Some wisdom from Twain
Mark Twain once quipped that “life would be infinitely happier if we could only be born at the age of eighty and gradually approach eighteen". We work tirelessly to convince our clients that their portfolio would be significantly larger if they would invest mostly in stocks and forget about it until they were sixty-five. Of course Twain’s fantasy is not possible but our investment approach has proven itself over time. With that said, one must nurture the ability to tolerate gut wrenching volatility at times and it usually rears its ugly head when things look most optimistic. That happened in the roaring twenties, the dynamic 60’s, the heady dot-com era, and the real estate boom of 2005-2007. Each boom was followed by a bust, but will it be different this time?
Most of the busts mentioned above were Fed-induced, but that was based on classic economic theory when the Philipps curve was still worshipped by most members of the Fed. The economy overheats, the Fed worries about inflation and raises rates to stay ahead of the curve. We are clearly living under a new economic paradigm, Modern Monetary Theory. Will MMT be a financial weapon of mass destruction or unleash a new wave of economic-cycle-free prosperity. The answer to this question is unknowable, in my opinion, but is worth further exploration.
Japan is probably our best case study as they have been practicing MMT for quite some time. Since MITI and the Japanese growth miracle waned in the early 80’s, the central bank stepped in to fill the void. Dramatic monetary intervention pushed interest rates to zero and they have stayed there for the last 15 years. With the yen serving as a reserve currency like the dollar, they have been able to maintain a closed monetary loop. Deficits have ballooned and yet the yen has remained strong, inflation has stayed in check, and rates remain at zero. Emboldened by the success of MMT, the Japanese central bank has ventured into buying equities during the last two downturns. They now own about 75% of all Japanese equity ETF’s and maybe 20% of the Nikkei. The only apparent side effect has been very slow growth. We can theorize that this is due to a misallocation of financial resources. If Adam Smith were around today, he would roil at the central bank’s “strong hand” in trying to control the economic cycle versus the “invisible hand” that moves capital and resources around where they can be most productive.
Within this framework, slow growth looking out the next 10 years and beyond is our best prognosis. We have in fact probably borrowed from Peter to pay Paul, as Japan has done as well as Europe. In the short term, transitory inflation will surge and our hope is that the Fed doesn’t overreact. Deficit spending will continue and revenue sources will have to rise, further handicapping our growth potential. Rates may spike but then settle back toward zero as the stimulus wears off and transitory inflation fades. Rising productivity and technological innovation will help us sustain some economic momentum while keeping labor costs in check. In the next downturn the Fed may very well buy equities, mirroring the MMT track of the Japanese central bank. Equities should continue to be the best financial investment, provided that one stays focused on companies with top tier growth prospects and sustainable business models. Twain also reputedly said, “history doesn’t repeat itself, but it does rhyme”. I believe that to be sage advice with regard to the markets.
Please call or email me with any questions or observations at jess.ellington@aubwm.com or 843-412-1420.
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