We Have a Problem
Friends Don’t Let Friends Buy and Hold
Dallas, SIC, and Conversations
My recent letters described what I think the future will look like. I hasten to add, it isn’t what I think the future should look like or what I want to see. Almost the entire developed world has painted itself into a corner.
It won’t necessarily be terrible. I don’t expect another Great Depression or economic upheaval, but we will have to adapt our portfolios and lifestyles to this new reality. The good news is the changes will happen relatively slowly. We have time to adapt.
In war movies, it’s common for the dashing leader to make bold promises like, “We will never retreat!” ahead of a glorious victory. The assumption is that retreat is bad. But real-life military strategists say retreat can be the right move. When the odds are against you, better to save your ammunition for another time. Better yet, adopt a new strategy that gives you a better chance.
My last few letters may look like retreat, but I’m just recognizing reality. There is no plausible path to stopping the world’s debt overload, much less paying it off, without a serious and painful purge. If you know of such a path, please share it with me, but I haven’t seen one. So I foresee a tough decade ahead.
- Entitlement spending, interest on the debt, defense spending, and so forth will continue to produce trillion-dollar-plus deficits.
- No constituency is arguing to reform the entitlement system by reducing benefits. By the middle of the next decade, deficits will be in the $1.5 trillion range even under the CBO’s optimistic assumptions. While the numbers look marginally different elsewhere, the developed countries are all going the same direction: toward higher deficits.
- Following the next recession (and there is always one coming), the US deficit will be well north of $2 trillion and the total debt will quickly rise to $30 trillion. It will almost certainly be in the $40 trillion range before 2030. Unless interest rates drop significantly, simply paying the interest will consume much of the tax revenue. (Fortunately, I expect interest rates to drop significantly. Think Japan.)
- A growing body of academic literature and real-world experience suggests there is a point beyond which debt becomes a drag on growth. That means that the recovery after the next recession will be even slower than the last one. If, as I expect, the Federal Reserve and other central banks react with massive quantitative easing, it is entirely possible that the whole developed world will begin to look like Japan: slow nominal GDP growth, low interest rates that penalize savers, low inflation or even deflation, etc.
- In such an environment, normal equity index funds won’t produce the returns many have grown to expect.
- Public pension funds will get hammered in the bear market and many will have difficulty meeting their obligations. Governments will be forced to either cut benefits, raise taxes, or both. That is not going to make for a happy citizenry. It will play out in different manners all across the world, but the resulting frustration will be the same. And to put it very bluntly, “frustration” is inadequate to describe the result of underfunded pensions. Retirees made plans for their futures based upon receiving those pensions. And taxpayers likewise make plans.
- All of this will have significant investment implications, which we will visit below and in great detail in the coming weeks and months. But Japanification, to use a word, is going to make income and wealth inequality worse, not better.
This all being the case, the priority now isn’t whether to “retreat,” in the sense of changing your investment strategies, but how and to where, so you can pick up the fight later. Developing a strategy requires us to understand exactly what is happening and why. So I’m looking at the situation from different angles.