The most important trend for investors for the past 35 years, let alone the last 20, has been the slow but steady drop in interest rates to today’s record low levels. The bull market in bonds (when interest rates fall, bond prices rise) began in 1985. As Robin Wigglesworth writes in the Financial Times, the last bond bull market of comparable length ran from 1873 to 1909, and we’ve now almost surpassed that. This headwind of falling rates, more than anything else, has driven the extraordinarily strong returns seen across financial markets – both bonds and equities – in recent decades. Will it continue for the next 20 years, or does regime change lie ahead?
We suspect the latter. We’re not the only ones. Indeed, Paul McCulley, former chief economist at Pimco (the giant bond fund specialist) believes that “if the [investment] ideas that have worked over the last 40 years work going forward, then democracy has failed”. It’s a dramatic way to put it, but his point is that the crushing of inflation has come largely at the expense of the man and woman in the street. “The reason financial markets have done well over the last 40 years is because we’ve been in a 40-year disinflationary environment… and that’s because we’ve shifted power in our economy, both domestically and globally, from labour to capital.” He believes the pendulum is swinging back, as populations around the world vote for change. And that means the old ways of investing won’t work anymore.
Trump: a triumph for democracy?
Few politicians illustrate the shifting political consensus more clearly than Donald Trump. Writing on Bloomberg, Karl Smith argues that, contrary to what is accepted wisdom to some, Trump didn’t simply inherit a strong economy from his predecessor Barack Obama. The ongoing fall in unemployment since 2016 – from what was deemed “full employment” levels at the time – has been driven by Trump’s active pursuit of several “growth-enhancing policies”. He cut taxes, as you’d expect of a Republican administration. But he also increased public spending (usually a Democrat position) and pressurised the Federal Reserve to cut interest rates and keep them low.
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As a result, says Smith, real median household income for American families has grown from $62,898 in 2016 – “just $257 above its level in 1999” – to nearly $69,000 in 2019. So in fact, asserts Smith, while trade wars were a mistake, Trump’s other policies helped the US economy significantly. “Trump proved that an aggressive growth strategy can improve the fortunes of the average American family. That strategy should continue.” Continue it will, regardless of the party in power. The “Overton window” (the parameters of the politically possible) has shifted firmly in favour of big spending and against any policies that smack of “austerity”. The coronavirus outbreak and the resulting massive government intervention has only accelerated this political shift.
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Central bankers give way to politicians
We can see a similar dynamic playing out in the UK. As Russell Napier, investment historian and founder of research platform Eric points out, the line between monetary policy (the remit of central banks) and fiscal policy (the tax and spend powers of government) hasn’t so much been blurred as erased. For example, the UK government wants to introduce new 95% loan-to-value, long-term mortgages to make houses more affordable for first-time buyers. “The incentive to the commercial banks to extend such credit, and to thus create new money, is a government guarantee of the new mortgages to an extent yet to be disclosed… This is not fiscal policy – it is monetary policy conducted by government.” And unlike decisions taken in the wake of 2008, this state intervention in the money-creation process is not being driven by any economic emergency. Instead, it’s the use of “bank balance sheets to achieve what the prime minister believes will be greater social justice”. And if that’s the case, then “what might money not be created for?” As Napier puts it, “this new monetary tool is the gift that keeps on giving to those seeking re-election”.
In their most recent Long-Term Asset Return study, Deutsche Bank analyst Jim Reid and his team argue that there have been five distinct “structural super-cycles” since 1860 (see chart on page 5 for more details). We’re now entering the sixth, which they describe as “the age of disorder”. As the name suggests, it promises to be a much less investor-friendly era than the preceding “second era of globalisation”, which ran from 1980. The “age of disorder” involves several big-picture themes, but one is the question of how the world deals with its massive debt levels. Part of the solution to that is likely to be a shift to a more inflationary world – one in which politicians embrace the likes of helicopter money and modern monetary theory (MMT), which is the idea that governments with control of their own currencies should simply print whatever is necessary to fund public spending.
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