The Global "Old Nor­mal"

by Michael Nairne, Tacita Cap­i­tal

Investors can be excused for their pre­oc­cu­pa­tion with short-term Invest­ment results. Amidst a cas­cade of dis­mal eco­nomic news, the trauma of a pre­cip­i­tous fall instock price­sand the over­hang of a decade-long drought in equity returns,the idea of "tak­ing a long-term view", to many, seems hope­lessly pollyanna-ish. Yet, long-term plan­ning has never been more essen­tial. Aging "Baby Boomers"today are grap­pling with retire­ment fund­ing chal­lenges that span mul­ti­ple decades at a junc­ture where inter­est rates are atdis­mally low lev­els not seen since World War II.

For­tu­nately, just as the exces­sive opti­mism of the tech boom was so mis­guided at the turn of the mil­len­nium, the exces­sive pes­simism of today's "new nor­mal" may be sim­i­larly mis­placed. Accord­ing to a com­pre­hen­sive report by Citi Invest­ment Research and Analy­sis (CIRA), global GDP growth over the next sev­eral decades is likely to enjoy a pace not seen since the post WWII recon­struc­tion and growth boom of the 1950's and 1960's. This faster growth is illus­trated in the fol­low­ing graph which com­pares the annual aver­age world real GDP growth for the decades since 1950 with CIRA's fore­casts for the com­ing four decades.

The 4.6% and 4.7% annual real GDP pro­jec­tions for­this and the next decade, respec­tively, harken back to the 4.7% and 5.0% growth rates after WWII.

Cap­i­tal invest­ment, tech­no­log­i­cal imi­ta­tion, insti­tu­tional devel­op­ment, human cap­i­tal avail­abil­ity and indus­tri­al­iza­tion were the key fac­tors in the post WWII boom. Notwith­stand­ing the strong real annual GDP growth rate of 3.9% in the US from 1950 to 1973, it was the 9.3% and 5.5% respec­tive annual growth rates of Japan and the Euro­pean Union-15 that really lifted world GDP growth.

These same fun­da­men­tal dri­vers of growth are at work again in the emerg­ing economies and this is expected to repli­catethe brisk global growth achieved after WWII. In par­tic­u­lar, CIRA fore­casts that devel­op­ing Asia will con­tinue its ascent in the world econ­omy. Devel­op­ing Asia grew from 14% of real world GDP in 1990 to 27% in 2010 – a nearly dou­bling of its share of global GDP — and is fore­cast to reach 44% of real world GDP by 2030.

The CIRA is not alone in pro­ject­ing more robust long-term global growth. The Con­fer­ence Board Global Eco­nomic Out­look 2011 has fore­cast a 4.4% real annual growth in world GDP over the next decade while Gold­man Sachs has pro­jected a 4.1% real annual growth rate over the next twenty years. In gen­eral, the devel­oped nations are fore­cast to expand at a tepid pace while emerg­ing mar­kets grow robustly. As emerg­ing economies become a big­ger share of the world econ­omy, their faster growth accel­er­ates total world GDP growth.

Long-term GDP growth is ulti­mately a key deter­mi­nant inthe growth in cor­po­rate earn­ings which, in turn, drive stock price appre­ci­a­tion and div­i­dend increases (See our Com­men­tary – The Real Deal – at http://www.tacitacapital.com/?q=node/29.) For exam­ple, dur­ing the period 1991 to 2010 when the world real GDP grew by a more mod­er­ate 3.2% per annum, the real price appre­ci­a­tion of the MSCI All Coun­try World Indexwas­sim­i­lar at 2.9% per annum. Hence, an increased real annual growth rate for the global econ­o­myof 1.0% to 1.5% per annum in com­ing decades would, all other things being equal, enhance real cap­i­tal appre­ci­a­tion by an equiv­a­lent amount.

Eco­nomic growth is only one part of the return equa­tion. One of the last­ing lessons of the tech boom is that stock returns are highly depen­dent onthe val­u­a­tion at the point of entry. For­tu­nately, accord­ing to a recent report by McK­in­sey Global Insti­tute global stock val­u­a­tions have fallen over the past decade to a level not seen since 1990. This is illus­trated in the fol­low­ing graph which com­pares market-to-book value ratios for global stocks for selected years from 1990 to 2010.

Val­u­a­tions sky­rock­eted in the 1990's as the "new era" par­a­digm and tech bub­ble pro­pelled prices to manic lev­els. By 2000, investors were pre­pared to pay $2.90 for every $1.00 of book equity of global stocks. Due the tech bust and the crunch of the global credit cri­sis, val­u­a­tions have since been in con­stant decline. They have now returned to the fairly priced lev­els of 1990 – not cheap, but not expen­sive either.

Rea­son­able stock val­u­a­tions and­faster world eco­nomic growth offer the poten­tial for higher real returns from global equi­ties. Based on assump­tion­sthat reflect brisk global growth (see Appen­dix I), we have fore­cast a long-term, expected real total return from global stocks of 6.3% per annum — only mod­estly below the 6.6% annual real return of U.S. stocks since 1926. Impor­tantly, this expected return reflects an equity port­fo­lio that is invested glob­ally includ­ing emerg­ing mar­ket stocks.

With the cur­rent fix­a­tion on the gloomy "new nor­mal" in the US and Europe, many investors are over­look­ingthe full global pic­ture. The dri­vers that pro­pelled post WWII growth to vig­or­ous lev­els have emerged again. Cer­tainly, the world econ­omy will be sub­ject to the nor­mal dynam­ics of the busi­ness cycle,swinging between peri­ods of con­trac­tion and expan­sion. Over the longer-term, how­ever, these force­scre­ate the poten­tialof a global "old nor­mal" of resur­gent growth and for patient investors, the prospect of higher real­re­turns from stocks glob­ally than has existed for sev­eral decades.

Sep­tem­ber 30, 2011

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Tacita Cap­i­tal Inc. ("Tacita") is a pri­vate, inde­pen­dent fam­ily office and invest­ment coun­selling firm that spe­cial­izes in pro­vid­ing inte­grated wealth advi­sory and port­fo­lio man­age­ment ser­vices to fam­i­lies of afflu­ence. We under­stand the chal­lenges of afflu­ence and apply the lead­ing research and best prac­tices of top finan­cial aca­d­e­mics and indus­try prac­ti­tion­ers in assist­ing our clients reach their goals.

Tacita research has been pre­pared with­out regard to the indi­vid­ual finan­cial cir­cum­stances and objec­tives of per­sons who receive it and is not intended to replace indi­vid­u­ally tai­lored invest­ment advice. The asset classes/securities/instruments/strategies dis­cussed may not be suit­able for all investors and cer­tain investors may not be eli­gi­ble to pur­chase or par­tic­i­pate in some or all of them. The appro­pri­ate­ness of a par­tic­u­lar invest­ment or strat­egy will depend on an investor's indi­vid­ual cir­cum­stances and objec­tives. Tacita rec­om­mends that investors inde­pen­dently eval­u­ate par­tic­u­lar invest­ments and strate­gies, and encour­ages investors to seek the advice of a finan­cial advi­sor.

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Michael is responsible for executive management of the firm and is the Chief Investment Officer. Prior to co-founding Tacita Capital, Michael was the Chief Operating Officer of Loring Ward Inc., a family office located in New York and Los Angeles. Michael was also a co-founder and Vice Chairman of Assante Corporation, Loring Ward’s former parent company, prior to its sale in 2003. During his tenure, Assante grew from $1 billion to over $20 billion in assets under administration. Michael has written and spoken extensively on wealth management matters, and has co-authored a best seller on fund management. For several years, he chaired the Investment Committee of LWI Financial Inc. which currently manages over $4 billion in assets. Read more from the author/contributor here.

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