The Good, The Not So Bad, And The Ugly

The global economic landscape has made some shifts of late that make for interesting future trajectories. It is not just economic change that weighs on financial outcomes, but also social, cultural, and demographic factors as well. We find these dynamics to be fascinating as we
believe them to be catalysts for the direction future challenges and prosperity take. We feel the bottom line question for the US is, How do we take advantage of a sea change that involves new players and the diminishing impact our economy has on the global financial markets and the profitability of our portfolios?

The last decade appears to have pushed the American consumer to the max? The leveraging of their real estate and credit cards have left many operating on fumes. We have been in this business for nearly three decades and the mantra of never underestimate the American consumer has certainly proven out. The possibility that this past decade has seen the peak of our prowess is real. Who is going to replace this group and what economic/business forces will drive them? The entities that many feel will provide the new economic leadership appear to be undergoing some fundamental shifts, and we feel it is important to understand this with the intent of how it might effect returns from around the world. Here is a description of the three groups that Investment Strategist Rod Smyth calls the “The Good, The Not So Bad, and the Ugly.”

The Emerging Economies

We imagine you are familiar with this fast growing sector of the world led by the China (and other Asian Tigers such as South Korea, Hong Kong, Taiwan and Singapore) India, and South America. China has no doubt been the leader when it comes to low cost manufacturing and their strategy to keep the Yuan low in comparison to other currencies has enhanced their export prowess. India has been regarded the exporter of services as your experience with any call center will attest to. A few years ago there was a return to the US for these services as quality became an issue, but the recent economic downturn has driven much of these operations back abroad. (A quick interesting sidebar, a client of mine has recently engaged prison inmates for call center operations to handle the cost/cultural/dialect issues). South America is known for its commodity oriented exports due to the richness of their natural resources.

What is beginning to unfold in these regions is the spreading of wealth and a growing middle class that all these exports have inspired. As these countries' middle class grows the economic energy turns inward. The impoverished that were looking first and foremost to put food on the table are now purchasing cars, cell phones, computers, and play stations. The ability to look to their population as an economic force is a game changer for these countries and affords an opportunity for economic growth similar to what the US experienced in the fifties and sixties. This growing consumerism changes not only the economic mix within the countries that contain these “wannabe baby boomers”, but the opportunities of the developed countries as well. The desire for a more sophisticated lifestyle leads directly to the technological prowess which developed countries, especially the US, have to offer. Without a doubt the biggest beneficiaries are the developing countries themselves and the impetus to become proficient in these languages has never been stronger.

The Not So Bad

Mr. Smyth believes US corporations (he includes Canada, Sweden, Australia, and Sweden in this group) have been early adopters in emerging market challenges and opportunities and should benefit from the shift described above. Many economists believe the current recession could last several years. There could be pockets of growth, but a full blown recovery leading to the next Secular Bull Market in domestic stocks could be five to ten years away. The decisions of our policymakers over the next several years will be crucial to how long it takes to reach full recovery. The last several years have been poor at best and if the unwillingness to be accountable and constant finger pointing do not stop it could take till the next decade. I believe a key component of staying above water and eventually recovering fully is taking advantage of the growing middle classes in the emerging countries. The significant amounts of cash on corporate balance sheets could be used to take advantage of that dynamic.

The Ugly

According to Smyth “Europe and Japan have been reluctant to restructure their economies, so after years of complacency they now have to make wrenching changes that are likely to keep them near, or even put them back in, recession over the next year. Furthermore, there is no guarantee that restructuring efforts will be enough to overcome entrenched interests, political sclerosis, cultural biases and relentless demographics, as Japan has amply demonstrated over the past two decades. However, to the extent that Europe and Japan are able to restructure, valuations are currently attractive and may present selective investment opportunities. Notably, Germany appears to be making the necessary adjustments to remain competitive in a Tripolar World. We are also watching for signs of structural change from Japan’s political and corporate establishment, if only because China’s rise can no longer be ignored or dismissed.”

As you are probably aware Japan has been in a Secular Bear Market since 1990. The chart here shows that the Nikkei peaked on January 1st 1990 at just under 39,000 only to fall to 14,300 in two and a half years.


What is most disconcerting that despite keeping interest rates extraordinarily low for the last twenty years their economy has not been able to create enough momentum to start a new Secular Bull Market. As you can see from the parallel line this major global index is at the same level it was in 1985. That is a long time for no progress!

Some think that the US could experience a similar malaise. I believe the chances of the US market entering into a period of that magnitude without progress is somewhat slim, as we have a more diverse economy and demographic base. Some of the countries in Europe might be another story as many of their economic/business strategies have been unproductive and several austerity programs are just getting under way. Hopefully our policymakers are watching and they understand how the lack of fiscal leadership has put these countries in this awkward position.

We hope this provides some enlightenment about the world’s economic players and their current standing. Understanding how these different economic factors, among others, impact the financial markets fascinates us. It is like a mystery novel that never ends.

Did You Know

Midterm elections will be held in the USA on 11/02/10 or just over 3 months from today. In midterm election years since 1950, the S&P 500 has averaged a gain of +8.0% (total return). The last time midterm elections were held with a Democrat in the White House was 1998 (Bill Clinton was president). The S&P 500 gained +28.6% in 1998. On a related note, in the 50 years ending 6/30/10, the split between “up” and “down” trading days on the S&P 500 is 53% “up” and 47% “down” (i.e., the change of the raw index at the close of consecutive trading days). When the index was “up” for the day, the average daily gain was +0.67%. When the index was “down” for the day, the average daily loss was 0.70%. Even though the average daily loss is greater than the average daily gain (in absolute terms), the overall average daily change for the index during the last 50 years was a gain of +0.023% since there were more “up” days than “down” days (source: BTN Research).

Final Thought

Go to Heaven for the climate, Hell for the company” - Mark Twain