Welcome to the Teenies, sorry about those returns
-James Saft is a Reuters columnist. The opinions expressed are his own–
As we say goodbye to a decade so abysmal it never even earned a nickname, it is time to take bets on how the coming 10 years will shape up in economics and financial markets.
Welcome, then, to the Teenies, a word that will describe the decade as well as the small returns in financial markets and the shrinking financial sector it will bring.
So, let’s run through some themes for the 2010s:
Banking – The decade will end with meaningful reform of banking in place, but what is not clear is if this happens soon or only after a new banking crisis brought on by an unwillingness to take tough steps now. The likelihood is that regulation limits leverage and causes the share of the economy captured by financial services to shrink. It will be a lousy decade to be a shareholder, but given the government backing, perhaps not a bad one to be a bondholder.
It will be a great decade in which to have credit skills; even if the ratings agencies escape meaningful reform, everyone is going to want to do their own homework and a shrinking banking sector will open up highly profitable opportunities for alternative avenues of credit.
Investment – Just as the last decade started with dot-comfever and ended with unease, the next one will be all about reconciling oneself to moderate returns and figuring out who is hurt worst by a world of slower growth, less volatility and less debt. My theory is that a balance sheet recession means growth in the developed world for the next few years will be restrained at best. The past few months have been heady, but don’t be fooled, it will be very hard work to make an overall portfolio return even 8 percent. As those expectations slowly deflate, pension fund risk will become much more important in investing. General Motors will not be the last icon partially brought down by its obligation to retirees.
Remember, all of the debt that has been racked up must be repaid, defaulted upon, outgrown or inflated away. If real growth is slow, and I am betting it will be, the choice between the other three sisters augers badly for returns.
Repayment, or a balance sheet recession, will limit growth. Just look to Japan if you want to see what that looks like. As debts have been in large part nationalized, default will be less of a factor, unless we have a sovereign crisis. That leaves inflation, which for the United States will make a big comeback two or three years out. A bout of developed markets inflation will be lousy for returns, and anyone wanting to play it will do better in emerging markets.
Emerging Markets – With the possible exceptions of technology and health care, there are just going to be better opportunities in emerging markets compared with the developed world. Consumption growth within emerging markets can insulate them partly from sluggish developed growth. Will there be bubbles? Absolutely, especially in China, when toward the end of the decade it opens up financially, attracting capital like iron filings to a magnet. But bubbles that put chickens in pots rather than granite on counter tops are better bets on so many levels.
U.S. Housing – By the end of the decade Americans will no longer confuse housing consumption with investment. The U.S. remains overbuilt and has a huge population of renters who don’t yet know that they are not owners. Foreclosures will remain a drag on housing prices for a couple of years. The U.S. government will do what it can to cushion the fall in prices; the blank check it recently wrote to Fannie Mae and Freddie Mac is evidence of that. Even so, a stabilization in housing will not be followed by a new boom in prices, not with credit as hard to get as it likely will be. The average new house in 10 years will be slightly smaller than today’s.
As for commercial real estate, the tallest building in most U.S. cities will still be the tallest in 10 years time.
The Dollar – The dollar will someday lose its reserve currency status, but this will be a decade of transition rather than dethronement. China will over time take steps to make the yuan an alternative and by the end of the decade the stage will be set for a new regime. The biggest risk facing the dollar is how international holders react if and when inflation takes hold in two years or so.
All in all, the most striking thing about the last 10 years is not that investors were separated from their money by a series of bubbles in the West, but rather the growth in incomes and capabilities in places like China and India, which was nothing short of miraculous.
That is a trend to celebrate, and one with legs.