In his latest newsletter (November 2009), The "3-D" Hurricane Force Headwind, Robert Arnott (founder, Research Affiliates) examines how Deficit, National Debt, and Demographics, the 3 Ds, mean that we should lower our expectations for real return from markets over the next 25 years. Arnott, a fundamental indexing academic and innovator, has been warning, via his papers, that investors be modest. For example, it is interesting, given that Research Affiliates, the creators of fundamental equity indices, that its founder, Arnott, has spent most of the last year discussing bonds, and reversion to mean.
Here are a few excerpts from the latest newsletter.
In this issue we examine three critical long-horizon issues â the deficit, the national debt, and demographicsâand find a disturbing structural headwind that will impede the real returns we can expect from financial assets in the years ahead. The coming quarter century will be very, very different from the past quarter century; the lessons weâve learned in the past generation may lead us astray in the coming generation.
On the (D)eficit:
The latest year shows a deficit of 10% of GDP, but even this isnât a problem as long as itâs a oneoff deficit incurred to help avert a major financial and economic crisis. Right? Right⌠if the past average really was 2.4% and the current deficit really is temporary.
But ...
The average increase in our national debt, including unfunded obligations and GSEs, soars to 9.8% of GDP for the past 25 years. The latest 12 months saw our public debt and unfunded obligations grow by 18% of GDP! No wonder the debt seems to have grown crushingly large.
Arnott's case is compelling, and sounds quite similar to what his Newport Beach bond market peer, Bill Gross, calls the "New Normal," though Gross has not elaborated on it as specifically, as Arnott does here and in past letters. Whether you agree with this or not, its a must-read.
For more on Debt and Demographics, and to read Rob Arnott's complete newsletter, click here.
