Stability is the “new” growth
Recently, commentators in the US have been framing many economic discussions in terms of the “new,” meaning post-recession, ______ (fill in the blank). One might hear that Atlantic City, or some other local beach, is the new Riviera. Or that Hyundai is the new Cadillac, or Macy’s the new Neiman’s. Or that companies with flat year-on-year revenues are the new growth stocks.
This shifting downward in consumer behavior–and, therefore, in near-term expectations for economic performance in the US–has been neatly summarized in the catchphrase “the New Normal” being promoted by PIMCO, the California-based bond management company now a part of the German insurer Allianz.
Three posts, the first today
I’m going to address this topic in three posts. This one will be about what the New Normal is. The second will be about how world economies could develop in different directions. The third will be about implications for stocks.
What about bonds? First of all, my expertise is in stocks, so you have to take what I say about bonds with a grain of salt. Second, bonds seem to me to be extraordinarily expensive. Governments around the world have pushed interest rates down to as close to zero as possible in order to and a panic in financial markets. Rates don’t seem to me to be able to go down any farther. They can only remain the same or go up. In the latter case, bond prices will tumble. So sub-par growth around the world for as far as the eye can see is the only scenario in which bonds make sense. Perhaps by coincidence, this is the New Normal that PIMCO describes.
What the “New Normal” is
The New Normal seems to me to have four main points:
1. The long-term growth rate of the US economy is no longer the 3%+ that we have experienced over the past generation, but rather 2% or so.
This is actually not new, since the Federal Reserve has been talking about this development over the past decade. Reasons? slowing growth of the work force, caused by slowing population growth and a plateauing of female work force participation.
2. The recent years of consumer feast, based on easy credit and inflated house values, must be followed by a period of GDP famine, while consumers use their cash flow to repay excessive debt and rebuild savings rather than buy new things.
Although we may have to go back to the Eighties (i.e., pre-Greenspan) to see this kind of adjustment, this also makes sense.
Here come the controversial ones—
3. The damage done to the economy during the easy money era will take much longer to repair than the consensus expects. “New Normal” real GDP growth will be 1%-2% annually. And growth will only be that high because the economy will be on continuing government life support. Interest rates will therefore remain at current low levels indefinitely.
4. Developing countries which have been dependent on exports to the US for their own GDP expansion will be unable to adjust to the new situation. They won’t be able to develop domestic sources of growth to replace lost sales to the US. In consequence, their GDP growth rates will plummet to close to the (new, anemic) US GDP growth rate.
This would imply three things:
You won’t be able to avoid the mess in the US by looking abroad.
You also won’t be able to find companies in the US with large foreign exposure which will be able to weather the domestic storm with profits intact.
The US won’t be rescued by demand from Brazil, China, India, Russia or the Middle East. Their growth stories will just melt away.
PIMCO on stocks as an alternative to bonds
Bill Gross, one of the founders of PIMCO, has given the firm’s views on stocks in a recent Bloomberg interview. In it, he seems to argue that:
1. nominal GDP growth in the US will be around 3% annually for a long time
2. the earnings of publicly-listed stocks are linked to domestic GDP
3. therefore, stocks will have annual returns of about 5%.
What did he say??
This argument makes no sense. The second point is incorrect. The third, if it does indeed follow from the second, is at best not particularly relevant, and is potentially misleading. (To be fair to Mr. Gross, I didn’t hear the interview reported by Bloomberg and have contacted Bloomberg, without success, to try to see precisely what Mr. Gross said. In his monthly PIMCO commentaries, however, it does seem to me that he believes about stocks something like what I’ve just outlined.)
More on the New Normal in my next posts.