The summer correction has investors rethinking assumptions that global growth will lift all boats. The debt problems of the United States and Europe have become so worrisome that a Bank of America Merrill Lynch survey of 244 fund managers this week found a majority now bearish about global economic growth.
After the 2008-2009 financial crisis, I read several books dissecting what happened. More recent books make it clear the debt problems that triggered the 2008 debacle never really went away. For those looking for an end-of-summer read, I heartily recommend two Wiley-published books: John Mauldin’s Endgame: The End of The Debt Supercycle and Gary Shilling’s The Age of Deleveraging.
Mauldin attributes to George Soros the observation that the collapse of the financial system is real and far from over: “Indeed, we have just entered Act II of the drama, when financial markets started losing confidence in the credibility of sovereign debt.” Mauldin also interviews the authors of another must-read: Carmen Rogoff and Kenneth Reinhart’s This Time is Different.
They argue the next recession will be about deleveraging. 2008 was about governments coming to the rescue of corporations crippled by debt. Today, it’s about governments overwhelmed by debt, up to and including the United States.
Countries have limited options to get out from under their debt burdens: They can default, inflate, live within their means or grow their way out. The latter is the preferred route, which is why so many are disheartened by lacklustre growth. Without it, recession and lower stock prices are likely.
Unlike Greece — which is stuck with the euro — the United States has the advantage of its own currency, one that is also the world’s reserve currency. Mauldin expects the United States will resort to “financial repression” — some combination of inflation and devaluing the greenback. This would provide less pain for Americans but will hurt bond investors and foreigners.
He foresees less growth and more frequent recessions. He refers to the unprecedented experiment by the Federal Reserve and other central banks to reflate the global economy — dubbed The Great Reflation in Anthony Boeckh’s excellent book of that name. Boeckh’s current newsletter addresses the U.S. debt supercycle of Mauldin’s subtitle: “The enormity of the current crisis is evident ... market reaction has made it clear that the authorities have lost control. Even France is now affected.”
How can investors assimilate all this looming bad news? It’s tricky because as Boeckh and Mauldin point out, it’s not clear if the ultimate outcome of deleveraging will be deflation or inflation.
Politicians inevitably opt for inflation but Mauldin doesn’t rule out deflation first, followed by inflation or even hyperinflation. His book points to some regions, including the U.K., that are in inflation mode while others, like Japan, stay mired in deflation. (Mauldin colourfully describes Japan as a “bug in search of a windshield.”)
Mauldin scarcely mentions Canada except to say it and Australia have been the only major countries to escape a housing debacle. However, he sees any China slowdown as ominous for Australia’s resource-heavy economy, which should give Canadian resource bulls pause.
Shilling expects deflation, a stance he’s held at least since he wrote Deflation back in 1998. He predicts a decade of slow growth and/or outright deflation. His list of a dozen investments to avoid includes makers of big-ticket consumer items and lenders, home builders and suppliers, banks, junk bonds, low- or old-tech capital equipment producers, commercial real estate, commodities, and Japan and emerging markets.
His 10 buys include treasuries and quality government and corporate bonds, dividend-paying stocks of utilities, consumer products and health care, makers of small luxuries, the U.S. dollar, North American energy, productivity enhancers and investment advisors and financial planners.
Mauldin has two lists, depending which you think is more likely. If deflation, his recommendations are similar to Shillings’. If inflation, “buy things the government cannot print or create at will,” like gold and other precious metals, hard commodities and real estate. He also suggests inflation-linked bonds, corporate bonds, materials and energy stocks, consumer staples and “commodity currencies” like the Canadian/Australian dollar or Brazilian real.
It’s a tall order putting all this together. Investors need to pay close attention to economic developments, work with exceptional advisors and be nimble. Those with no view on the tug of war between inflation and deflation could do worse than stick with a traditional balanced (50/50) portfolio of stocks and bonds, like the balanced Fidelity example we looked at last week. Exposure to alternative investments and hedging via reverse ETFs or ETNs may also be in order.
But first, get a glimpse of the possible future by catching up on these reading suggestions.
Financial Post
jchevreau@nationalpost.com
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