I stole this leadline from the FT blog of Gavyn Davies, hedge fund manager, former head of the BBC and, before that, a Goldman economist. Davies, in turn, lifted it from economist John Normand of JP Morgan.
Great Moderation 1.0
“Great Moderation” is what people began calling the period from 1984 (the recovery year after the two major oil crises of the 1970s) through 2008 (when the world financial system almost melted down). The idea was very highly conceptual and self-congratulatory–one of those end-of-history, we’ve-reached-Nirvana sort of things. Modern economics, it was asserted, had finally reached the point where it could control the business cycle. Never again would developed economies overheat badly; never again would they experience deep recessions.
Obviously, this was wrong, as events of 2008-2010 proved.
In hindsight, the manual labor-intensive parts of Western economies were suffering severe structural damage as China emerged as a global economic power. “Moderation” was being achieved only through an inappropriately loose money policy implemented by Alan Greenspan, and Mr. Greenspan’s failure to carry out his responsibility to supervise mortgage lending in the US. For their part, the US banks, freed by Congress from the shackles of Glass-Steagall in 1989, were engaging in widespread, highly lucrative, mortgage fraud. That enabled wild overbuilding of the domestic housing stock–employing all those displaced manual workers.
Then the music stopped.
Great Moderation 2.0
GM 2.0 is a different sort of animal, though. The idea this time is that developed economies are barely out of intensive care, so they can’t get much sicker. And, for the same reason, the energy necessary for wild partying just isn’t there.
The upshot of all this is that the world is in for a protracted period of slow but steady growth, with low inflation and without any sharp lurches downward.
The implications for equity markets are relatively favorable, I think.
The stock market in a slow-growth world would likely have two characteristics:
–mature companies in this sort of environment will grow mainly by taking market share away from others in its industry. Me-too firms, whose chief virtue has been the ability to rise with the tide, will likely struggle, while innovators prosper.
–rapid growth will be hard to come by. Firms in new areas or with genuinely novel products will be scarce and should therefore be highly prized. Maybe not to the loony tunes level that many had soared until recently. But, if correct, GM 2.0 is a strong argument for beginning to sort through the rubble sooner rather than later.