Bain’s “A World Awash in Money” (II)

Let’s assume that Bain is correct that the world will be awash in capital over the next decade or so, and that this money will be coming both from investors in the developed world and–increasingly–from the emerging world as well.

I draw two conclusions from this (keeping in mind that Bain may, or may not, be correct):

1.  Interest rates won’t rise as much as the Wall Street consensus expects.  The Fed is saying that the normal rate for overnight loans in the US is 4%+.  This implies that 10-year Treasuries should yield at least 5%, probably more.  If Bain is correct, these figures are much too high  …and, therefore, the rise in bond yields following Fed hints that monetary tightening is on the horizon may have already achieved as much as half the total rise that tightening will bring.

2.  Consider the factors of production:

–capital

–labor

–land/materials/resources and

–knowledge (technology, entrepreneurship, craft skill).

Which of these will be in short supply relative to the others?   I.e., which will be the most valuable?

If Bain is correct, it won’t be capital.

The natural resources boom of the past decade has resulted in mining companies making massive investment in new capacity.  Shale oil and gas are beginning to provide new low-cost sources of energy.  So the shortage factor is probably not land etc.

There’s still massive amounts of unskilled labor in emerging economies.  There’s also significant unutilized labor in the US and EU.  So labor isn’t the key factor.

That leaves knowledge, either as technology, craft skill or entrepreneurship as the factor of production in short supply.

 

For investors, the main takeaways are that:

–the current monetary tightening cycle may not be as negative for bonds or stocks as the consensus fears

–like the Internet, ready availability of capital undermines the defensive position of large companies with significant manufacturing capabilities and established brand names.  Think:  Hewlett-Packard, Dell, Barnes and Noble, J C Penney.

There’s a second point to this list, as well.  In all of these cases, finding leaders with the right knowledge base to put the firms’ substantial assets to work has proved to be very difficult.  It may be that in an environment where capital is easy to come by, talented entrepreneurs have much better alternatives than masterminding turnarounds for financial buyers.  If so, the value investor tactic of buying shares in asset-rich companies and waiting for something good to happen may not retain its traditional allure.  So-called value traps will outnumber successful turnarounds by a lot.

A world awash in money?: the Bain view

The other day I was reading a column in the Financial Times that referred to a study by the consulting company Bain.  Published late last year (I missed it then), it’s called A World Awash in Money.

Its basic premise is that the present condition of a “superabundance” of investment capital looking for a place to go to work is a permanent feature of the financial landscape.  Therefore, asset prices will remain higher than the consensus expects; interest rates will remain lower.

Three factors are involved:

–financial innovation, high-speed computing and increased use of leverage have allowed the pool of investment capital in the advanced economies to expand at a very rapid rate over the past couple of decades

–during the same time, GDP in the US and EU has been growing slowly, providing fewer new investment opportunities, and

–emerging economies like China will soon turn from being capital users to capital exporters, significantly increasing the amount of global capital searching for high-return projects to invest in.

In Bain’s view, this situation will have a number of important consequences:

1.  interest rates will remain (much) lower than the consensus expects

2.  in a capital-glutted world, bubbles like those in 1999-2000 and 2006-2007 have a high chance of recurring.  Therefore, investors must be ready to anticipate them and take defensive action

3.  investors will be forced to consider projects with extremely long duration (think: 20 or 30 years) to achieve superior returns

4.  the risks of investing in the developing world, where capital will be needed the most, will become more palatable to return-starved global investors

5.  achieving substantial real returns will require that both portfolio investors and company treasurers abandon their buy-and-hold, long-only mindset and become more like hedge funds.

 

I always find studies like this one interesting.  It’s not necessarily because they turn out to be correct.  It’s that they force you to think about the “big picture” and form an opinion on important investment issues.  In this case, it’s what happens if interest rates stay low.

I also find studies that argue, in effect, that the current state of the economic/financial world will persist for a long time to be particularly worrying.  In my experience, most times they come just before some dramatic and unanticipated change.

My take on the Bain study tomorrow.