Game Changer: Market Beware Slower Economic Growth
Note from dshort: Over the weekend I read Ed Easterling's fascinating new commentary on his Crestmont Research website. Below is an excerpt with a link to the full text in PDF format on Ed's site.
The headline across the financial press should read: "Grantham and Brightman Call Gross an Optimist." The irony is that last fall Bill Gross (PIMCO) reduced his long-term forecast for annual U.S. economic growth from the New Normal rate of 2% to 1.5%. That was depressing. Keep in mind that the annual long-term growth rate for the U.S. economy (real GDP) has averaged just over 3% for more than a century.
But then, amid a firestorm of interest and buzz, Jeremy Grantham (GMO) and Chris Brightman (Research Affiliates) separately made the case for a future of 1% annual GDP growth. Brightman's article, dated November 2012 and titled "1% ... The New Normal Growth Rate?," methodically and diligently spells out a future of 1% economic growth, absent policy changes. Grantham's article, also dated November 2012 and titled "On the Road to Zero Growth," makes a compelling case with intricate detail for 0.9% annual economic growth through 2030 and 0.4% thereafter.
The storm has continued. Amid strong reactions to his November report, Grantham doubled-down in February and offered further explanation in support of his lower-growth outlook. Gross initially seeded a bit of hope that the era of New Normal may be waning—at least temporarily for 2013 with economic growth returning to 3%. But his latest comment hot off the press states that "...a 2% new normal economy is the best we can expect." With the qualifier "is the best," Gross may be easing back to his most recent position at 1.5%. That rally sure didn't last very long.
Of course there are numerous other perspectives about economic growth. The latest tally includes about 1.5 opinions per economist (reflecting economists' penchant for the phrase "on the other hand"). Some economists are more optimistic, others more pessimistic, and more than a handful are on both sides of the fence. But these three gentlemen are highly respected and well-followed pros, and their calls are not short-term guesses. Their opinions are well-developed analyses with policy-level implications.
The purpose of this article is to look beyond the details of each argument. That is, the objective is to understand the long-term implications for the stock market. Whether your preferred economist advocates 2%, 1%, or 0% long-term growth, the outcome is similar in direction though varying in magnitude. The impact will lie somewhere between bad and worse. "Grantham and Brightman Call Gross an Optimist!" The following discussion includes an excerpt from the book Probable Outcomes. It explores the possibility that future real economic growth may have downshifted from its historical trend of 3%–and more significantly, it highlights the implications.
Historically, the prospect of slower economic growth had not often been considered by economists and analysts, but it is now mainstream thinking. The implications of slower growth on stock market returns would be dramatic for investors.
SHIFTS & CYCLES
Most investors recognize that the stock market delivers extended periods of above-average and below-average returns. These periods are known as secular stock market cycles. The last full secular bear was 1966-1981. The most recent secular bull ran from 1982-1999. Our current secular bear market started in 2000, and it still has a long way to go. Figure 1 presents all secular stock market periods since 1900.
Figure 1. Secular Stock Market Cycles
Here are two earlier commentaries that offer insight on Ed's perspective on investment expectations and planning.
Ed Easterling is the author of Probable Outcomes: Secular Stock Market Insights and award-winning Unexpected Returns: Understanding Secular Stock Market Cycles. He is President of an investment management and research firm, and a Senior Fellow with the Alternative Investment Center at SMU's Cox School of Business, where he previously served on the adjunct faculty and taught the course on alternative investments and hedge funds for MBA students. Mr. Easterling publishes provocative research and graphical analyses on the financial markets at www.CrestmontResearch.com.