"Kee" Points with Jim Kee, Ph.D.

Global forces: We will be recording our second quarter webcast this week, and I usually give a quick summary of my portion for Kee Points. Taking a step back from the trees to view the forest, the following four observations define the investment landscape since the 2007-09 crash.

  

The first is the steady decline in global risk measures as central banks and governments around the world have made clear their intent to keep global credit markets from seizing up. By standing ready to buy debt securities, these actions ensure that countries with debt problems – greatly exacerbated by the global recession which reduced revenues and increased expenditures – don't get pushed into default by rising interest rates due to a lack of demand for their debt. As an aside, macroeconomic theory is inconclusive regarding the appropriate degree of austerity (reduced government spending) required to normalize the situation. The idea that macroeconomics is in a state of flux comes as a surprise only to non-economists, who seem to re-learn it during every crisis.

 

The second defining characteristic of the global economy is the downshifting of global growth that has occurred more or less continuously since 2009. It appears that we bottomed last fall but are currently hitting another flat spot. Global strategists assert that these "growth breaks" last about three months. For reference, the real global growth averaged around 2.8 percent for most of the past half century, hitting 4-5 percent during the 2000s as China joined the World Trade Organization. Estimates for 2013-14 range from 2-2.5 percent (World Bank) to 3-3.5 percent (IMF).

  

Equities in the U.S. have rebounded fully from the 2007-09 crash. It has been a pretty good run for stocks, although below average as the market typically regains the lost ground from a big (10%+) downward movement in two to two and a half years. That, combined with the fact that corporate profits as a percentage of the economy (GDP) are near all-time highs suggests that the rebound has not resulted in a wildly overvalued stock market. Valuation measures tend to confirm this: we see the market as neither obviously overvalued or undervalued.
 

Coupled or decoupled?: As I have mentioned before in Kee Points, a big discussion among international investors even prior to the crash was whether or not emerging economies had become "decoupled" from developed economies. That would mean a more fully developed consumer sector (rising middle class) and less dependence on exports (i.e. consumers from other countries). Given their faster growth, that would also mean that their markets would gain share and outperform in both up and down markets (generating “positive alpha”). Unfortunately, the emerging markets have outperformed during rising markets and then underperformed during falling markets, making them a high beta play, for now anyway. As Dr. Victor Canto at La Jolla Economics put it, “If the consumer sector fully develops in these regions, it may be possible for them to decouple, and eventually generate their own growth without depending on the economic progress of the developed world. At that point the long run performance will move from a beta effect to a pure alpha effect.”

 

The best analysis to describe what unfolded over the last few years is that financial crisis led recessions are followed by below-average recoveries. This research suggested that the rebound would be slower than normal where the banking crises were most severe, like the developed world, and it was. And it also suggested that the (economic) rebound would be faster where the financial systems were least affected, like the developing world, and it was. Finally, it argued that the private sector deleveraging would take years to accomplish (and it has) and that only then would the most affected economies move back up towards their normal growth paths. I think the next 12 months will tell us about that one! 

 

Worth watching: According to Christian Ledoux, STMM’s Director of Equity Research, defensive sectors such as Healthcare, Staples, and Utilities have outperformed this quarter while the overall market was up over 10 percent, the first time that has happened since 1989. Research outfit Gavekal sees this outperformance of “counter-cyclicals” as evidence of global slowdown (and recent data point to a soft spot in growth for sure), but a competing explanation is the on-going search for yield, particularly as investors lack enthusiasm for long-term bonds. There may be a little of both, and we’ll be watching global data points closely over the next several months.