Summary: My wise colleague says the world is suffering from too much debt, so growth will be disappointing. You can make a modest return in equities, but if you want to make real money investing, you have to pick stocks in technology and biotechnology. Right now there are hundreds of small companies working on significant products. Many will fail, but a few will change the world.
Key take out: Picking the right companies can produce impressive returns in a difficult overall market environment.
Key beneficiaries: General investors. Category: Economics and investment strategy.
I have a wise colleague who has built his reputation by identifying important trend changes early and putting serious money behind his conclusions. Descended from a mercantile family that operated canteens selling food and weather protection along the Silk Route, he was educated in Europe, trained in New York and returned home to take advantage of the wealth-creating opportunities resulting from the post-war recovery. Listening to conversations around the dinner table, he was encouraged to focus on the major events early, and his success is a product of this skill. That success is reflected in his homes and other comforts he enjoys. His art collection spans centuries, from Canaletto to Koons, but what keeps him vibrant is ideas.
We get together a few times a year, but this year our conversation was by telephone.
He says: “The whole world is suffering from too much debt. As a result, growth almost everywhere is going to be slow. I know you believe the problem is insufficient demand, but the major industrialised countries already have considerable debt and do not want to add any more to it to stimulate the consumer. Japan is an exception. They already have the highest debt to Gross Domestic Product (GDP) of any major country and they are willing to add more. China is an exception on the other side. They are in a position to take on more debt because their debt to GDP ratio is low.
“Without more fiscal stimulus, demand will be tepid and growth will be disappointing. This is the state of the world now, and it is likely to endure for some time. In the near term, I don’t see a calamity, just sluggish economies and many equity markets not doing much.
“It is not easy to make money these days.
“In the past, if you had the right asset allocation, you could do well for institutional investors. Now most asset classes are fully valued. The bond market is expensive, equities are not cheap anywhere, gold is dead; other commodities are in bear markets, the emerging markets are generally not attractive, China is dangerous, and Europe and Japan are reasonably fully priced. As I said last year, the only way to make serious money is by carefully investing in innovation. You can make a modest return in equities in the major markets – I agree with you that the US market will end the year higher than it is now. But if you want to make real money investing, you will have to do it by picking stocks in technology and biotechnology, and I would emphasise the latter.
“Most people still don’t recognise the gigantic implications of this phenomenon. Major breakthroughs are going to be taking place in cancer, heart disease, Alzheimer’s, diabetes, multiple sclerosis and other diseases. Picking the right companies can produce impressive returns in a difficult overall market environment. Right now there are literally hundreds of small companies working on significant products. Many of them will fail, but a few will change the world the way Google and Facebook did. Most are located in California and Boston, but there are also some in Europe and Asia. The United States is dominant, however. You should spend your time trying to understand what these companies are doing. The returns for picking the winners could be huge. What’s more, the pace of innovation is quickening. The rewards for proper asset allocation will be very modest. I like Facebook (ticker: FB); Salesforce.com (CRM); biotech ETFs; an industrial company, CS Industries ; Visa (V); Apple (AAPL) , of course; Alibaba (BABA); and Palo Alto Networks. I am out of Google.
“Think of all the tasks your smartphone can do for you. There is almost no question that comes to mind that cannot be answered with a Google search, from politics to sports to business to entertainment. I am convinced technology has made the world more productive, but it is hard to measure. The recent figures on productivity are negative, meaning there is less output per worker hour, but the benefits of information technology may be difficult to determine in traditional ways.
“There is also a question of the impact technology is having on the middle class. Millions of jobs have been eliminated through robotics and other forms of technology. The technical skills required to get and hold a good job are increasing all the time. Service jobs are growing, but manufacturing jobs are rising more slowly, and service jobs generally are lower-paying. Many kids completing college cannot find jobs in their chosen field and are forced to work at something temporary to pay the bills and student loan debts. This is a problem that is likely to get worse as more technology breakthroughs take place, so the social implications of this phenomenon are enormous. Advances in biotechnology also have the social costs, as more people live longer.
“In addition there is the problem of wasting time. Playing video games rather than reading books, and communicating with followers on Twitter, can keep a young person busy. The typical Facebook user is said to be spending twenty hours a month on that site. According to recent studies, the average college student only spends one hour a night studying alone, perhaps because of other distractions. These numbers could signal problems for American competitiveness going forward, so there is a downside to what is happening in technology.
“Looking around the world, trouble is everywhere. That is why you have to narrow your investment focus. In Europe, the Greek situation seems intractable. The Syriza party was elected by making promises that are difficult to keep. The economy is doing poorly, so it is hard to create a budget surplus that will enable the country to pay back some of its debts, even if the creditors were to discount the obligations. The new government promised relief from austerity, but its creditors want work rule changes, increases in the value added tax, reform of the generous pension system and greater flexibility in terminating employees. The Greek people want to stay in the European Union and maintain the euro as the country’s currency, but they do not seem willing to endure the sacrifices to make that happen. From the point of view of creditors, Greece’s unwillingness to compromise is unnerving, but that stance will change. I still think a deal of some sort is likely. Europe is fearful of the unintended consequences of a default and exit from the Union. Angela Merkel worries that the euro might appreciate if Greece leaves, making German exports less competitive. The situation looks dim now, but I think some temporary solution will be found. In the long term, however, I am not optimistic about Greece staying in the Union.
“Looking at other financial markets... China is working hard to rebalance the economy in favour of the consumer and away from infrastructure and investment in state-owned enterprises, but it is a long and difficult process. They will probably reach their target of 6½ per cent to 7 per cent growth, but they will have to increase their debt to reach that objective. Happily, their balance sheet is in a position to permit that. Real growth without the fiscal stimulus is much slower than that rate, which is why I am concerned about the Chinese equity market. I wouldn’t worry too much about China’s territorial expansion. That may be a problem in the longer term, but right now the leadership is focusing on reducing corruption and maintaining growth.
“I think we have seen the low point for the price of oil. I know inventories are huge and shale producers are back on stream, but I think $US55–$US65 is the bottom for Brent. The battle is between the Saudis and the shale drillers. The Saudis are shipping a million barrels a day above their stated quota in order to keep the shale producers in check, but demand is increasing slowly and prices will continue to rise modestly.
“Regarding some other issues, I believe the US Federal Reserve will tighten in September, but the increase will be small and they won’t raise rates at every meeting. I expect longer-term rates to rise but stay low by historical standards. The euro should remain in the 1.05–1.08 range against the dollar. European exports are doing well at that level. I do not see a break below par. Everyone is looking for a big correction in the US equity market, but while it looks somewhat expensive to me, so much money in the world wants to have a position in American stocks that I don’t think the indexes will decline much. The vigorous merger and acquisition activity will continue, and I think that will help the markets.”
While there may be more risks than opportunities out there, my wise colleague believes you can always find ways to increase your net worth.
Byron Wien is vice chairman of Blackstone Advisory Partners LP, where he acts as a senior advisor to both Blackstone and its clients in analysing economic, social and political trends. This is an edited version of his latest commentary.