October 13, 2010
Been down so long . . .
A glum consensus about the economic future has enveloped our collective minds like fog descending on the coast at sunset. It is now almost universally agreed that economies in the United States along with Europe and Japan are likely to grow at only about two percent a year or less for the next five to ten years or longer. Readers of our recent commentaries know that we are part of this collective mindset. The odd thing is that most who subscribe to this dim view of the future fail to realize that it is mainly a repeat of the past. For the last ten years the U.S., Europe and Japan have all grown at an average rate of no more than two percent a year and in the case of Europe and Japan this was true for another decade or more before that. Indeed, in the United States where the purchasing power of the median family’s income has barely increased since 1973, a majority have experienced no economic improvement for the last 37 years.
Although the U.S. has grown faster than two percent since 1973, often at a much faster pace, most people have fallen behind because the top 1% have increased their incomes from about 9% of all incomes to above 20%, and the rest of the top fifth have also fared well. In effect, the top two deciles of income earners in the U.S. have increased their share of the pie by about the same amount as the pie has grown, leaving everybody else not much better off than their counterparts thirty-five or forty years ago. Once we take account of reduced and eliminated pensions, increased taxes for the poor; dramatically higher fees for public colleges and universities, decreased access to health care for many Americans, the diminished levels of educational achievement both absolute and relative to other countries, and the record high percentage of Americans who are in prison both in our history and compared with every other country in the world, it is apparent that most Americans are materially worse off than were their parents and in many cases their grandparents.
So the new consensus forecast is a belated recognition of the long standing reality. As was true in the Great Depression, our recent financial crisis and its glum sequel have been lightning rods for the feelings of disappointment, frustration and intense anger that have been building for a long time. For the most part this anger has been mobilized and focused by the political right, much as in the 1930’s. Perhaps this is because left of center governments, which were widely in power at the beginning of the crisis, are perceived as complicit in the bailing out of the bankers and corporations responsible for the mess, while giving short shrift to its multitudes of poor and middle class victims. And, more to the point, it is because those governments were indeed and have continued to be much more sympathetic to the interests of the wealthy and powerful than to anyone else.
Along with rising anger, international cooperation continues to decline. Most countries are now trying to increase their economic growth and reduce their unemployment by exporting more to and importing less from other countries, just like the “beggar thy neighbor” policies of the 1930’s. Countries try to do this by imposing tariffs or import restrictions on goods from elsewhere and by encouraging a fall in the value of their own currencies so that their exports will be cheaper for foreign buyers and their imports will be more expensive for domestic buyers. Currency depreciation is generally an ineffective remedy because differences in income, costs and quality tend to swamp all but the largest changes in currency exchange rates.
Moreover, once one country succeeds in bringing down its exchange rate by lowering interest rates or promising to print more money to buy its own bonds or intervening in foreign exchange markets, it is easy enough for other countries to do the same, as Japan did recently with an intervention to punish traders less than a week after the United States brought the dollar down with promises of low interest rates and more money printing to buy bonds. In the end, it is simply impossible for every nation to lower its exchange rate versus every other nation, just as it is impossible for all countries to grow by exporting more to every other country while importing less.
The contributions of currency and tariff “wars” to the global Great Depression have surely been exaggerated in history and economic textbooks as well as the editorial pages of the Wall Street Journal. It is undeniably true that when each nation went “off” the gold standard – the mother of all devaluations as it were – there was a large and rapid improvement in its economy. And it is undoubtedly true that Quantitative Easing, a new euphemism for printing money to buy bonds, and near zero interest rates for a prolonged time, are each pain-relief medicine for bruised economies in addition to the benefits that might come from a decline in a country’s currency. As a result it is usually difficult to say whether a country is pursuing an appropriate domestic policy or a pugnacious international policy.
The more sinister aspect of the 1930’s was the spread of nationalism, xenophobia, persecution of immigrants, autocracy, militarism and ultimately a global conflagration of real wars that became World War II. All of this is painfully apparent in the world today: France expels the Roma in violation of the Declaration of Human Rights and the Charter of the European Union. Anti-immigrant parties have won recent victories in Australia, Austria, the Netherlands, France, and many other countries. The United States continues to build a wall on its Mexican border, reinforced by posses of vigilantes organized by local sheriffs. Violence against ethnic minorities, immigrant or otherwise, is on the rise in China, South Africa, Egypt, most of the countries on the periphery of the former Soviet Union and in many other places.
In such a world military spending and weapons exports have the dual appeal of serving the national interest against the perceived enmity of a hostile world and of creating more jobs and economic activity. Here again examples abound from the United States to China and many countries in between. So while it is easy to dismiss the talk of currency wars and trade wars as political theater, it is equally easy to imagine a growing plague of the politics of hatred and insecurity leading to more repressive domestic regimes and more global warfare, however disguised it may be as defense against aggression, peacekeeping, upholding international law, the war on terrorism, or the war on drugs.
There is an understandable but incorrect tendency to assume that so much bad news for the health and well-being of human society must be bad news for the stock market and other investment areas. We have said before and say again that high unemployment, high inequality, low economic growth, low inflation and low interest rates are all logically and historically good for stock markets and for government and other relatively secure bond markets. The history of previous great financial crises and their aftermaths shows stocks recovering early and smartly as they did last year. The same history shows stocks and bonds earning decent returns, especially after adjusting for the small effects of inflation, during many years of slow growth and high unemployment following a crisis.
With interest rates near zero on cash and less than 3% on most safe bonds, numerous stocks with current dividend yields of 3% to over 6% are clearly attractive, especially if they have plentiful cash but limited investment opportunities. The cash can be used to increase dividend payouts or to repurchase outstanding shares. Repurchasing shares makes the remaining shares more valuable because they own a larger fraction of the company and can receive a larger dividend. So, in many cases, even if a company is not growing faster than 2% or not growing at all, it can still maintain a dividend that is currently higher than most bonds and it can grow that dividend by repurchasing shares.
All or some of these positive characteristics apply to most of the U.S. and developed world stock markets. As a result we think that stock markets in these regions could provide returns of 5% to 6% a year over the next four to eight years. We expect to do somewhat better than these stock markets with less risk by focusing on stocks with high dividend yields and an ability to buy back their own stock. Also in the developed world we favor companies that are low cost producers and suppliers in sectors like information technology and discount retailing. Globally we also favor companies exposed to the still rapid growth of consumption in emerging markets and to the still rising demand for food and industrial materials, again mostly from the emerging economies.
At present we favor some bond holdings even in “all equity” portfolios as insurance against renewed economic decline or price deflation, each of which we consider possible but with small probabilities. The bulk of our equities are still in the United States. In the rest of the world we are more favorable to Europe and Emerging Markets and have moved to a less than average exposure to Japan.
Zevin Asset Management, LLC is a global top-down investment management firm whose philosophy is rooted in the idea of avoiding major losses rather than seeking big gains. Our disciplined approach removes the emotion from investing by indentifying attractive regions and sectors from around the world while experienced analysts concentrate on stock selection. For both social and investment reasons, we focus our stock selection on well-managed companies with sustainable business practices.