Welcome To The Decade Of Slow Economic Growth

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by: Diesel
Summary

In the last 100 years, multiple factors were in play to ensure economic growth.

Those factors are disappearing quickly.

Returns will be much smaller going forward.

The world economy has grown tremendously in the last 100 years driven by multiple factors such as population growth, technological advancements and rapid urbanization, not to mention a healthy dose of inflation (with exceptions) throughout the time. We expect the global economic growth to slow down not temporarily but in a more permanent fashion moving forward as these factors are changing.

Investors would benefit from adjusting their portfolios accordingly and allocate more of their portfolios towards defensive positions and keep their cash reserves growing in case better buying opportunities arise. Let's discuss some of the reasons why we expect the global economy to grow at a smaller pace moving forward.

Population factors

The world population has grown tremendously from about 1.5 billion to nearly 8 billion in the last 100 years, driven by major advancements in medicine and urban lifestyles, which has been driving global economic growth. Population growth can drive economic growth in multiple ways. First, it ensures that there is an ever-growing market for goods and services (demand side) as well as an ever-growing pool of employees who are ready to take on jobs or start their own companies (supply side).

Population growth also tends to be good for the growth of economy from a microeconomic standpoint. When people have more kids, they need bigger houses, bigger cars, more furniture and more groceries. If people have fewer kids, they need fewer things and they don't have to spend much. Obviously, going on a vacation or eating out would cost a lot less for a smaller family with fewer kids, which reduces the revenue potential for industries such as the service industry.

Now the world's population is growing at a much smaller rate because people are having fewer babies than any time in the history. Earth's population growth rate slowed down from high 2% range to low 1% range and this is mostly driven by Africa at the moment. If we exclude Africa and a few select countries, the earth's population is not growing much at all anymore. If the global economy is expected to grow at a rate of 3%, but the world's population grows at a rate of less than 1%, this makes things harder.

Fertility rates have been dropping in the developed countries for nearly 40 years, but they dipped in 2008 when we had our last economic crisis. Many people thought that the dip was temporary due to the recession, but now 11 years later we are starting to see that it is a rather permanent change. We need a fertility rate of 2.1 just to keep the size of the population constant. The US enjoys a fertility rate of 1.8 and this is one of the highest in the developed world. In Asia, Korea's fertility rate is 1.1, Japan's rate is 1.4 and China is looking at 1.6 thanks to the one-child policy. In Europe, Germany is 1.6, Italy is looking at 1.3 and most European countries range between 1.3 and 1.8. If it wasn't for immigration, Europe would be losing population, but it is barely keeping its population size constant just like its economy, which hasn't seen any meaningful growth since the mid-2000s.

The only place in the world where the population growth rate seems to be high is Africa, but the continent lacks the infrastructure and investments to fuel any meaningful economic growth similar to what China and India achieved since the 1980s.

Urbanization factors

When population growth fails to fuel growth of an economy, urbanization can help. One great example of this is China, which saw its urbanization rate quadruple since 1980 and this brought amazing economic growth despite slowing population growth. Urbanization results in many benefits including production efficiencies, which drives combined wealth over time.

Here is the problem though: the developed and developing nations are already mostly urbanized and there isn't much more room for growth. Let's take the US where 270 million out of the population of 320 million are urbanized and the rest of the population have little interest in moving to the cities. China's GDP growth of 6-8% is pretty much in line with its urbanization growth rate, but once this slows down, the country's growth rate will also have to come down, and we are already seeing signs of this happening. Currently roughly 60% of China is urbanized with possibly room for another 20%.

Ironically, urbanization slows down a nation's population growth rate even though it helps with economic expansion because the urban population, on average, has fewer children and smaller families across the world. Urban people are more likely to get married at a later age or never at all and more likely to have only 1 child or none at all. Basically, when a country undergoes urbanization quickly, it gives up population growth in favor of short-term economic expansion.

Inflation

Another factor that will contribute to slower economic growth in the future is the inflation rate. While inflation is considered a "scary" word, a healthy dose of inflation (around 2%) can help drive economic growth by increasing wages and spending across the board. Currently, with all the central bank money printing and low interest environments around the world, the inflation rates are looking particularly anemic.

As long as companies continue to spend their money on buybacks instead of growing their core businesses, inflation rates will continue to be tamed, which will limit the economic growth we can achieve.

Technological advancements

Technological advancements certainly help economic growth by increasing output of goods. Just look at the global food production which multiplied over the years. According to World Bank, just between 1960 and now, the global food production almost quadrupled. A hundred years ago we had trouble feeding 1.5 billion people while now we can comfortably feed 8 billion people even though the average diet today has far more calories than it had 100 years ago. This is nothing short of a miracle.

On the flip side, we are passing a point where technological advancements might be playing against economic growth. Robotics, artificial intelligence, and machine learning are likely to replace many human jobs, not only those that rely on repetitive manual labor, but even those relatively more complex jobs such as driving cars, trucks and buses. Meanwhile, companies are getting more efficient and learning to do more with less resources, which might help their margins but hurt global economic growth in the long term.

Monetary policies

Currently, monetary policies in developed countries is so accommodating that there isn't much room for them to get even more accommodating. With interest rates near zero in America, Europe and Japan, there isn't much central banks can do to jump start their economy if things go south (even though they seem to be good at inflating asset prices without driving actual economic growth).

So if the world population is not growing anymore and our markets can't expand to a larger number of customers and workers, interest rates can't go much lower, urbanization rates have little room to grow, technology is actually reducing the need for more workers, not to mention an ever-aging world population, what exactly will drive economic growth in the next decade or so?

Slowing economic growth wouldn't be a problem if valuations weren't so rich, but the current stock valuations are already pricing in strong future growth that might or might not actually happen. One valuation metric (apart from traditional metrics such as the P/E ratio) I like to look at is dividend payout ratios of some well-known global customer staple stocks because this can tell me the lengths these companies go to in order to sustain or grow their dividends. I pulled a small sample of these companies in the chart below, and as you can see, dividend payout ratios range from 60% to 105%, which means these companies are overextending themselves as it is and any future dividend growth will be very difficult to achieve moving forward unless an economic miracle happens or inflation suddenly blows up.

Another metric I'd like to look at is debt of companies. In the last 10 years, central banks around the world gave companies easy access to cheap money and companies used this money to drive stock buybacks rather than invest into their businesses. Well, this reduced the share counts in most companies but increased debt levels tremendously.

Let's look at Coca-Cola (KO) just as an example. In the last 10 years, the company's share count dropped significantly while its total debt and debt-to-equity ratios skyrocketed. Why? You guessed it correctly: the company took on debt to buy back more shares. This is not just a Coca-Cola problem as we see this in almost every blue chip out there.

Corporate debt has been rising across the board for the last decade. This behavior was driven by easy money policies of central banks around the world and these policies didn't help the average person much. In the graph below, you'll see the non-financial corporate debt of American companies collectively. Companies will continue to engage in this behavior for as long as they can get away with, which means we'll be seeing anemic growth and low capital investments for a long time to come.

Source: St. Louis Fed

So if companies are already loaded with debt, allocating more and more of their earnings to dividends and buybacks, the population growth is slowing and all the trade wars going on around the world, what exactly will fuel further economic growth? Will central banks, governments and corporations around the world suddenly change their ways and invent new ways of growing the economy?

This doesn't mean that I suddenly expect the market to crash and come down to earth, but I certainly expect anemic returns in the future. In Europe and Japan, we have already been seeing flat to down markets, and even in America, the stock market has been largely flat between January 2018 and now.

Dividend growth is also likely to be anemic moving forward. The chart below shows the total corporate dividends in a given year in American stocks, and while the line has been growing year over year, you can see that the growth has been flattening. In 2011 and 2012, the average dividend growth was 22% and this rate dropped to 7% between 2013 and 2016. Since 2016, the average annual dividend growth rate is 2.15%. Where will future dividend growth come from when companies have 60-70% payout ratios as it is?

Conclusion:

All signs show that economic growth and stock market returns will be anemic if not negative in the next 10 years unless Africa can pull a miracle similar to what China and India did since 1980s. The global population growth is shrinking, inflation is non-existent, companies are putting their money to buybacks instead of growth, people are aging, companies and governments around the world are loaded with debt, urbanization is mostly done in most parts of the world, central banks are running out of bullets, not to mention the fact that stocks are valued at an average P/E of 22 as if we are enjoying a global economic boom.

Something has to give sooner or later. Investors would be better served by allocating their portfolios to defensive positions with having cash reserves on the sidelines in case better opportunities arise in the future.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.