Russ Koesterich lunch – Colorado CFA Society
Why is the outlook for growth in the US and other developed markets so dim? And where in the world can we find growth? Russ Koesterich, Chief Investment Strategist at Blackrock iShares, provided some answers to these questions at a recent CFA (Chartered Financial Analysts) Society event in Denver. BSW portfolio manager Elias Bachmann, worked with the CFA Society of Colorado and Blackrock/iShares to bring Russ to this Denver event.
The Problem The US economy is generally expected to grow at a rate of 2% or less over the next three to five years, far below the 4% historical average. In Russ’ view this “uninspiring” recovery risks reaching “stall speed”, which like a weakened immune system, leaves the body susceptible to outside threats. He sees the fiscal cliff (http://en.wikipedia.org/wiki/United_States_fiscal_cliff ) as one of the primary forces threatening the US economy because the mandatory spending cuts and tax increases that follow will hit the US economy where it hurts the most: the consumer, whose immune system has also suffered from stagnating incomes and high debt levels. This toxic combo seems more likely given the lack of progress and resolution in Washington. Unfortunately, polls point to continued political division.
The Reason To provide some context for the slow growth problem Russ offered the three “Ds”. The first “D” deleveraging, addresses the ongoing process of reducing debt levels among private companies and consumers. Paying down debt seems reasonable, except that the cash-flow used to pay down debt would otherwise fuel investment and consumption. With absolute debt levels relative to disposable income still above historical averages, this deleveraging may continue for several years. The second “D”debt, refers to the absolute level of debt. While consumers and the private sector work towards paying down their liabilities, the Federal government continues to pile on more. The increasing burden of servicing this debt eventually reduces the government’s effectiveness at converting tax receipts into value-creating civic investments. Thirdly, “d”emographics remain a problem as more citizens begin to collect retirement related entitlement payments.
Diamonds in the Rough The US is by no means alone because the developed markets of Europe and Japan also suffer from high debt loads and aging populations. Nevertheless, Russ pointed out that this condition is not a foregone conclusion for all developed economies. Canada, Switzerland, Singapore, Australia, Norway and New Zealand have avoided this problem through greater debt discipline, have better demographics, and their stock markets trade at lower valuations, making them more attractive destinations for investment capital.
Emerging Opportunities While some developed markets offer opportunity, emerging markets continue to offer the best long-term growth prospects. In fact, Russ finds emerging markets particularly attractive due to four factors. First, after long periods of outperformance, emerging market stocks suffered due to the low growth expectations in the developed world. As a result, valuations of emerging market stocks are now below their long-term averages. Second, despite their long history of high inflation, emerging markets currently experience a modest rate of inflation. Third, lower inflation has a significantly more positive effect on profitability of emerging market companies than their developed market counterparts. It should be noted they are equally more vulnerable when inflation rises. Finally, the volatility of emerging stock markets has declined relative to that of developed stock markets. Remarkably, prices have not responded to reflect this more stable environment.
Insurance Central banks such as the Federal Reserve and the European Central Bank have demonstrated their itchy trigger finger for monetary easing as a defacto response to slow economic growth. We continue to search for conclusive evidence that this policy works. We believe it will eventually spur inflation. In the face of this money creation, currency debasement and the consequent inflation BSW agrees with Russ that gold should have a strategic role in any investment portfolio.
In summary, things don’t look good for mature economies because they generally have aging populations and debt levels that risk growing faster than their economies. Politicians are often loathe to vote for measures that curtail government spending, because the disappointment it brings jeopardizes their own jobs. However, given the paralysis in our government and the potential ride over the fiscal cliff, there are opportunities to position a portfolio with both long-term growth themes and insurance against foolish monetary policy.
–Elias Bachmann, Portfolio Manager
Figure 1: BSW’s Elias Bachmann with Russ Koesterich