Neel Kashkari was hired in 2009 by the well-known bond manager PIMCO to build its equity business. Prior to joining PIMCO he was with the US Treasury, and was a high profile member of Henry Paulson's crisis management team during the initial period of the 2008 financial crisis. Neel writes a monthly piece with a focus on equity and global financial markets, and I thought his recent piece was particularly insightful. To summarise:
-Western medicine can sometimes be too focussed on treating symptoms to make the patient feel better while Eastern medicine is more focussed on balanced and healthy living and thereby preventing disease.
-In a similar vein, policy makers in the US as well have focussed on reducing the symptoms rather than cure the underlying disease which is caused by a 30-year addiction to debt-fuelled consumption, which can only be cured by developing a growth strategy.
-Instead, US policy in the last three years has bought time by supporting consumer spending which is the largest component of US economic activity (over 70% of GDP from 62% in the 1960s).
-As a result of such government policies (which include the stimulus, payroll tax holidays, low interest rates and quantitative easing) , consumption has bounced back to pre-crisis levels suggesting that government policies have been effective. But is this another case of treating the symptoms rather than curing the disease?
-Another case in point is the recent liquidity operation (LTRO) by the ECB, to inject cheap three year money into European Banks. While this does provide stability in the short term, it does not cure the underlying illness which is too much debt taken on by their societies to fund excessive spending, which cannot be supported by the low growth of their economies.
-As per a recent McKinsey Global Institute report, the US is far ahead of other countries in terms of deleveraging, with the US consumer now having less debt than in 2008. They estimate that US households face roughly two more years of deleveraging to bring debt to disposable income levels back to the historical trend, thereby allowing the economy to resume its normal growth trajectory.
-However, the historical trend implies debt to income levels of "only" 100%, rising from 55% in 1955. Is this a sustainable trend and good for the US economy in the longer run?
-To delve deeper into this issue, one has to look at the savings rate in the US, which has declined from 8% in the mid-80s to almost zero before the crisis of 2008. After the shock of 2008, the savings rate climbed to 6%, but alarmingly has slipped back again to below 4% in recent quarters fuelling the recent rise in consumption.
-This fall in savings is taking place against a back-drop of high unemployment, implying that millions of people do not have any income and are therefore not included in the savings rate calculation.
-It is only when overall consumption dollars climb, while unemployment falls, savings remain high and consumption as a % of GDP remains flat (or falls) can we be sure that the US economy is finally on a path of sustainable growth. Consumption fuelled by stimulative government policies is like a nasal decongestant, it only masks the symptoms of the underlying "cold" (debt).
-The implications for equity investors is to concentrate on high quality global companies which sell into higher growth markets. Be cautious on consumer discretionary stocks (i.e. autos) which assume a return to trend line growth once the crisis has passed.
An interesting insight and does warrant caution about the longer-term sustainability of an economic recovery and market upside in the developed world. The problem of lack of growth in the developed world is deep rooted, without easy solutions and the lack of political will required to address the issue. This makes the case to invest in the future "global growth generators" countries as discussed in last week's newsletter all the more compelling!
As I have mentioned previously on numerous occasions, a core equity portfolio weighting in China and India would be an appropriate strategy for the long term. In terms of timing, the two recent Reserve Ratio Requirement (RRR) cuts by the PBOC imply a significant injection of liquidity which typically presages an uptrend in the Chinese stock market (as the graph below illustrates).
Sources: CFLP; Li & Fung; BIS; Plexus Holdings.
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-Western medicine can sometimes be too focussed on treating symptoms to make the patient feel better while Eastern medicine is more focussed on balanced and healthy living and thereby preventing disease.
-In a similar vein, policy makers in the US as well have focussed on reducing the symptoms rather than cure the underlying disease which is caused by a 30-year addiction to debt-fuelled consumption, which can only be cured by developing a growth strategy.
-Instead, US policy in the last three years has bought time by supporting consumer spending which is the largest component of US economic activity (over 70% of GDP from 62% in the 1960s).
-As a result of such government policies (which include the stimulus, payroll tax holidays, low interest rates and quantitative easing) , consumption has bounced back to pre-crisis levels suggesting that government policies have been effective. But is this another case of treating the symptoms rather than curing the disease?
-Another case in point is the recent liquidity operation (LTRO) by the ECB, to inject cheap three year money into European Banks. While this does provide stability in the short term, it does not cure the underlying illness which is too much debt taken on by their societies to fund excessive spending, which cannot be supported by the low growth of their economies.
-As per a recent McKinsey Global Institute report, the US is far ahead of other countries in terms of deleveraging, with the US consumer now having less debt than in 2008. They estimate that US households face roughly two more years of deleveraging to bring debt to disposable income levels back to the historical trend, thereby allowing the economy to resume its normal growth trajectory.
-However, the historical trend implies debt to income levels of "only" 100%, rising from 55% in 1955. Is this a sustainable trend and good for the US economy in the longer run?
-To delve deeper into this issue, one has to look at the savings rate in the US, which has declined from 8% in the mid-80s to almost zero before the crisis of 2008. After the shock of 2008, the savings rate climbed to 6%, but alarmingly has slipped back again to below 4% in recent quarters fuelling the recent rise in consumption.
-This fall in savings is taking place against a back-drop of high unemployment, implying that millions of people do not have any income and are therefore not included in the savings rate calculation.
-It is only when overall consumption dollars climb, while unemployment falls, savings remain high and consumption as a % of GDP remains flat (or falls) can we be sure that the US economy is finally on a path of sustainable growth. Consumption fuelled by stimulative government policies is like a nasal decongestant, it only masks the symptoms of the underlying "cold" (debt).
-The implications for equity investors is to concentrate on high quality global companies which sell into higher growth markets. Be cautious on consumer discretionary stocks (i.e. autos) which assume a return to trend line growth once the crisis has passed.
An interesting insight and does warrant caution about the longer-term sustainability of an economic recovery and market upside in the developed world. The problem of lack of growth in the developed world is deep rooted, without easy solutions and the lack of political will required to address the issue. This makes the case to invest in the future "global growth generators" countries as discussed in last week's newsletter all the more compelling!
As I have mentioned previously on numerous occasions, a core equity portfolio weighting in China and India would be an appropriate strategy for the long term. In terms of timing, the two recent Reserve Ratio Requirement (RRR) cuts by the PBOC imply a significant injection of liquidity which typically presages an uptrend in the Chinese stock market (as the graph below illustrates).
Sources: CFLP; Li & Fung; BIS; Plexus Holdings.
1 of 1 File(s)
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