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We've got a global growth crisis--evidence, strategies, and stock picks for The Great Slowing
07/02/2013 8:30 am EST
Growth has faltered in Brazil, Russia, the European Union, Mexico, China, the United States and more. Economic systems based on state-controlled/state-directed demand—such as China and Russia—have seen growth rates fall. Economic systems based on the creation of consumer credit—such as Brazil—have stumbled and can’t seem to get up. Systems hoping to use cheap central bank money to stimulate growth—such as the United States—haven’t seen growth commensurate with the trillions in debt added to central bank balance sheets. Economies such as the EuroZone that have combined cheap debt with budget austerity can’t—now that Ireland has moved back into recession—point to a significant success story.
No matter the region, no matter the economic policy response, no matter the economic system, growth is very hard to come by.
The big question for investors is Why?
If you want to figure out where to put your money for the decade ahead, and how much risk you can afford to take, and what kind of returns you might expect, the reason behind the global slowdown in growth—I’d go so far as to call it a “global growth crisis”--is critical.
I’ve got an explanation. I’ll lay it out in this post and you can judge if it makes any sense to you and if you think it can help guide investment decisions.
I think the global crisis in growth has been brought on by decades of really, really bad decisions on how to allocate capital. Too much has gone into unproductive uses—frequently, ironically, in an effort to support economic growth. The flood of cheap money from the world’s central banks has multiplied the effects of this misallocation of capital by 1) making everyone believe that capital was really cheap and abundant just as the world is approaching an era of scarce and expensive capital, 2) allowing governments to believe that they could paper over the problems in their economies with cheap money, and 3) letting countries put off necessary decisions and investments until dangerously late in the game.
Even now many countries are still behaving as if cheap money can fix the problem.
Many, but not all. If you’re investor with a long-term view, this is a time to overweight economies that show the best chance of escaping this crisis (either through intelligence or luck), to underweight those economies that show every sign of stumbling deeper into a growth crisis, and to adopt stock picking strategies that will let you avoid the worst of these potholes.
I’d put Mexico and Brazil in that first overweight group. I’d put Russia and the European Union in that second underweight group. And I’d put the United States and China into a toss-up group.
Let me explain why.
Of course, there could really be no global growth crisis.
It could simply be coincidence. The Brazilian model of growth founded on expanding cheap credit for a rising “middle class” could be failing at the same time as the Russian model of state-controlled kleptocracy has run out of gas. Possible but given the differences of the economies involved, it seems unlikely.
It could all be global blowback from a slowdown in China’s economy. That might—and does to my mind—explain a good part of the slowdown in Australia and Brazil—but given how little—relatively—the U.S. economy depends on exports, it again seems unlikely.
It could be all a result of the money-printing, blow-up-their balance sheet policies of global central banks. Well, I’d certainly say that central bank policies play a role in the current stage of the crisis, but I see those policies more as a reaction to the growth crisis than a cause of it. Central banks launched their campaign of printing money and expanding their balance sheets in response to a global growth crisis already in progress. I think that flood of cheap money made the underlying problems worse—but I don’t think it caused them.
To take a look at root causes, let’s turn to Russia and Brazil, two countries with very different economies but both facing a growth crisis.
Russia first. There’s no real argument between experts inside and outside Russia that the Russian economy is in trouble. In May the European Development Bank cut its forecast for 2013 GDP growth to 1.8% from an earlier 3.5%. A month earlier the Russian Ministry for Economic Development had cut its forecast for 2013 to 2.4% from 3.6%. In addition the ministry had warned that the country risked falling into recession by the fall of 2013.
And both experts inside and outside the economy say the country needs to act immediately to revive growth.
But the experts outside and inside the government offer very different growth prescriptions. The outside experts emphasize reforms to the country’s financial system that would make Russia more attractive to foreign and domestic capital. We’re not talking minor reforms—we’re talking about changing the financial and legal system so that investors and entrepreneurs don’t wind up in jail because someone with powerful political connections wants to take over a business or to eliminate a competitor. About 110,000 people are in jail in Russia for economic crimes. Some of those imprisoned have lost ownership of their companies to the police or other officials who brought them to court on fraud charges. You know there’s a big problem because the government has proposed amnesty for 13,000 of those in jail for economic crimes.
But recent stimulus proposals from the Putin government focus on business as usual. Russian president Vladimir Putin has proposed taking up to $43.5 billion from state pension funds and investing it in three big infrastructure projects: a modernization of the Trans-Siberian Railway, a new 500-mile high speed rail line between Moscow and Kazan, and a new superhighway ring road around Moscow.
In other words when the country desperately needs to attract foreign capital to modernize and expand the energy industry that provides the bulk of government revenue, the Putin has proposed the same kind of centrally controlled, big ticket projects that haven’t worked very well for the Russian economy as a whole.
The contrast between Russia’s big infrastructure, state-controlled export driven economic strategy and the strategy that has driven Brazil’s growth in recent years couldn’t be more extreme. Brazil’s economic strategy, under the Lula and Rousseff governments, was to grow a new consumer class by increasing incomes using conditional cash transfers from the government to lift families out of poverty. For example, the Bolsa Familia—which by 2011 covered 26% of the country’s population—provided monthly cash payments to poor families—paid by debit card to the female head of household—for each child attending school. The government then leveraged that higher income through policies that provided cheap and easily accessible credit for the purchase of household appliances and other consumer goods.
That economic strategy has major success to its credit. In 2010 Brazil’s economy grew by 7.5%. And Brazil had seen its GINI co-efficient of economic inequality fall from 0.596 in 2001 to 0.518 in 2009. (The closer a GINI score is to zero, the more economically equal a country is. For comparison, the United States had a GINI score of 0.468 in 2009. China’s GINI was 47.4 in 2012, according to the CIA World Factbook. Denmark, among the world’s most economically equal countries had an estimated GINI coefficient of 0.248 in 2011.)
But recently that strategy has fallen apart. Growth shuddered to just 0.9% in 2012 and the economy grew at only an annualized 1.9% rate in the first quarter of 2013. At the same time inflation has climbed until it hit an annualized 6.46% in May. That’s within spittin’ distance of the central bank’s 4.5% give or take two percentage points inflation target. Which leaves the Banco Central do Brasil with a no-win choice of slowing the economy to fight inflation or risking that inflation will run out of control.
You don’t have to be an economist to figure out what’s wrong with Brazil’s economy—the protestors that have taken to the streets across the country in recent weeks have a very accurate idea. Brazil, they say accurately, has neglected infrastructure—a nine-cent far increase in bus fares in Sao Paulo for terrible service triggered these protests. The country has spent billions on soccer stadiums and let education languish. Health care is in scant supply and expensive.
Economists can put more specific numbers to those charges but they don’t disagree. A record gain harvest in 2013 has overwhelmed Brazil’s roads and ports with 12% of grain spoiling before it reaches consumers. Only 5% of Brazil’s roads are paved versus 50% in China. The country’s ports and airports are rated among the worst in the world and the country’s road infrastructure is worse than India’s.
In 2012 Brazil became the sixth largest economy in the world, overtaking the United Kingdom. But only 17% of Brazilians 18-24 are enrolled in university degree programs or have a degree. Less than 50% of Brazil’s workers have finished high school. Is it any wonder that productivity growth in Brazil has turned abysmal. From 4.1% in 2010, productivity has tumbled to 0.7% in 2011 and to 0.3% in 2012.
As with Russia, when the economy hits a crisis, the impulse in Brazil has been to try more of the same—an impulse made easier, as in Russia and other economies by having more of the same require only more debt rather than tougher structural changes.
In Brazil, though, that impulse has run dead on into a consumer who is drowning in debt. Credit outstanding to households grew to 44% of disposable income from 18% in a decade. It’s impossible to fix Brazil’s growth problem by engineering an increase in consumer borrowing.
I don’t mean to suggest the Brazil and Russia are unusual—indeed my point in picking two countries with such disparate economic strategies is to argue that we’re looking at a global growth problem that transcends national differences in economic policy.
The United States tried to use cheap mortgages and a housing boom to bridge its way back to growth after the slowdown in growth in 2001 (1.1% growth) and 2002 (1.8%) after the heady growth of the late 1990s (4.2% growth in 2000 and 4.9% growth in 1999.) And we know how that turned out.
China used massive stimulus to avoid the worst consequences of the global financial crisis but the result has been an economy that’s getting less bang for every stimulus buck. State-owned enterprises get the bulk of available capital—85% of bank loans in 2009—because they provide huge numbers of jobs for local governments, but profits have been dropping in good part because all that capital has create massive overcapacity in industries such as steel and solar. In the first quarter of 2013 profit growth for state-owned enterprises dropped to 5.3% from 7.7% growth in the first quarter of 2012. Total productivity growth in China dropped to 2% in 2011.
As in the United States where it’s easier to have the Fed do it than to actually introduce structural changes in the economy, the economic policy up to this point has been to hope that the People’s Bank can manage to generate the economic growth the country needs and still keep inflation and asset prices under control.
I could continue my around the world survey to take in Japan, India, Turkey, and the EuroZone, just to mention a few stops, but let me switch gears instead.
If we do indeed have a global growth crisis, and it’s likely to last for a while, whatever short-term rallies and corrections we may see, what does that mean for your portfolio.
Five things I think. Call them five rules for a global growth crisis.
- First, if global growth is going to be slow I don’t think investors are going to see much in the way of price inflation. Interest rates will almost certainly go up as central banks and governments struggle to pay for the huge debt they’ve run up—and that debt will be harder to pay off without price inflation—but I don’t think investors can count on inflation to run up the price of commodities, for example.
- Second, if global growth is going to be slow, the expected rate of return on stocks is going to be modest—and on bonds it’s likely to be very, very modest if interest rates are climbing. I know dividend stocks are getting pummeled right now on interest rate fears and because they had such strong run up, but I continue to believe that if you can find a 5% yield in the stock of a company that can increase dividends over time, you should snap up those shares.
- Some countries will struggle and then fail to meet the challenges of an era of slower economic growth—they won’t make the structural changes they need to make or those structural changes will be just too tough to implement. Other countries have a better chance to find policies that will result in better than average (for their peer group) economic growth. In the “they’ve got a very tough row to hoe” group I’d put Russia, Japan, and most of the EuroZone. In the “they’ll beat the averages” group I’d put Brazil, Mexico, Norway, Poland, Canada, and Singapore. The big toss up countries are the United States and China. I’d put the U.S. in the “beat the averages” group largely on the luck of the U.S. energy boom. China’s course will depend on the political skills and ideological flexibility of its new leadership team. It’s way too early to render that judgment. In general and over the long-term, I think you should overweight “beat the averages” economies and underweight the laggards.
- While a rising tide lifts all boats, a lagging economy doesn’t sink all companies. Even lagging economies claim national stars that are global leaders. The fact that they’re headquartered in Brazil or France or Japan is close to irrelevant for these companies who manufacture or deliver service from facilities around the world—and compete not with domestic sector peers but with the handful of true global leaders. You can find my ideas for some of those companies in my Jubak Picks 50 Best Stocks in the World portfolio http://jubakpicks.com// .
- Oddly enough the world’s struggles with slow growth will actually work to the benefit of some companies. For example, there are companies that deliver the kinds of solutions that governments need. In Brazil, for instance, the protests have taken down the stock market in general hard but Kroton Educacional (KROT3.BZ in Sao Paulo) has held its own and even climbed on some days. The thinking is that Kroton Educacional, as the largest provider of private education in Brazil, will benefit as the government spends more to meet protestors’ demands for more access to higher education. In the same vein I’d look for shares of companies that give governments the ability to keep the lid on social protest either by providing better services—more sewers in the Philippines from Manila Water (MWC.PM in Manila)—or more roads and airports in Brazil from infrastructure investor and operator CCR (CCR3.BZ in Sao Paulo.) I’d put food staples companies in this category too since I think governments stressed by demands for more jobs or better health care will do everything they can to make sure that their populations have something to eat. The Roman emperors were onto something, in my opinion, with that bread and circuses thing. To me that suggests tortilla giant Gruma (GRUMAB.MM in Mexico City), chicken producers Industrias Bachoco (IBA in New York or BACHOCOB.MM in Mexico City) and BRF (BRFS in New York or BRFS3.BZ in San Paulo.) And it suggests retailers that can bring a wider variety of goods to underserved consumer populations. That would include 7-Eleven owner Seven & I (3382.JP in Tokyo) and Hengan International Group (1044.HK in Hong Kong.)
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , I liquidated all my individual stock holdings and put the money into the fund. The fund did own shares of CCR, Gruma, Hengan International, Industrias Bachoco, Manila Water, and Seven & I as of the end of March. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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