My concern rests on a number of considerations. First, even though financial repair had largely taken place four years ago, recovery has only kept up with population growth and normal productivity growth in the US, and has been worse elsewhere in the industrial world. Second, manifestly unsustainable bubbles and loosening of credit standards during the middle of the past decade, along with very easy money, were sufficient to drive only moderate economic growth. Third, short-term interest rates are severely constrained by the zero lower bound: real rates may not be able to fall far enough to spur enough investment to lead to full employment. Fourth, in such situations falling wages and prices or lower-than-expected are likely to worsen performance by encouraging consumers and investors to delay spending, and to redistribute income and wealth from high-spending debtors to low-spending creditors.
The implication of these thoughts is that the presumption that normal economic and policy conditions will return at some point cannot be maintained. Look at Japan, where gross domestic product today is less than two-thirds of what most observers predicted a generation ago, even though interest rates have been at zero for many years. It is worth emphasizing that Japanese GDP was less disappointing in the five years after the bubbles burst at the end of the 1980s than the US GDP has since 2008. In America today, GDP is more than 10 per cent below what was predicted before the financial crisis.
If secular stagnation concerns are relevant to our current economic situation, there are obviously profound policy implications.
Lawrence Summers, Financial Times, 15 December 2013
Those of you that have followed my investment strategy previously, will know that I have had a consistently cautious view of the world which predates the financial crisis of 2008. It’s not that I’m perpetually bearish though. There have been times in my investment career when I’ve had a much more sanguine view of the global economic outlook and have positioned my portfolios accordingly. I just try to be realistic about what’s going on in the world economically. I don’t believe the world is going to grind to an economic halt, I just think that there are some major structural challenges which are not being addressed by policy makers.
I have a great deal of sympathy with Larry Summers thinking about the structural issues constraining global economic growth, as outlined in his Financial Times article in February. These secular problems, which Summers articulates far more coherently than I ever could, are evident in the high levels of unemployment that we see across the developed world, the very low levels of productivity growth, declining real wages and a lack of investment.
In short, there is a lot to worry about in the world. Whether it is the continued impact of the massive influx into the global labour market that has accompanied the rapid emergence of Asian and Latin American economies over the last couple of decades, which I believe principally lies behind some of the issues that Summers outlines. Or the unsustainability of China’s economic model, the problems at the heart of the Eurozone, or the consequences of the gradual withdrawal of the Fed’s extraordinary monetary policy on global financial markets.
There are many problems out there – some are structural and some are cyclical but they are all connected. Yet, what I detect from financial markets is practically zero awareness of any of these issues. If you take a long-term view, though, you have to consider them – they are very relevant to my time horizon. It is my job to worry about these things. My investors pay me to ensure they get an appropriate long-term risk-adjusted return. If I ignore the risks, how can I ever hope to achieve that? I’d only be looking at one side of the coin. That is why it is all relevant.
So in my endeavour to add value on a three to five year view, I cannot ignore these issues and challenges. However, despite these headwinds, there are, as ever, opportunities to be exploited.
Once such example would be AstraZeneca. This company has represented a big position in my portfolios for a few years now. In fact, it’s one of the biggest positions I’ve ever held. It has been a controversial holding, with many other investors finding it difficult to understand why I found the company so attractive. For a long time, the market failed to see the value but therein lay the opportunity.
The crucial mistake the market made, in my opinion, was to view research and development (R&D) – for the whole pharmaceutical industry, but particularly for AstraZeneca – as an expense rather than an investment. AstraZeneca has continued to invest in its business through some challenging years but the market failed to attach any future value to this substantial commitment to R&D. I felt compelled to build a large position in the company because I believed that this R&D would deliver future value.
More recently, the market has started to arrive at the same conclusion. AstraZeneca is a company that is investing in its future and it is beginning to pay off. Not only has the market begun to appreciate this, its competitors have also clearly noticed, as evidenced by the recent bid from Pfizer.
My strategy is to build a portfolio of companies like AstraZeneca that I believe can survive and prosper in this troubling world that I foresee. The long-term global economic outlook is absolutely relevant to this because it frames my expectations about what to expect from all companies. I will invest in those that I believe will survive and prosper, and I will avoid those that I think will not. As a strategy, it really is that simple. The difficult part is making the right judgements but I believe I can find enough safe, reliable, attractively valued companies to build a portfolio which, in aggregate, can deliver an attractive long-term risk-adjusted return. I strongly believe that this will prove to be a superior return over the long-term when compared to the UK stock market as a whole and that achieved by other asset classes. In other words, I believe I can add value.
I will keep you fully informed of my progress.