Intermission on the Stage of World Finance

by: Marvin Clark
The G-20 Summit is over and the US has walked away without a major commitment. From the US perspective, this has been a failed summit. The remaining G-19 member’s outlook could be interpreting this as a success. Our developed and emerging nations economic partners stood up to the minimum demands of the United States. It will not be the last time this outcome occurs.

As recent calls from various interests for a return to a global gold standard, US quantitative and non-quantitative easing proposals, emergency standby EU guarantees on possible defaulting Irish debt, currency wars, protectionism, and inflation/double-dip recession concerns are washing across the globe, notwithstanding Friday’s blood-letting on Wall Street, two fundamental events are occurring concurrently that may or may not be escaping investors awareness.

The first phenomenon is the acceleration of the structural evolution occurring in international commerce. The brunt of this change falls completely on US financial shoulders. Once upon a time, our successful or unsuccessful economic conditions rose or fell primarily on our own predilections.

Raw materials around the world were consumed or ignored, without regard to supply or cost, by the capricious needs and changing desires of the US. Many nations benefited from sharing their natural resources with us.

Today, the role of puissant global power is being performed by an ascending Zhongguo or People’s Republic of China (PRC). The US is controlling less and less of our own economic fate. Fears ran through global markets overnight as China’s October inflation rate of 4.4% exceeded the prior’s month 3.6%. Also, China’s Consumer Price Index in October rose to an annualize rate of 12.1% up from the previous month’s 5.2%.

As a result, every US market was hit with selling; the DJIA fell 90.52 or .8% to 11, 192.58; the S & P 500 fell 14.33 or 1.18% to 1199.21 and NASDAQ fell 37.31 or 1.46% to 2518.21. The Bond market was hit worse; the 2-year, 10-year, and 30-year Treasury all fell on Friday, the day that Ben Bernanke started QE II by purchasing $7.23 billion in Treasuries coming due between 2014 and 2016.

In commodities, gold lost $35.00 or 2.49% to $1368.30; silver fell $1.39 or 5.07% to $26.015, oil lost $3.08 or 3.51% to $86.53.

Two things: first, global markets and their economies are concerned that China may begin a series of interest rate hikes to cool off their economy, thereby, stifling global growth and second, 15 years ago markets weren’t concerned about the Central Kingdom’s inflation rate.

As disconcerting as this may be for US investors, this is the shape of things to come. The final cost of deregulation, NAFTA, one-way free trade, access to cheap labor, and open markets, plus developed nations’ seed capital generously pouring into emerging markets stretching over the last 20 years, has produced today’s critical mass for a radical realignment of global economic power and market share. International capital will proceed with this new perspective on global economics.

The second fundamental shift occurring, particular to the US economy, is the inevitable demise of the later 20th century business model in the 21st century. Corporations pursuing an endless mission of maximizing shareholders value from endless rising cash flow levels and robust Deltas on the back of an ossifying American economy, will discover that that formula for success is breaking down. The formula began breaking down at the onset of a NAFTA induced globalization.

This morning I spoke with a retired senior executive from the insurance industry, a friend. He told me that this week MetLife was exiting the long-term care insurance business. This follows other insurance companies that have exited both the fixed and variable annuity business in the last year. The insurance industry is realizing that their investment portfolios are becoming incapable of generating sufficient returns to sustain several of their traditional business lines going forward. Insurance industry mergers and consolidation will only kick the can down the road - not solve the problem.

Moreover, medical, pharmaceutical, and technological innovation over the next decade may extend their customer’s average lifespan 5 to 10 years or greater, crimping future earnings. Corroborating this thesis, Bill Gross of Pimco made a confession about this new reality and the subsequent detriment to the future performance of his $2 trillion portfolio in his November letter to investors.

Performing objective analytical [connecting the] dot work, this is precisely the precarious position airline and automobile industry union workers and their unions found themselves, over the last decade, which is now facing municipal workers. Austerity ideologues and the mainstream media demonize and batter retirees and their unions who merely want their mutually agreed to benefits upon retirement.

These contractual terms were earned in good-faith negotiations much like the negotiated terms of a mortgage contract. They are not the villains; the true villains are simple math and careless long-term assumptions.

Failure of the marketplace to deliver non-guaranteed but optimistic presentations of average annual assumption rates, promoted as achievable by the investment industry, revealed the limitations of the marketplace and free markets. Securing organizations asset management business was the motive. Everyone suspended disbelief.

I recently attended a Global Asset Allocation Summit and Emerging Managers Summit, both events hosted by Opal, and I was mildly shocked to hear that pensions and trusts are still clinging to 8% and 9% average annual return assumptions for their portfolios. That orthodoxy was never seriously challenged by most attendees. The predominant asset allocation are still comprised of equities, fixed income, and real estate. Alternative Investment percentages are insignificant.

While such returns were obtainable during the secular bull market of the 1980s and 1990s, investment portfolios now are confronting a secular bear stock market, a collapsed credit market restricting liquidity, punk consumer demand, and a residential real estate market in depression. For the foreseeable future, a consistent domestic 8% - 9% average annual return in a traditional asset allocation mixture is doubtful.

Realize that the inability of the marketplace to deliver on these ring-size returns is only the effect. The cause of this arrested development is the before-mentioned structural change in international commerce which renders the general usage of the 20th century US business model itself unrealistic. The average American is absorbing petite returns on her principal in CDs and T-bills, flat wages, and shrinking net worth from stock market and real estate losses.

Retiring baby boomers comprises a significant portion of affluent consumers. That generation’s consumption appetite and spending patterns have forever changed. Consumers, representing 70% of today’s US economy, are also gun-shy from one too many bubbles bursting lately to aggressively invest anymore. Consumer sentiment surveys oscillate from month to month, a clear sign of uncertainty and anxiety.

Reconciling never-ending corporate earnings increases with stunted cash flows and insecure disposable income from a mature economy captained by a constipated government, lacking a coherent industrial, fiscal and monetary policy and supposedly driven by upset and untethered voters, is unrealistic.

A once 50-cent cup of coffee is now a $4 Starbucks (NASDAQ:SBUX) Venti Iced 24 oz. Caffé Vanilla Frappuccino/Soy/Whipped Cream; a $.25 phone from a phone booth is now a $125 monthly mobile smartphone bill from Verizon (NYSE:VZ); free broadcast TV is now a high-speed internet and premium $200 monthly cable bill from Comcast (NASDAQ:CMCSA). Free daycare in a single-paycheck home is now a $200, $300, or $400 weekly KinderCare daycare expense for both working parents.

Daily expenses that were recently considered trivial are now deemed luxuries for many. I would avoid many retail stocks whose products for consumers are totally discretionary in nature.

The dreaded disease afflicting our economy is the big C - change. There is no cure. It is inevitable. How capital is managed differently, in a new century with different parameters, is equally important as where and when to invest.
The last global intermission began shortly after the end of World War I and concluded after the end of World War II. The curtains are falling on that mid-20th century world that we inherited from the greatest generation, whether or not we approve or are prepared for the aftermath.

Make no mistake; we are in another historical intermission. The datasets and impermanent financial laws of physics of the 20th century are approaching their expiration date.

Disclosure: None