The old normal versus the new normal

Ian de Lange of Seed Investments writes that the US consumer confidence level increase of 2,3 points in January and with December is positive but notes that this comes off a very low base.

Wells Fargo views the Consumer Confidence Index as a truth detector of economic conditions because it’s closer to actual conditions on the ground.

Their view has been for some time that the Old Normal has morphed into the New Normal as the 3 key tenets driving the old normal reversed. 

The 3 main drivers of the old normal were:

•             deregulation
•             globalisation and
•             increased leverage

The New Normal started with the bankruptcy of Lehman Brothers on the 15 September 2008. From that date we have witnessed a global tightening in regulations, increased protectionism and deleveraging.

Their new normal is an environment that looks like this:

•             reduced consumption and increased savings rates
•             de-leveraging
•             re-regulation and de-globalisation
•             4-5% nominal GDP growth
•             cyclically low interest rates with potentially higher secular rates
•             cyclically low inflation with potentially higher secular inflation

Some points from two separate studies quoted by Pimco, which analysed past financial crisis over decades and even centuries, are telling:

•             The legacy of a banking crisis is greater public indebtedness. On average a country’s outstanding debt nearly doubles within 3 years following the crisis.
•             On average once a country’s public debt exceeds 90% of GDP, its economic growth rate slows by 1%.
•             Typically deleveraging begins 2 years after the beginning of the crisis and lasts for six to seven years.
•             Initial conditions are important. With many developed countries displaying high levels of public debt and running excessive budget deficits manoeuvrability is reduced.

On the tightening of regulations, just last week US president Obama threw the global banking industry into turmoil, when he made the call for a ban on banks running their own proprietary trading, hedge funds and private equity.

Following the 1929 financial crisis, the US ushered in what was known as the Glass-Steagall Act, which separated commercial and investment banking. This remained law until 1999, but could now effectively be introduced again.

How does this translate into an investment outlook?

US fund manager GMO, who in the main appears to agree with the views expressed by Pimco are concerned about the ongoing stimulus provided by central banks and specifically the US Federal Reserve, saying “Over stimulus was painful in the 2000 break and extremely painful in 2008, but the Fed soldiers on with its failed strategy like Field Marshal Haig in World War I (“The machine gun is a much over-rated Weapon.”)

The dilemma then is that while global assets are generally on the expensive side, given the ongoing loose monetary policy there is a high probability that they continue to get more expensive.

Across the various stocks and bonds that they provide a forecast for, their view is that US high quality stocks will provide the best real return. “For the longer term, the outperformance of high quality U.S. blue chips compared with the rest of U.S. stocks is, in my opinion, nearly certain” (which phrase we at GMO traditionally define as more than a 90% probability).”