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Dr. Stephen Leeb is the editor of The Complete Investor newsletter. The Complete Investor newsletter has earned awards for Editorial Excellence for 2004 and 2005 by the Newsletter & Electronic Publishers Association. Dr. Leeb is the author of six books on investments and financial... More
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Game Over: How You Can Prosper in a Shattered Economy
  • The developing world takes over 0 comments
    Sep 29, 2009 12:07 PM | about stocks: AAPL, SRCL, FPL

    A couple of economic statistics released last week suggest the economy may be growing more slowly than expected/hoped/prayed. These included a slowdown in housing and weaker durable goods orders (now that the cash for clunkers program has ended).

    However, the biggest event was the G20 meeting in Pittsburgh, in which it was decided that the annual summit of the G8 (an organization of the world's top 8 developed economies) will now be replaced by a meeting of the G20 – a group that includes many of the developing and resource-rich nations I've been bullish on. This passing of the baton signals an important change in the world.
     
    The days of U.S. hegemony have ended. Political power is shifting from Europe, Japan, and the U.S. to Asia, South America, and other developing nations, in recognition that economic power has gone the same way. In terms of goods produced, Chindia's economy has surpassed that of the U.S. The economy of the entire developing world now equals the entire developed world. And given the huge population of the developing world, we must conclude its growth potential far exceeds ours. If we ever get back on top again, it won't be for a very long time.
     
    We've talked before about what this change implies. The developing world's voracious appetite for commodities promises to act as a tax on the developing world – pushing up prices to new heights and choking growth. Oil and some commodities may have corrected recently, but even another 10%-20% decline will only be a buying opportunity. As long as worldwide growth remains positive, commodities will be in a long-term bull market.
     
    What's more, this change will have a more subtle but important impact on stock market returns...
     
     
    MOVE OVER ENGLAND AND ROME!
    THE U.S. TAKES A SEAT ON THE “FORMER CENTERS OF THE WORLD” BENCH
     
    If you've been told you can expect to make 10-12% a year from an index fund, think again. The stats don't back up such creative spin.
     
    People who talk about the long-term average return on stocks generally rely on some 83 years worth of data. A few people trace market history back as far as 1804, but it's not clear whether stats from back then are reliable enough or standardized enough to base conclusions on. 
     
    Nonetheless, whether you start from 1804 or 1926, all the data on long-term stock market performance is based on the U.S. Moreover, they cover a time when the U.S. went from being a developing nation to king of the developed world.
     
    When looking at this data, you must realize that the U.S. did not grow at the steady pace suggested by the long-term average. In the developing phase, growth was far more rapid. But as our economy matured, growth began to slow. Therefore, as an 83 or 205-year-old economy, the U.S. is unlikely to ever enjoy the pep and vitality it did in its youth. Nor will it likely become the fastest growing nation ever again, not when there are young whippersnappers like China and India running against us.
     
    True, between 1970 and today, the growth rate of the U.S. exceeded that of the equally mature, developed nations (excluding Canada) by about 0.5% a year. We were the best of the old-timers. 

                However, during this period, average real returns from stocks were far less than in the 40 years before 1970 – despite the Great Depression of the 1930s. We had reached middle age and didn't realize it because the developing world was still in diapers. But the U.S. and the rest of the developed world were past their prime. 

    Now, it's not impossible that in the future the U.S. could regain some of its former influence. Kind of like a spry octogenarian who still has a few tricks up his sleeve. However, as we become a smaller piece of the global economy, we are losing status. With power shifting elsewhere, the U.S. will have to accept other nations' terms more often and dictate terms a little less. Consequently, our stock markets probably won't produce the same high returns everyone has been raised to expect.
     
    Indeed, rather than plan on the long-term average returns continuing, we must recognize that real returns have been in a slow decline for 40 years (the late 1990s being just a bump in the road). 
     
    As investors, our path is clear... 
     
    DON'T BET ON GRANDAD
     
    If we could give you one overriding piece of advice for the next few years, it is to avoid index funds or any other strategy that replicates the return on the S&P 500. We simply cannot see any scenario in which that would pay off well. Of course, there are many money managers who don't come close to beating the market, so an index fund might outperform the laggards. But if you want to get rich, you'll need to beat the S&P by a wide margin, and that means investing elsewhere.
     
    We've said before that the economy seems destined to experience further bouts of either high inflation or deflation. It's hard to say for sure which. Curiously, whichever one you hope for depends a lot on your financial status.
     
    If you're a financial institution, for instance, or simply very wealthy, you will probably hope for deflation. During the Great Depression of the 1930s, stocks, bonds, and T-bills all posted fairly decent returns. Certainly, they were more profitable than in the 1970s when inflation ruled. So if you're living off your financial assets, deflation will seem more appealing.
     
    On the other hand, if you are struggling to raise a family in an economy where jobs are scarce, deflation is your worst enemy. Consequently, the majority of voters will find inflation more bearable, which is why we expect the government will err that way.
     
    Yet, since we don't know for certain which of the two 'flations will result, we must find security in either event. Which brings us to the subject of gold.
     
    Since 1971, gold bullion has returned an average of 9% a year – roughly equal to the long-term return on the international stock markets. In the more recent past, gold has outperformed every other major asset.
     
    What makes gold's performance in the past four decades especially impressive is that it took place during periods of both inflation and deflation. 
     
    So gold is more than a hedge. It's an asset class of its own, and one that deserves a heavier weighting.
     
    (An example of a hedge would be zero coupon bonds, which protect you even better than gold against a deflationary event.)
     
    As for stocks, apart from avoiding index funds or any other overly diversified approach, we will steer you towards companies that can thrive in either inflation or deflation.  We are looking now at companies which have dramatically outperformed over the last 10 years, produced strong double-digit returns, are sound enterprises, and retain the fundamental advantages they have enjoyed in the past. Since these companies thrived in both inflationary and deflationary periods, they have a better chance of thriving going forwards.
     
    Some obvious examples of such companies are Apple (AAPL) and our recommended defence stocks. Stericycle (SRCL) has the advantages of being a deep franchise in the growing area of medical waste. Another curious success story is FPL, which is one of the few utilities to produce double-digit returns.
     
    But whatever you invest in from now on, bear in mind that times have changed. You cannot depend on the past as a reliable guide to the future. Just like you wouldn't expect Muhammad Ali (now age 67) to win the heavyweight title again, don't expect the U.S. market to outperform the rest of the world. You must look at who's up and coming now.
    Themes: utilities, energy, zero coupon bonds, technology, third world Stocks: AAPL, SRCL, FPL
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