I've talked to a good few interesting people in the past week. But two are of particular interest at the moment. The first is David Stockman, author of The Great Deformation, The Corruption of Capitalism in America a book that has been at the top of the bestseller lists in the US since it came out in April. The second is Dambisa Moyo, the almost impossibly glamorous author of, among other must-reads, How the West Was Lost: Fifty Years of Economic Folly, and The Stark Choices Ahead.
Both were and I guess this is obvious deeply pessimistic on the future of the US in particular. While their arguments are far from identical, they are both convinced that America, with its insistence on using monetary policy to mismanage interest rates and distort markets, along with its badly structured welfare state and low prioritisation of education, has a sad future ahead of it. Stockman was once director of the Office of Management and Budget in the US (under Ronald Reagan) and Moyo was named as one of the 100 most influential people in the world by Time magazine. So it is worth listening to both of them.
I also happen to think they are mostly right. Politicians in the West, caught in traps set by their short electoral cycles, have made a nightmare series of bad decisions about public spending, the roles of the state and of course about what we should think of as money and how we should price that money. Then there's the demographic profiles of Western countries, with their growing numbers of older people; economies designed to grow on the back of consumer spending don't grow much as their populations age and cut back spending. It is hard to see where a return to credit and baby-boomer style economic growth will come from.
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It is a lot easier to make up a good story about how emerging countries, with their lower debts and younger populations, will see fast economic growth than it is to come up with one about how the US will although now there is the prospect of energy independence on the horizon, it is clearly getting a tad easier.
But it's a big step from being able to say that one group of countries will grow faster than another in gross domestic product terms to saying that you should expect stock markets in the faster-growing group to outperform the rest. Several studies have shown that this isn't often true. The opposite very often is. Many explanations have been offered for this, but I suspect it comes down to the way the proceeds of growth are distributed at different stages of growth.
When a country is growing fast, wages are most likely to be growing fast too so more than you might expect goes to labour over capital. Rapid growth also gives companies one-off opportunities to build market share. If they take it, prioritising volume over margins, they won't make much in the way of profits possibly for many years. Then there are the many governance issues in emerging markets: state ownership, family-controlled companies, dodgy property rights and so on. These tend to ensure that the majority of the spoils can end up going to the minority of shareholders.
If you look at it all like this, surely it would make sense to say that one should pay lower prices for companies based in emerging markets (as is the case in Russia, which I advocated recently), regardless of how fast it looks like those markets might grow. After all, you are taking more risks. There's likely to be a long wait before the dividends start rolling in, and the longer you have to wait for something, the higher the risk that you will never get it. We should pay a premium not for emerging-market growth but for the kind of steadily rising profits and dividends we are more likely to get in the West.
This is all something to bear in mind as you look at the carnage in emerging markets over the past week. Bonds, equities and currencies have all been clobbered. Investors who bought at high prices to get exposure to economic growth are now finding that there is something worse than paying a premium for the wrong thing. It's not getting even that thing. So as the cheaper yen makes emerging market exports look less competitive, as China clearly slows down and the debate begins about the end of quantitative easing in the US, they are selling.
But here's one thing to note before you dismiss Asia and Latin America out of hand: one day, all the markets we now think of as emerging will be developed. They'll turn their minds from all-out economic expansion to profits and at the same time their populations will demand proper governance and the odd dividend. Then their markets will soar. With that in mind, a nice little chart was slipped to me over a pub table by Tim Guinness of Guinness Funds a few months ago. It looks back at Japan's economic growth and its stock market performance. The latter ran at 10% or so a year from the early 1950s to the 1970s as the country industrialised and invested.
In 1955, Japan had 5.2 cars per thousand people. By 1966, that number was 79. In 1970, it was 168. The stock market rose, but not in a particularly spectacular fashion. But around then, the Japanese economy shifted gear down to more like 5% growth as the country entered a later industrial shift to a more consumption-based economy. Look at a chart of the Nikkei and you will see what happened next. It rose steadily throughout the 1970s and went completely nuts in the 1980s.
So here's something to think about: in 2000, China had 4.9 cars per 1,000 people. In 2012, it had 74. By 2016 or maybe earlier it should have close to 168. It should also have seen growth fall to 5% or below. A few years before then might be good time to invest.
This article was first published in the Financial Times.
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