The events in global economics last year were highly alarming, the sovereign debt crises in many countries have worsened significantly, and we are facing a situation today where a large number of governments, countries and individual states are facing technical bankruptcy. Of course, central banks and the IMF can put together bailout programs, and the Fed can engage in further quantitative easing programs, but all of these measures will come at a price. It would be outright foolish to believe that all this liquidity can be created out of thin air without real economic consequences.
These consequences do not come overnight, but it might take two or three years until we see the negative impacts. It is understandable that today’s central bankers are highly concerned about the reemergence of deflation and its destructive effects on their economies.
One only needs to look at the situation in Japan, where the economy has been in deflation for most of the last 20 years. A bit more than 20 years ago, Japan’s leading equity index, the Nikkei, stood at 39,000 points; it has only recently gone back up over 10,000 points. Two decades of devastating losses in equity markets: This tells us that structural problems can take a very long time to correct.
Another example is U.S. equity markets, where indices are pretty much back to the levels seen in 2000. This is not only a lost decade of flat performance, but, once the decreasing value of the U.S. currency is taken into consideration, an outright shocking loss that highlights the true dimension of the problem.
We believe that many western nations have entered a prolonged period of deep structural change that will take many years to be completed. For decades, western nations have enjoyed increasing prosperity that resulted in a steep increase of government spending and a seemingly never-ending increase in the build-up of welfare states. This has resulted in huge amounts of government debt in many major economies today -- and the problem is now made worse by changing demographics, chronic overregulation and the wrong economic incentives.
The large debt burden faced by many countries is in sharp contrast to the very healthy balance sheets of many large corporations, and this has led to a situation in which many large multinational corporations’ bonds are perceived to be safer than government paper of individual countries. This is fascinating and shows us the limits of textbook economics. Wasn’t the yield on government bonds considered the benchmark for the risk free return? Didn’t they tell us that over a long period of time equities should outperform bonds? Well, tell that to someone who was invested in Japanese equities for the past 20 years, and the chances are that they do not agree with textbook economics anymore.
But let us go back to the basics of today’s situation. The world economy is expected to grow at a rate of about 6% this year, after a strong recovery of almost 7% last year. That’s not a bad number, you might say. The problem is that global growth is spread very unevenly these days, with an ever-growing share coming from emerging markets such as China, India and Brazil, while western markets are only experiencing anemic growth. While new emerging markets present very attractive opportunities for large international companies, it means that export-oriented businesses in saturated western economies should do reasonably well, thus outperforming firms with a focus on domestic business.
Here a big problem for the U.S. and the European Union becomes obvious, as many companies do not have a high enough focus on exports. Take for example the European Union, and compare France and Germany. It is very clear that Germany is much better positioned to take advantage of the export opportunities that these new emerging markets present. Just think of cars like Mercedes, Volkswagen or BMW: They are market leaders in most of these emerging countries. Now think about the French carmakers for a moment … think a bit harder … do you even know the names of its automakers? Renault, Citroen, Peugeot ... but these producers are all significantly less successful in those new markets.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.