MacroR esearchBoard mrbpartners · P m mrt 2017 mr 5 b e ar eear ar m Too much debt might be a problem m But it is not the biggest problem m Nor the most immediate one m Who owes

MacroResearchBoard

partnersmrbI n d e p e n d e n t I n v e s t m e n t S t r a t e g y

Misconceptions, Reality and Investment Strategy

Peter PerkinsPartner, Global [email protected]

April 2017

Presented by Peter Perkins

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MRB PARTNERS INC. m www.mrbpartners.com m Copyright 2017©2m

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m Debt is elevated, but is misunderstood and likely won’t be the catalyst for the next crisis (it’s usually overestimating demand)

m There are many unusual aspects to this cycle, as well as misconceptions

m The global economy is rife with structural imbalances, with Switzerland being a prime example

m Investors either appear too pessimistic about the future or too optimistic; somewhere in between is probable

Main Themes


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Yes, Debt Levels Are High By Historical Standards

MRB Partners Inc © 04/2017

80

120

160

80

120

160Global: Credit to Nonfinancial Institutions* (US$ tn)

200

220

240

200

220

240

2002 2004 2006 2008 2010 2012 2014 2016

Share of GDP (%)

* Source: Bank for International Settlements



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But The Economy & Dollar Are Keys


-5

0

5

10

140

150

GDP* (%YoY, Inverted, LS

Credit To Private Nonfinancial Institutions** (% of GDP, RS)

Global:

-10

0

10

2002 2004 2006 2008 2010 2012 2014 2016

Trade-Weighted Dollar*** (%YoY, Inverted, LS

Credit To Private Nonfinancial Institutions** (% of GDP, RS)

140–

150–

* Source: IMF** Source: Bank for International Settlements*** Major currencies; source: Federal Reserve



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m Too much debt might be a problem

m But it is not the biggest problem

m Nor the most immediate one

m Who owes the debt is as important in determining risk as how much is owed

m Solving the debt problem requires stronger nominal GDP, both now and in the future

m As well as longer-term changes to our health care and pension systems

m The latter without the former will not be enough

m You can’t cut your way out of your debt problem, or into health

The Debt Problem


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Misconceptions About The Global Economy

m Misconception: Debtor nations haven’t adjusted much

Reality: Greece’s national saving rate has risen by 15% of GDP since2007; Spain’s by 12%

m Misconception: Rise in total debt has jeopardized the global economy

Reality: It prevented a depression and allowed a recovery

m Misconception: Hyper-accommodative monetary policy has created major risks

Reality: It has prevented misguided fiscal policies from exacerbating economic problems

m Misconception: Economic adjustment is primarily the responsibility of debtors;

Reality: Debtors can’t adjust if creditors don’t


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Many Debtor Countries Have Adjusted A Lot

Change In Saving Rate (% Of GDP)

2007-2010 2010-2016 2007-2016

Private Sector

Public Sector National Private

SectorPublic Sector National Private

SectorPublic Sector National

Germany 3.3 -4.4 -1.1 -1.3 4.4 3.0 1.9 -0.1 1.9

Greece 8.3 -4.5 3.8 3.5 7.8 11.3 11.8 3.3 15.2

Ireland* 37.7 -32.4 5.3 -20.8 31.4 10.7 16.9 -1.0 16.0

Italy 0.8 -2.8 -2.0 3.8 1.8 5.6 4.6 -0.9 3.6

Portugal 7.8 -8.2 -0.4 2.0 8.2 10.2 9.7 0.1 9.8

Spain 17.1 -11.4 5.7 1.0 4.9 5.9 18.1 -6.5 11.6

Switzerland 5.4 -1.3 4.1 -5.0 -0.7 -5.6 0.4 -2.0 -1.5

U.K. 6.4 -6.7 -0.3 -9.4 6.3 -3.2 -3.1 -0.2 -3.5

U.S. 10.2 -8.1 2.0 -6.4 6.8 0.4 3.7 -1.2 2.4

* Reflects government bailout of banks


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m The capital markets cycle is advanced relative to the economic cycle

m Economic cycles have been more desynchronized across countries/regions than normal

m The policy cycle has lagged the economic cycle by an abnormal amount to offset household de-leveraging, fiscal drag

De-Synchronized Cycles


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Easy Fed Policy Has Brought Forward Capital Markets Cycle

0

4

8

0

4

8Federal Funds Rate (%)

Talyor Rule* (%)U.S.:

-4

0

-4

0

1990 1995 2000 2005 2010 2015

Nominal GDP (%YoY) Minus Federal Funds Rate (%)

* MRB calculation



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The Government Has Been A Drag On U.S. Growth


-1

0

1

2

3

4

-1

0

1

2

3

4

1980 1985 1990 1995 2000 2005 2010 2015

U.S. Real Government Consumption & Investment (% 5-Year CAGR)

Note: Compound annual growth rate


Usually a source of growth


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m There are chronic current account surplus and deficit countries, reflecting structural problems and lack of adjustment

m Free capital flows appear incompatible with stable exchange rates, yet most countries want both (impossible trinity)

m Central banks have multiple targets, with too few tools

m EM countries are net global lenders, yet with higher domestic growth rates

m EM countries have built a massive FX war chest, but are punished if they use them

m There are debtor prisons (e.g Greece)

Economic Realities & Problems


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Chronic, Large Trade Imbalances Signal Structural Problems

m Large current account deficits

• Australia (4.4% of GDP avg since 2000), Greece (7.5% avg). U.K. (3%) , U.S. (3.7%)

m Large current account surpluses

• Singapore (19% avg!), Norway (12%), Switzerland (11% avg!), Taiwan (9% avg), Germany (5% avg), China (4%), Japan (3% avg)

• Switzerland has had a current account surplus each of the past 35 years!

m Policies and prices are not adjusting to correct global trade imbalances


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Singapore & Switzerland: Structural Surpluses


1980 1985 1990 1995 2000 2005 2010 2015

SwitzerlandSingapore

-10 -10– –

0 0

10 10– –

20 20– –

Current Account Balance* (% of GDP):

* Source: IMF



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m U.S. de-leveraging dampened growth, but appears over

m Euro area debt crisis/recession in 2011-2012 was a political choice, not a secular force

m Government has subtracted from growth this cycle, having boosted growth in the past (again, this was a political choice)

m Depressed “animal spirits” rather than cost of capital, profitability or other factors is inhibiting private investment; there is no definitive shortage of potential investment opportunities

m Low productivity growth is a measured fact, but few if any know what will drive it

Is Secular Stagnation The Right Diagnosis?


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Who’s Adam Smith? Cost & Return On Capital Are Out Of Whack


1975 1980 1985 1990 1995 2000 2005 2010 2015

Global Return On Equity* (%)U.S. 10-Year Government Bond Yield (%)

4 4– –

8 8– –

12 12– –

16 16– –

* Source: MSCI


Rent extractors


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Earnings, Not Just The Fed Is Driving Stocks


100

150

200

100

150

200

12-Month Forward Earnings*

12-Month Trailing Earnings*

S&P 500:

100

150

200

100

150

200

2002 2004 2006 2008 2010 2012 2014 2016

U.S. Nonfinancial Corporate Profits**

* Rebased; smoothed; source: Thomson Financial / IBES** Includes IVA & CCADJ; rebased; source: U.S. Bureau of Economic Analysis


Strong earnings performance


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The Equity Risk Premium Is High

-4

-2

0

2

4

6

-4

-2

0

2

4

6

1975 1980 1985 1990 1995 2000 2005 2010 2015

MRB Global Cyclically-Adjusted Equity Risk Premium* (%)

* Cyclically-adjusted earnings yield minus G7 10-year government bond yield; normalized for the ROE cycle


Valuation cushion for stocks


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m Firmer global growth, plus prospects for U.S. fiscal support

m Rising corporate profits following 2015-2016 profits recession

m Valuations don’t drive equity market performance on a 1-2 year horizon

m Stocks have a valuation cushion versus bonds, although corrections likely as Fed hikes

m Moderate returns on equities, losses on bonds imply poor aggregate portfolio returns

m Commodities, alternatives unlikely to significantly enhance performance

Moderately Positive Cyclical Outlook For Risk Assets


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Capital Markets Cycle: More Normal Than Believed

200

100

200

100

Global Stock / Bond Ratio*

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Real Stock Total Return**

Real Bond Total Return**

100 100– –

400 400– –

* Global MSCI stock market total return index divided by 10-year global government bond total return index; rebased** Deflated by OECD G7 CPI; rebasedNote: Shaded for NBER-designated U.S. recessions


Peaks just ahead of recessions


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Gold For The Long Run?


20 20– –

80 80– –

320 320– –Global Stock* / Gold Total Return

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

40 40– –

80 80– –

160 160– –

Gold / Crude Oil** Total Return

* U.S. dollars; source: MSCI** Equally-weighetd aggregate of Brent, OPEC, and WTI crude oil pricesNote: All series rebased



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Get Real About Investment Returns


Balanced Portfolio Returns* (% CAGR)

Conservative Portfolio Returns** (% CAGR)

Aggressive Portfolio Returns*** (% CAGR)

Country/RegionReal

ReturnNominal Return

Real Return

Nominal Return

Real Return

Nominal Return

U.S. Dollar Portfolio 2.7 4.8 2.0 4.1 3.3 5.4

Stocks 4.2 6.1 4.2 6.1 4.2 6.1

Fixed Income 1.1 3.1 0.6 2.7 1.2 3.2

Gov’t Bonds 0.1 2.2 0.1 2.2 0.1 2.2

Risk Products 2.6 4.7 2.6 4.7 2.6 4.7

Commodities 1.8 3.9 1.8 3.9 1.8 3.9

Cash 0.5 2.6 0.5 2.6 0.5 2.6

Euro Portfolio 2.7 4.3 1.7 3.3 3.5 5.1

Sterling Portfolio 1.6 3.7 1.0 3.0 2.1 4.2

* Balanced portfolio is 50% global equities, 25% domestic 10-year government bonds,15% risk products, 5% global commodities, and 5% domestic cash, measured in local currency; rebalanced annually** Conservative portfolio is 35% global equities, 45% domestic 10-year government bonds, 10% risk products, 5% global commodities, and 5% domestic cash, measured in local currency; rebalanced annually *** Aggressive portfolio is 70% global equities, 17.5% domestic 10-year government bonds, 12.5% risk products, 0% global commodities, and 0% domestic cash, measured in local currency; rebalanced annually

% CAGR: Compound Annual Growth Rate From 2016 to 2026


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Conclusions

m Our over-emphasis on debt has been misplaced—attention should be focused on growth-boosting measures and longer-term re-balancing

m The global economy has a number of structural problems, including the failure of creditor/surplus countries to allow adjustment

m The capital markets cycle will only expire when the global economy is verging on recession, which is not on the immediate horizon

m Long-term returns for major asset classes will be low, primarily because the 35-year decline in discount rates is behind us


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Contact

For more information regarding MRB - The Macro Research Board, please contact:

Amy SmithManager, Client RelationsTelephone: +44 (0) 20 7073 2819Mobile: +44 (0) 7551 008618Email: [email protected]

Peter PerkinsPartner, Global StrategyTelephone: +44 (0) 20 7073 2795Email: [email protected]

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Documents

MacroR esearchBoard mrbpartners · P m mrt 2017 mr 5 b e ar eear ar m Too much debt might be a problem m But it is not the biggest problem m Nor the most immediate one m Who owes