Submitted by Lance Roberts of Street Talk Live blog,
In Part III of Lance's series of reports from the 10th annual Strategic Investment Conference, presented Altegris Investments and John Mauldin, the question of how to invest during a deleveraging cycle is addressed by A. Gary Shilling, Ph.D. Dr. Shilling is the President of A. Gary Shilling & Co., an investment manager, Forbes and Bloomberg columnist and author - Mr. Shilling's list of credentials is long and impressive. His most recent book "The Age Of Deleveraging: Investment Strategies In A Slow Growth Economy" is a must read. Here are his views on what to watch out for and how to invest in our current economic cycle.
Six Fundamental Realities
- Private Sector Deleveraging And Government Policy Responses
- Rising Protectionism
- Grand Disconnect Between Markets And Economy
- Zeal For Yield
- End Of Export Driven Economies
- Equities Are Vulnerable
Private Sector Deleveraging And Government Policy Responses
Household deleveraging is far from over. There is most likely at least 5 more years to go. However, it could be longer given the magnitude of the debt bubble. The offset of the household deleveraging has been the leveraging up of the Federal government.
The flip side of household leverage is the personal saving rates. The decline in the savings rate from the 1980’s to 2000 was a major boost to economic growth. That has now changed as savings rate are now slowly increasing and acting as a drag on growth.
However, American’s are not saving voluntarily. American’s have been trained to spend as long as credit is readily available. However, credit is no longer available. Furthermore, there is an implicit mistrust of stocks which is a huge change from the 90’s when stocks were believed to be a source of wealth creation limiting the need to save.
My forecast for GDP growth going forward is that it will remain mired around 2%.
The response to the stalled economic environment and deleveraging cycle has been massive government interventions. The Fed’s original program of zero interest rates have failed to promote borrowing. The next step was unprecedented Quantitative Easing.
The Fed’s dual mandate is full employment, currently targeted at 6.5%, and price stability (inflation) around 2%. The Fed has been very clear that the current QE programs are directly tied to these targets.
However, monetary policy is a very blunt instrument, but the Fed believes that it will work within a 5 step process.
- The Fed buys treasuries and mortgage bonds out of the market.
- The increase in liquidity is then reinvested into the equity market.
- The rise in asset prices creates a wealth effect for consumers.
- With stronger confidence consumers spend more which creates demand on businesses.
- The increase in demand leads to job creation.
The problem is that there is little evidence that Q.E. programs are fulfilling their intended role.
History is not a controlled experiment. There is no way to tell what would have really happened had the Fed not intervened after the financial crisis.
However, what we can absolutely measure, is the impact of the Fed’s activities on the economy. If we measure the increase in real GDP for each dollar of increase in debt we find that it has been close to nil. From 2001 through the end of Q2-2012 – we find that there has been only a 0.08% increase in real GDP per dollar of increase in debt.
While the economy has failed to ignite - there has been a sharp surge in market capitalization as a percentage of nominal GDP. Currently at levels well above the long term average it is unlikely that this is the beginning of the next great secular bull market.