in the 2020s. I now think it unlikely, given policy preferences in both countries, for this not to happen. However....
2) China's economic "miracle" is coming to an end, and it is being challenged already by India, whose macroeconomic situation appears stronger. However, to be 3rd, means to be passed by 2 countries, and the other country will be ..... drumroll please .... the United States. Thus, I am predicting that China's growth rate will fall below that of the US after 2030.
Let us consider how this happens, to increase economic growth you have to increase either labor (hours worked) or capital (productivity). The rapid productivity gains that every "tiger" economy, be it Japan, Korea, Taiwan, or Ireland, indeed every industrializing country, experiences in early stages of industrialization inevitably comes to an end. Remember that it took Britain 100 years, the Americans 70, the Germans 50, and pretty much everyone else 30 years to convert, with higher rates of growth the later a country started. The reason for this is not leadership, or "economic system" but simple math - the later you start industrializing the cheaper any given productivity-enhancing technology is, thus you can "skip" generations of technologies (the Chinese did not start industrializing by using Arkwrights Water Frame to drive their textiles), and move productivity ahead faster.
Having caught up several generations of technology, China must now deploy more expensive technologies which require more sophistication, and China doesn't produce any of them. While they can purchase much of this (from Germany and elsewhere), it is not clear that Chinese firms have the education an educated workforce and competent corporate managers. It is not clear that an education system run by the Communist Party can create such a workforce. It has not succeeded anywere else. Services productivity, the driver of eocnomic growth for developed economies, is even harder to sustain without specific management skillsets, suggesting that the services sector in China will remain a productivity laggard, even as it becomes the largest part of the economy beyond 2030. I suspect that Chinese education will prove to be inadequate to the task, suggesting that their productivity may grow more slowly than that of the US, and more on European levels of around 1% per year, particularly after 2030.
But slower and slowing productivity growth is only half the story - the other half is labor. China's labor market has benefitted from abundant rural labor and the "demographic dividend" which occurs at early stages of low birth rates. With fewer children being born, the share of the population that is working age rises, increasing output per head, and crucially, enabling women to enter the workforce in significant numbers and to invest in becoming middle- or highly-skilled (thus increasing both hours worked and output per hour). This dividend might be considered something of a "loan" because it has a nasty consequence: eventually, low birthrates and few children leads to fewer new labor force entrants.
If the situation becomes particularly acute, as it is in Japan, Italy, much of Eastern Europe and now China, the actual labor force can shrink. So while adding workers (or making them work longer) adds to GDP, fewer workers, will subtract from it. Moreover, increasingly wealthy Chinese may decide to consume more leisure time (everyone else who gets rich does), which would mean fewer workers working fewer hours. A decline in the labor force of even 0.2% would be enough to convert the 1% productivity gain into a mere 0.8% growth rate. A more severe decline could virtually wipe out all economic growth (see Japan for a real life example of how this happens, note that huge government spending, or "investment" if you are of a lefty persuasion, has failed to change the basic math).
Even if you believe China can sustain Anglo levels of productivity growth, a declining workforce means that China will grow more slowly than the US, where labor force growth continues apace, in part do to strong net immigration. The Chinese could also seek to import labor from elsewhere, but culturally Asian econmies are not immigrant friendly.
But wait, I hear some voices say - what about the rise in the currency? Clearly the rise in the Yuan will aid China's ascension. Indeed, it is because of this that I believe China cannot help but become the largest economy in the world. If the currencies were allowed to float, China's currency might increase by 30-35% against the dollar as everyone who is currently shut out of holding Yuan piles in. Because China has a managed-peg, or allows only a bit of adjustment each year, there is lots of demand to hold Yuan and apparently little downside. If you can borrow in US dollars at next to zero percent and invest in China with at 7-10% (holding Chinese short term paper) and you "know" that China's currency is going to rise against the dollar, you essentially have a case of risk-free arbitrage in which you can borrow cheap, earn positive carry on the interest differential and experience the compounding effect of having the currency you are holding rise against the one you are borrowing. An investor's wet dream. All you need is leverage....
However, the macroeconomic rationale for holding Yuan fades as China's status as the boom economy does. Therefore, that which investors "know" turns out to be wrong, and the UNWINDING of those positions will lead to a surge in the value of the dollar. Thus, I expect the dollar to rise against the Yuan after 2030 on macro fundamentals.
Ergo, the US reclaims its lead over China. This post is too long to cover India, but suffice it to say that India has many advantages, including the fact that its economy is more open, it's currency convertible, English is widely spoken, it has focused on services and on training top management talent, and it is now looking to manufacturing to employ more of its poor, oh, and India's birthrate, while falling, remains above replacement rate, which means it will have a growing labor force over the next 4 decades. It's less rapid growth is more sustainable, and its political system better able to resist a major social crisis, which gets us to our final prediction.
3) A final factor that will impede China's growth and rise, and will contribute to a currency crisis, is the political crisis almost certain to accompany an abrupt end to Chinese growth. The Chinese have become accustomed to getting much richer each year, and have been willing to put up with quite a bit of grief from Communist party apparatchiks in order to maintain it. Rural folks who feel left out of the boom have been demonstrating against the Party in increasing numbers. The Party has been able to hold onto the critical support of coastal regions, where the money and the power lie. Once these people experience the disillusionment that inevitably comes from having their expectations disappointed, particularly those among the rapidly expanding lower middle class that sees itself on the first rung of a ladder that will carry it to the wealth of the upper class Chinese, if not in this generation than in the next, the Communist Party will have difficulty maintaining legitimacy. It is possible that the entire edifice will collapse. It is also possible that it will increasingly resort to nationalism as a justification for strong central command, which may result in China getting involved in regional wars, wars it may not win (though it may not "lose" them either). Either way, a crisis within the Communist Party, or within the political system more generally will lead to major disruption and a withdrawal of foreign investment and a fall in domestic investment as well. Lower investment means lower productivity, and indeed, output will fall for the first time since the 1970s.
I suspect that the disruption will be on a scale with that of Russia, though different, since China is building better institutions than the creaking Soviet sytem did. If the CCP tries to hold power by force, as they did in 1989, the situation could be particularly bad. Ultimately, China will come through it, but with a possible decade of political turmoil holding back productivity gains, the legitimacy of its government undermined and a major foreign crisis, such as a war with India or Taiwan, will leave its position in the world much diminished. Indeed if this crisis comes sooner (with the next leadership transition scheduled to begin in 2012), China may never make it to number 1, with the US able to hold out until the 2030s when it gets passed by India, instead.
And now the best thing about long range predictions - it will be decades before anyone knows if I'm right. But I reiterate my view that investment in China is fraught with danger.
As a bonus link, I include the Economist website that has moved forward the date of China's ascendancy to the world's largest economy. In essence, the Economist assumes that China's nominal GDP will grow strongly, even as real GDP growth begins to decline (due to inflation running at 4%), but that since the Yuan will continue to appreciate against the dollar, high inflation will actually serve to help make China richer, faster.
I promised you 3 predictions about China, though, and here they are:
1) China will become the largest economy in the world in the 2020s
2) By 2050, it will have fallen back to third.
3) Slower economic growth will provoke a political crisis in China, and this will lead to a major recession and a fall in China's output.
My rationale:
1) China's continued growth coupled with inflation and a slow but steady increase in the value of the Yuan, will enable China to overtake the US sometime in the 2020s. I now think it unlikely, given policy preferences in both countries, for this not to happen. However....
2) China's economic "miracle" is coming to an end, and it is being challenged already by India, whose macroeconomic situation appears stronger. However, to be 3rd, means to be passed by 2 countries, and the other country will be ..... drumroll please .... the United States. Thus, I am predicting that China's growth rate will fall below that of the US after 2030.
Let us consider how this happens, to increase economic growth you have to increase either labor (hours worked) or capital (productivity). The rapid productivity gains that every "tiger" economy, be it Japan, Korea, Taiwan, or Ireland, indeed every industrializing country, experiences in early stages of industrialization inevitably comes to an end. Remember that it took Britain 100 years, the Americans 70, the Germans 50, and pretty much everyone else 30 years to convert, with higher rates of growth the later a country started. The reason for this is not leadership, or "economic system" but simple math - the later you start industrializing the cheaper any given productivity-enhancing technology is, thus you can "skip" generations of technologies (the Chinese did not start industrializing by using Arkwrights Water Frame to drive their textiles), and move productivity ahead faster.
Having caught up several generations of technology, China must now deploy more expensive technologies which require more sophistication, and China doesn't produce any of them. While they can purchase much of this (from Germany and elsewhere), it is not clear that Chinese firms have the education an educated workforce and competent corporate managers. It is not clear that an education system run by the Communist Party can create such a workforce. It has not succeeded anywere else. Services productivity, the driver of eocnomic growth for developed economies, is even harder to sustain without specific management skillsets, suggesting that the services sector in China will remain a productivity laggard, even as it becomes the largest part of the economy beyond 2030. I suspect that Chinese education will prove to be inadequate to the task, suggesting that their productivity may grow more slowly than that of the US, and more on European levels of around 1% per year, particularly after 2030.
But slower and slowing productivity growth is only half the story - the other half is labor. China's labor market has benefitted from abundant rural labor and the "demographic dividend" which occurs at early stages of low birth rates. With fewer children being born, the share of the population that is working age rises, increasing output per head, and crucially, enabling women to enter the workforce in significant numbers and to invest in becoming middle- or highly-skilled (thus increasing both hours worked and output per hour). This dividend might be considered something of a "loan" because it has a nasty consequence: eventually, low birthrates and few children leads to fewer new labor force entrants.
If the situation becomes particularly acute, as it is in Japan, Italy, much of Eastern Europe and now China, the actual labor force can shrink. So while adding workers (or making them work longer) adds to GDP, fewer workers, will subtract from it. Moreover, increasingly wealthy Chinese may decide to consume more leisure time (everyone else who gets rich does), which would mean fewer workers working fewer hours. A decline in the labor force of even 0.2% would be enough to convert the 1% productivity gain into a mere 0.8% growth rate. A more severe decline could virtually wipe out all economic growth (see Japan for a real life example of how this happens, note that huge government spending, or "investment" if you are of a lefty persuasion, has failed to change the basic math).
Even if you believe China can sustain Anglo levels of productivity growth, a declining workforce means that China will grow more slowly than the US, where labor force growth continues apace, in part do to strong net immigration. The Chinese could also seek to import labor from elsewhere, but culturally Asian econmies are not immigrant friendly.
But wait, I hear some voices say - what about the rise in the currency? Clearly the rise in the Yuan will aid China's ascension. Indeed, it is because of this that I believe China cannot help but become the largest economy in the world. If the currencies were allowed to float, China's currency might increase by 30-35% against the dollar as everyone who is currently shut out of holding Yuan piles in. Because China has a managed-peg, or allows only a bit of adjustment each year, there is lots of demand to hold Yuan and apparently little downside. If you can borrow in US dollars at next to zero percent and invest in China with at 7-10% (holding Chinese short term paper) and you "know" that China's currency is going to rise against the dollar, you essentially have a case of risk-free arbitrage in which you can borrow cheap, earn positive carry on the interest differential and experience the compounding effect of having the currency you are holding rise against the one you are borrowing. An investor's wet dream. All you need is leverage....
However, the macroeconomic rationale for holding Yuan fades as China's status as the boom economy does. Therefore, that which investors "know" turns out to be wrong, and the UNWINDING of those positions will lead to a surge in the value of the dollar. Thus, I expect the dollar to rise against the Yuan after 2030 on macro fundamentals.
Ergo, the US reclaims its lead over China. This post is too long to cover India, but suffice it to say that India has many advantages, including the fact that its economy is more open, it's currency convertible, English is widely spoken, it has focused on services and on training top management talent, and it is now looking to manufacturing to employ more of its poor, oh, and India's birthrate, while falling, remains above replacement rate, which means it will have a growing labor force over the next 4 decades. It's less rapid growth is more sustainable, and its political system better able to resist a major social crisis, which gets us to our final prediction.
3) A final factor that will impede China's growth and rise, and will contribute to a currency crisis, is the political crisis almost certain to accompany an abrupt end to Chinese growth. The Chinese have become accustomed to getting much richer each year, and have been willing to put up with quite a bit of grief from Communist party apparatchiks in order to maintain it. Rural folks who feel left out of the boom have been demonstrating against the Party in increasing numbers. The Party has been able to hold onto the critical support of coastal regions, where the money and the power lie. Once these people experience the disillusionment that inevitably comes from having their expectations disappointed, particularly those among the rapidly expanding lower middle class that sees itself on the first rung of a ladder that will carry it to the wealth of the upper class Chinese, if not in this generation than in the next, the Communist Party will have difficulty maintaining legitimacy. It is possible that the entire edifice will collapse. It is also possible that it will increasingly resort to nationalism as a justification for strong central command, which may result in China getting involved in regional wars, wars it may not win (though it may not "lose" them either). Either way, a crisis within the Communist Party, or within the political system more generally will lead to major disruption and a withdrawal of foreign investment and a fall in domestic investment as well. Lower investment means lower productivity, and indeed, output will fall for the first time since the 1970s.
I suspect that the disruption will be on a scale with that of Russia, though different, since China is building better institutions than the creaking Soviet sytem did. If the CCP tries to hold power by force, as they did in 1989, the situation could be particularly bad. Ultimately, China will come through it, but with a possible decade of political turmoil holding back productivity gains, the legitimacy of its government undermined and a major foreign crisis, such as a war with India or Taiwan, will leave its position in the world much diminished. Indeed if this crisis comes sooner (with the next leadership transition scheduled to begin in 2012), China may never make it to number 1, with the US able to hold out until the 2030s when it gets passed by India, instead.
And now the best thing about long range predictions - it will be decades before anyone knows if I'm right. But I reiterate my view that investment in China is fraught with danger.
Thursday, December 30, 2010
Has the Stock Market Gotten Riskier? - Investing - Stocks - SmartMoney.com
Why are retail investors leaving equities amid strong returns and strong corporate profitability?
This is a terrific article about the reasons that the stock market should be stalling. In short, the market has become more volatile, which, in portfolio theory, means that it involves more risk and therefore require a higher risk premium.
The article suggests that valuation shouldn’t be the source of the problem, given that investors were willing to pay more in 2007 for assets that had a lower earnings yield.
Instead, it suggests that the sharp increase in the number of large movement days, up or down, that have occurred in the last 25, 15 and 10 years (2/3rds of extreme price movements since 1950 have been crammed into the last 15 years), has changed investors perspective on the “riskiness” of the market.
Portfolio theory says that assets are priced relative to each other, and that an investor begins with a “Risk-free” rate, one where the exact prices and returns are calculable with 100% knowledge, e.g. a Treasury bill. Riskier assets should require a higher risk premium to compensate the investor for taking on the additional risk.
Risk is considered to be the volatility around an expected return. If a Risk Free investment guarantees me 2% (no volatility – I will get my expected return, because the US government WILL make the payments it has promised, when it has promised them), then to hold a riskier asset, one where I could lose money (one possible return outcome is negative) I must be able to have a reasonable expectation of finishing well above 2%. How much exactly is known as the “risk premium”.
Stock prices have risen as the risk free rate has collapsed to near zero – increasing the premium offered by risk assets. (The risk premium is calculated by taking the expected return of the risk assets minus the risk free rate, E(r)[Risk Asset] – R(f) rate. If E(r) remains constant and R(f) gets smaller the spread will increase).
If the original premium is correct, then prices of the risky asset should rise reducing expected returns on the risky asset to the point where expected returns maintain the same risk premium.
However, if volatility in stock prices rises, the greater risk suggests that the equity risk premium should rise, and therefore, lowering the risk free rate will not raise equity prices as much as would be expected. In fact, if the risk free rate is perceived to be heavily manipulated, such as by extensive central bank intervention (QE2, anyone), then it may not be perceived as the true “risk free” rate.
The article suggests that retail stock investors may be catching on to this, since, in spite of the strong equity returns since March 2009, investors have yanked over $100 bn out of equity mutual funds (that has to putting hurt into someone’s management fees … wealth managers be warned). The article notes, rightly that dividend yields (which reduce the volatility of returns by adding a regular payment that is not subject to market pricing) have collapsed from 5% to 2% over the same time period (that is, since 1950).
I think the writer underestimates the significance of the lowered expectations of returns. For years, investors were fed a steady diet of the idea that 1) equity premia were too high, 2) that the stock market experienced a geometric growth average of around 10% – at least since 1926, and 3) that over the “long term”, the market goes up. Thus, what financial “professionals” were selling to retail investors was something like a turbo-charged savings account. In exchange for “temporary” losses, an investor – really a saver – could earn a high return on their savings. Wealth building 11% returns were to be expected.
Of course, it hasn’t turned out that way. Geometric returns since 1926 have fallen, as stocks have moved sideways for 10 years, earning only the dividend yield. Americans shouldn’t feel too bad – if you invested in Japanese equities anytime since the early 1980s and have held, you have experienced negative returns, money invested in 1989 is still underwater by 70%.
But here is the thing – portfolio theory says that given a specific level of volatility an appropriate risk premium can be determined. I think that the risk premium is also a factor of expected returns. 11% returns, when compounded over decades, produce very positive financial outcomes. Lower that amount, to 8% or in my opinion a more realistic 6%, and all of a sudden, dreams of big houses, vacation homes and a boat begin to look less like sure things, and purchasing equities with savings begins to look like a risky way to pay for healthcare and food in retirement – you know, the stuff our parents and grandparents purchase.
Suddenly, the stock market doesn’t look like the best place to put one’s savings. And so, the retail investor wants to put more money into lower volatility assets, to be sure to have something left with which to purchase necessities. It may require increasing the amount one saves from earnings dramatically.
The article’s author does suggest a good additional approach – create an asset of your own by starting a business. As he notes, most of the inputs are inexpensive right now, and with few attractive options to invest your money in portfolio assets, a business may be the best wealth builder yet.
Here is the link.
Has the Stock Market Gotten Riskier? - Investing - Stocks - SmartMoney.com
Friday, December 10, 2010
The US Midterm's Unwritten Story
2010 was a generational election.
Immense amounts of ink have been spilled talking about the Tea Party and the causes of the Republican victory - economic distress, Democratic legislative priorities, poor "communication" of initiatives, lack of youth voters, and the like. What you haven't heard about is a changing of the guard, generationally. This will have profound implications for politics and the economy (and macro investment factors) for the next several electoral cycles.
America has at times had major elections which have seen a change in the age of its officials. We tend to notice this more directly when presidential generations change, such as in 1960 or 1992. But Congressional elections have also been subject to generational change, and with it a change in the political tenor of the country.
The Generational Divide
Many people would argue that the boom runs until 1964, when the US Census declared an end to the (demographic) Baby Boom. But researchers Strauss and Howe have made a compelling case that the Boomer psychographic ended at 1961, and that those born after are actually part of a different generation, too young to remember the Kennedy administration or his assassination, and too young to have participated in the counterculture movements of the late 1960s (either affirmatively or in awestruck horror).
Thus, those born after 1960 are part of the famous, and maligned "Generation X". Barack Obama is part of this generation, which has different attitudes towards political warfare: less ruthless and much less committed to destruction of one's enemies. Instinctively, younger voters understood when Obama talked about "change" in politics and about a "post-partisan" climate, that he meant that he was not going to continue fighting Boomer culture wars, he was not going to try and remake the country in his own image, and he wasn't committed to the utter destruction of his opponents.
In short, he wasn't going to engage in the shrill histrionics of Rush Limbaugh or Keith Olbermann: classic Boomers. Instead, he was going to be analytical, thoughtful, reasoned and practical, all classic Xer traits. A welcome change, quite frankly. The one commentator to pick up on this was E.J. Dionne, who noted that Obama's campaign was "waging a subtle fight against a generation - my generation, the Baby Boomers".
The brilliance of the subtle campaign was that most Boomers didn't recognize it. Boomer journalists, too self-focused, and still seeing themselves as the drivers of American culture, and perhaps terrified of the implications for their own longevity, failed to cover it. Thus, many Boomers on the left voted for him, thinking that he endorsed their ends and means, and rejected the symbol of their own generation, Hillary Clinton, who both loved engaging in the politics of personal destruction and who was a classic culture warrior. In fact, much of the anti-Hillary vitriol was aimed at preventing her from becoming a symbol of the cultural change her own generation wrought.
Thus, it is no suprise that much of the frustration with Barack Obama on the Left (or as his own Press Secretary said "the Professional Left") is that he doesn't share Boomer attitudes towards political methods and means, even as he espouses fairly leftist policy. Obama's actual policies and policy priorities were a liberal wish list, and yet the Left is totally frustrated, even as Obama has delivered for them. What he seems to lack is the passionate hatred for people who disagree with him, and the Boomer Left, which controls much of the official political media, see the lack of hatred as weakness, even a betrayal of the cause.
The 2010 Election
If the 2008 election saw the Boomers lose the executive branch, 2010 saw a sharp rise in the number of nationally elected officials born after 1960, particularly in the House.
Entering the election, Boomers controlled most Governors mansions, had a narrow majority of Senate seats (though the Silent Generation held most of the committee chairs), and a solid lead in the House, with the other two generations, Silent and Xer approximately equal in size.
As the nearby chart shows, the Silent generation, which has held political power out of all proportion to its size, suffered major setbacks in Congress, losing 1/6th of its House seats and 8 Senate seats, out of 15 it was defending. Just wait as the next 2 electoral cycles see 20 more members up for reelection: I predict that they will lose more than 60% of those seats.
The Boomers fared better, losing a few governorships and actually gaining Senate seats from the Silent, but Xers made gains across the board, governorships, Senate seats, and big gains in the House, putting them well ahead of the Silent there.
Three additional facts are worth noting:
First, is that the Boomers lost share of offices. The generational research done by Strauss and Howe generational power waxes, then wanes, but once it begins waning, it does not wax again. This suggests that Boomer shares of all three institutions will likely decline in each election going forward. The 2010 election signifies that the high-water mark for Boomer power has passed.
Second, the House usually has the lowest average age of all three institutions, and is therefore the first place that a new generation gains power. While the Xers do not yet have a majority, it is reasonable to believe that they will continue to gain seats in all three areas in each of the next several electoral cycles. Much of this will come at the expense of Silent generationl lawmakers getting very long in the tooth, but as the House races show, it will also come at the expense of Boomers.
Third, while Xers will increase their share of government offices, Boomers may get one more crack at the Oval Office. Governorships are still largely in Boomer hands, which means that despite calls for Xers like Chris Christie and Bobby Jindal to run in 2012, Obama will likely face a Boomer challenger in the general election, and possibly in his primary.
Nevertheless, Generation X is now entering midlife and as the Boomer slide into dotage we will increasingly be confronted with Xer America. It has different outlooks, and different politics, and different economics. It will fall to this generation to decide how to confront America's most pressing problems, and their solutions will have big implications for all of us, not least in our investment strategies.
In future posts, we will examine the quintessential Xer political movement, the Tea Party and will also look at how probable Xer policy will affect the macro environment.
Immense amounts of ink have been spilled talking about the Tea Party and the causes of the Republican victory - economic distress, Democratic legislative priorities, poor "communication" of initiatives, lack of youth voters, and the like. What you haven't heard about is a changing of the guard, generationally. This will have profound implications for politics and the economy (and macro investment factors) for the next several electoral cycles.
America has at times had major elections which have seen a change in the age of its officials. We tend to notice this more directly when presidential generations change, such as in 1960 or 1992. But Congressional elections have also been subject to generational change, and with it a change in the political tenor of the country.
The Generational Divide
Many people would argue that the boom runs until 1964, when the US Census declared an end to the (demographic) Baby Boom. But researchers Strauss and Howe have made a compelling case that the Boomer psychographic ended at 1961, and that those born after are actually part of a different generation, too young to remember the Kennedy administration or his assassination, and too young to have participated in the counterculture movements of the late 1960s (either affirmatively or in awestruck horror).
Thus, those born after 1960 are part of the famous, and maligned "Generation X". Barack Obama is part of this generation, which has different attitudes towards political warfare: less ruthless and much less committed to destruction of one's enemies. Instinctively, younger voters understood when Obama talked about "change" in politics and about a "post-partisan" climate, that he meant that he was not going to continue fighting Boomer culture wars, he was not going to try and remake the country in his own image, and he wasn't committed to the utter destruction of his opponents.
In short, he wasn't going to engage in the shrill histrionics of Rush Limbaugh or Keith Olbermann: classic Boomers. Instead, he was going to be analytical, thoughtful, reasoned and practical, all classic Xer traits. A welcome change, quite frankly. The one commentator to pick up on this was E.J. Dionne, who noted that Obama's campaign was "waging a subtle fight against a generation - my generation, the Baby Boomers".
The brilliance of the subtle campaign was that most Boomers didn't recognize it. Boomer journalists, too self-focused, and still seeing themselves as the drivers of American culture, and perhaps terrified of the implications for their own longevity, failed to cover it. Thus, many Boomers on the left voted for him, thinking that he endorsed their ends and means, and rejected the symbol of their own generation, Hillary Clinton, who both loved engaging in the politics of personal destruction and who was a classic culture warrior. In fact, much of the anti-Hillary vitriol was aimed at preventing her from becoming a symbol of the cultural change her own generation wrought.
Thus, it is no suprise that much of the frustration with Barack Obama on the Left (or as his own Press Secretary said "the Professional Left") is that he doesn't share Boomer attitudes towards political methods and means, even as he espouses fairly leftist policy. Obama's actual policies and policy priorities were a liberal wish list, and yet the Left is totally frustrated, even as Obama has delivered for them. What he seems to lack is the passionate hatred for people who disagree with him, and the Boomer Left, which controls much of the official political media, see the lack of hatred as weakness, even a betrayal of the cause.
The 2010 Election
If the 2008 election saw the Boomers lose the executive branch, 2010 saw a sharp rise in the number of nationally elected officials born after 1960, particularly in the House.
Entering the election, Boomers controlled most Governors mansions, had a narrow majority of Senate seats (though the Silent Generation held most of the committee chairs), and a solid lead in the House, with the other two generations, Silent and Xer approximately equal in size.
As the nearby chart shows, the Silent generation, which has held political power out of all proportion to its size, suffered major setbacks in Congress, losing 1/6th of its House seats and 8 Senate seats, out of 15 it was defending. Just wait as the next 2 electoral cycles see 20 more members up for reelection: I predict that they will lose more than 60% of those seats.
The Boomers fared better, losing a few governorships and actually gaining Senate seats from the Silent, but Xers made gains across the board, governorships, Senate seats, and big gains in the House, putting them well ahead of the Silent there.
Three additional facts are worth noting:
First, is that the Boomers lost share of offices. The generational research done by Strauss and Howe generational power waxes, then wanes, but once it begins waning, it does not wax again. This suggests that Boomer shares of all three institutions will likely decline in each election going forward. The 2010 election signifies that the high-water mark for Boomer power has passed.
Second, the House usually has the lowest average age of all three institutions, and is therefore the first place that a new generation gains power. While the Xers do not yet have a majority, it is reasonable to believe that they will continue to gain seats in all three areas in each of the next several electoral cycles. Much of this will come at the expense of Silent generationl lawmakers getting very long in the tooth, but as the House races show, it will also come at the expense of Boomers.
Third, while Xers will increase their share of government offices, Boomers may get one more crack at the Oval Office. Governorships are still largely in Boomer hands, which means that despite calls for Xers like Chris Christie and Bobby Jindal to run in 2012, Obama will likely face a Boomer challenger in the general election, and possibly in his primary.
Nevertheless, Generation X is now entering midlife and as the Boomer slide into dotage we will increasingly be confronted with Xer America. It has different outlooks, and different politics, and different economics. It will fall to this generation to decide how to confront America's most pressing problems, and their solutions will have big implications for all of us, not least in our investment strategies.
In future posts, we will examine the quintessential Xer political movement, the Tea Party and will also look at how probable Xer policy will affect the macro environment.
Friday, September 03, 2010
Google Adsense
Well, I finally gave up on Google Adsense. Between PIN requirements, endless verification and the like, I just couldn't take it, and was tired of the public service announcements being run on the site.
The problem is, there is really no support. I entered my PIN ages ago, and yet my account kept saying that it required additional verification, but there was no where to input information. Contacting Google, however, is impossible. All they have a lots and lots of forums where users should do the work of providing support.
Even cancellation is difficult, I think because they want to prevent anyone from getting their cash.
So, I am trying someone else, we'll see how this works. Guess I'll need to write some more to get my traffic back up.
UPDATE: as I suspected, AdSense wouldn't let me cancel, because I don't have any record of how many impressions I had on my first day of service (in 2006!). The saga continues.
The problem is, there is really no support. I entered my PIN ages ago, and yet my account kept saying that it required additional verification, but there was no where to input information. Contacting Google, however, is impossible. All they have a lots and lots of forums where users should do the work of providing support.
Even cancellation is difficult, I think because they want to prevent anyone from getting their cash.
So, I am trying someone else, we'll see how this works. Guess I'll need to write some more to get my traffic back up.
UPDATE: as I suspected, AdSense wouldn't let me cancel, because I don't have any record of how many impressions I had on my first day of service (in 2006!). The saga continues.
Friday, December 18, 2009
How long until the job market recovers?
I highly recommend a visit to Mish's Economics blog.
It contains a very good and detailed account of just how long it might take before the US reaches the under 6% unemployment rate enjoyed in 2007 - and the results are NOT PRETTY to say the least.
Given the sheer drop in employed, and the trend in recent recessions for job losses to continue well past the end of the recession, Mish takes the long view and projects unemployment to 2020. With a set of what I believe are realistic projections, he concludes the US will not see 6% unemployment in the next decade. Period.
His report also includes a downloadable spreadsheet to play with the figures - essentially, we would have to create 150k jobs per month for the next ten years - without recession - to get the unemployment rate to 6% in 2020!
I won't repeat his analysis, suffice it to say, it is scary - and what if (as I believe likely) this turns into a double dip recession as the governments around the world find themselves with impossible fiscal situations and begin a process of cutting outlays and raising taxes - with more job losses rather than job gains?
Thanks to John Mauldin for pointing me to this.
It contains a very good and detailed account of just how long it might take before the US reaches the under 6% unemployment rate enjoyed in 2007 - and the results are NOT PRETTY to say the least.
Given the sheer drop in employed, and the trend in recent recessions for job losses to continue well past the end of the recession, Mish takes the long view and projects unemployment to 2020. With a set of what I believe are realistic projections, he concludes the US will not see 6% unemployment in the next decade. Period.
His report also includes a downloadable spreadsheet to play with the figures - essentially, we would have to create 150k jobs per month for the next ten years - without recession - to get the unemployment rate to 6% in 2020!
I won't repeat his analysis, suffice it to say, it is scary - and what if (as I believe likely) this turns into a double dip recession as the governments around the world find themselves with impossible fiscal situations and begin a process of cutting outlays and raising taxes - with more job losses rather than job gains?
Thanks to John Mauldin for pointing me to this.
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