After a brief hiccup at the start of the last quarter, markets roared into the new year in a relentless drive to all-time highs, again. The engine of the US economy is humming along providing ample job opportunities for middle income workers, accompanied by low interest rates and accommodating central bank policies around the globe.
For the first time in decades, wages for lower and middle income workers are rising faster than for managers and professionals. US manufacturing firms would repatriate more production, but a shortage of trained skilled workers to support higher tech factory jobs is limiting. The good news is that rising wages stimulate consumption and savings, providing a strong elixir for an economy ruled by consumers.
Led by technology at greater than 50% last year, all asset sectors, whether equity, fixed income, and most commodities were positive – except for livestock and agriculture. The world is very efficient at producing food surpluses while Baby Boomers go on diets, and fewer babies are born. With new food sources like Beyond Meat, who needs a cow anyway.
This era has been described by some bullish commentators as a new “Roaring Twenties”, similar to the so-named decade a hundred years ago. Innovation drives enterprise, technology increases productivity, banking is stable thanks to the newly created Federal Reserve, and the end of war drives commercial prosperity. What is not to like, so party on.
Recession? What Recession?
Clients often ask about the impending recession last predicted to happen as soon as last year. Welcome to the future, as the economy keeps growing. So much for prediction. I think it is fair to say two key processes are in place, creating the illusion of a struggling economy, though the overall picture remains more positive.
Technological disintermediation – this is the creative destruction that is taking out major firms, especially retailing. Bye-bye K-mart. Led by Amazon, retailing is undergoing generational change. This affects real estate firms, logistics, trucking, and other industries in the food chain. It is also unsettling to those displaced by the process. During the Roaring Twenties, technology moved vast numbers of people off the farms, even as banking, Wall Street, and industry soared.
Advance of automation and artificial intelligence –referring to the disintermediation of human skill sets by machine intelligence. This affects all sectors of the economy as software gets smarter, and it is not a simple additive process – it is change at an increasing rate of speed, affecting all human endeavors. This is a challenge to prospects for higher order (and better paid) skill sets, creating even more angst in the ranks of older workers facing technological redundancy. Google recently demonstrated a technology more effective at detecting breast cancers than traditional methods.
In cold terms, the net of these forces is an economy that continues to grow and be more productive while engaging in sector recessions, and increasing cognitive dissonance for people.
It is often the good times which make a portfolio manager nervous. It is in our DNA to be measurably paranoid. Markets go up and up, then come down, sometimes abruptly. We simply can’t predict when, or how far in either direction. But everyone hates to lose and therefore we must consider risk. It is our least favorite four-letter word, since ignoring risk may lead to unacceptable loss. Sometimes I fear people forgot 2008 and 2001.
Current events in the Middle East demonstrate this. Other events have shaken a key pillar of economic progress of the past 60 years, globalization. Globalization spread prosperity around the world, but it also created the rust belt, which has never recovered. Anti-globalization sentiment is taking hold as developing and emerging regions aggressively seek advantage and growth, while first world (older) economic systems resist losing power. Brexit and Tariffs reflect this.
The two big risk elephants in the room are those which no one dares speak of – debt, and deficits. The US, Europe, and Japanese fiscal imbalances are huge and politically intractable. Retiring populations are growing, workforces shrinking, and governments are spending more than they bring in.
Consider for a moment Social Security. The question often asked – what will happen to Social Security. Will it be cut? Will I get mine?
Sober up time – if nothing is changed, the latest Social Security Administration Trustee report projects that the benefit will be cut when the ‘trust’ fund runs out, in 2034, by 23%. Surprisingly, most people are unaware of this. Oh well, there goes the party.
The social safety nets of first world countries are all similarly strained. Add in public sector pension underfunding, and the tale gets worse. It remains to be seen how this resolves itself. It will not be a pleasant bump on the road.
Reasonable (not great) Expectations
We use cautious assumptions for long-term planning purposes because of both known and unknown risks. 2019 was a wonderful “once every couple of decades” result for investment returns, and (probably) not to be soon repeated, though nobody knows. That is always why we remain diversified and will rebalance in order to take risk off outperforming assets.
Let us celebrate the past year while watching for the next bump in the road. Potholes are often unseen.