Living in a low return world
- October 10th, 2013
Sometimes it is hard for investors to take their eyes off of the recent goings on in the markets, and now in Washington, to think about the really big picture trends that are driving markets. I recently came across a couple of longer articles that highlight the challenges investors will face in what is increasingly looking to be a low-return world.
Ironically one of the reasons why future returns are likely to be lower than have been in prior centuries is due in part to our increasing wealth. William Bernstein writing in the September/October 2013 Financial Analysts Journal* has a piece entitled: “The Paradox of Wealth.” The abstract reads:
A recent FAJ article by Laurence Siegel painted a sunny picture of the world’s economic and environmental future. Although the author agrees with Siegel’s analysis, his optimism does not extend to security returns; both theory and long-run empirical data support the notion that economic growth lowers security returns by reducing impatience for consumption and altering the supply–demand dynamics of capital—the price of living in an increasingly prosperous, safe, healthy, and intellectually gratifying world.
The article is a must-read in part because it belies the idea that we can naively extrapolate past returns into the future. We live in a world that is technologically (and demographically) quite different from that a century ago, let alone longer than that. This issue I took up in my book Abnormal Returns: Winning Strategies from the Frontlines of the Investment Blogosphere where I wrote:
Second and more important, what relevance do equity returns from these early periods really have to us today? The process of equity investing was very different back then. It took a much more intrepid investor to invest in equities in those earlier times. Information was scarcer, and the costs were much higher. Equities must have seemed like a much more speculative proposition back then than they do today. Today we have nearly unlimited data, nearly free commissions, and the ability to trade stocks with a mouse click. Today’s equity investor is no longer facing the hurdles an investor a century ago would have faced. We should therefore take these long-run estimates of the ERP with a big grain of salt.
Just as technology and wealth is changing the world we live in so is demographics. Neils Jensen in the Absolute Return Letter looks at the headwinds and tailwinds of demographics for the globe’s economy and financial markets. In the developed world the implication is that a rapidly aging population will put a damper on equity market returns for some time to come. The picture in the emerging markets is more mixed but there is an opportunity for multi-national countries to serve the world’s growing middle class. Jensen writes:
This implies that one needs to interpret the output with care. One example: With few exceptions, the largest companies in the world today are truly global and much less dependent on their home market than they were previously. The fact that Switzerland, and with it most of Europe, will age rapidly over the next 15 years will mean much less to Nestle now than would have been the case 20 or 30 years ago. One therefore needs to look not only at each and every country in terms of where it is in demographic food chain, but also at the constituents making up the local stock market.
Two points. The first is that technology and demography are not destiny. One can come up with any number of scenarios (good and bad) that would disturb this trend towards lower returns. The second is that a low-return world has huge implications for personal financial planning for society as a whole. US pension plans continue to project what seem to be too-high nominal financial market returns. If investors, both large and small, are unable to generate a return on their savings then it may be the case that savings, in addition to lifestyle changes, need to occur to allow for comfortable retirements. As Bernstein notes technology certainly plays a positive role here but so would a mandatory savings regime.
These trends are longer term in nature and much will happen in the meantime to perturb financial markets. However as you go about thinking about working and financial lives keep in mind that while much in our lives has improved we cannot assume that financial market returns will provide us with abundant returns to boot.
*I also found an earlier, ungated version of the paper here: http://larrysiegeldotorg.files.wordpress.com/2012/01/the-paradox-of-wealth-v2-formatted.pdf.
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