A World Out Of Balance

With $28 trillion in debt stacked on a $10 trillion economy, China has its fair share of excesses. The good news, according to Jones, is that most of this debt is internally funded by its excessive savings rate, which reduces the risk to America.

Contrarian thinkers might conclude the best reason to consider reallocating money to commodity-dependent emerging nations is that investors today hold them in total disdain, according to Fuss. Still, he adds they have not been beaten up that badly in his view. That is quite a statement given that many Brazilian equities are down 80% in dollar terms from their highs five years ago.

In Bernstein’s view, many investors are confusing symptoms and problems. The symptom is the underperformance of such credit-related asset classes as gold, private equity, hedge funds, commodities and REITs, all of which outperformed other asset classes between 2000 and 2008. Since then, all these groups have been underperforming on a secular basis. The problem is the ongoing deflation of the credit bubble of the last decade.

Some of the current problems in the U.S. can be traced to the strong dollar and the collapse of oil prices, which have triggered a mild profits recession, particularly among multinationals and energy companies. The twin forces of a possible increase in the fed funds rate coupled with at least a temporary end of the S&P 500’s profit cycle played a key role behind the recent stock market correction.

Among portfolio managers at the showcase, the bias favoring the U.S. assets was pronounced. Jim Swanson, chief investment strategist at MFS, was outspoken in his view that the U.S. economic expansion was not “a juiced up cycle” and was “very unlike the past three cycles.” Superior profit margins and unit labor cost advantages make the U.S. very competitive in a Darwinian global economy.

Private sector growth of 3% a year and shrinking government spending are clear positives in Swanson’s opinion. Furthermore, perma-bears who cite the Shiller PE ratio as a warning sign of a bubble are relying on a measure that, while very useful in certain instances, possesses some serious problems, he believes. It fails, for instance, to reconcile changes in accounting regulations and currency regimes.

America’s attraction to global investors can be explained partly by its relatively quick recovery from the great recession and its newfound energy independence. Between 2000 and 2008, the dollar fell 50% and the greenback is now in the process of retracing that move. As companies and countries try to slash prices and devalue currencies, Bernstein sees the trend as beneficial for both the dollar and U.S. consumers.

America is still facing serious challenges arising from debt, disinflation and demographics, prompting the gloom and doom crowd to question whether the U.S. is becoming Japan.

“The question they should be asking is: Is the whole world becoming Japan?” Bernstein says. “This is why monetary policy is becoming increasingly impotent.”

Why? Aging populations will place more severe strains on Europe, Japan and China than they will on the U.S.

Meanwhile, the world economy remains afflicted by massive overcapacity in the wake of the global credit bubble. Bernstein says that this in many ways resembles the liquidity trap Keynes depicted during the Great Depression. There is “virtually no inflation in the developed world” and “we believe it will continue.”

Why? The global economy has been transformed into a Walmart world where everyone is cutting prices to gain market share. Compounding this Darwinian environment, nations like China are devaluing their currencies and exporting deflation as competitive weapons. The U.S. economy and consumer could “feast on the rest of the world’s problems,” Bernstein says.

But for how long? It’s true that America isn’t dependent on exports to the degree that China, Germany and Japan are. Imported oil is no longer the Achilles’ heel it used to be. That doesn’t mean the U.S. can remain immune from a world where asset prices drift out of balance as central banks flail  and fiscal policy is neutered by political dysfunction.

Sitting on top of an imbalanced world where other nations are grappling with a smorgasbord of woes is comfortable for a while, but it isn’t sustainable. The U.S. found itself in that position in 1945. For decades, wages climbed as productivity rose but by the 1970s, foreign competitors were figuring their own ways to feast off of America’s bloated cost structures.

American workers may be benefiting from advances in medical science and enjoying the fruits of clever technology but aren’t seeing meaningful wage gains these days. In today’s global supply chain, where economic agents can react in nanoseconds, competitive advantages don’t last very long at all. And one has to wonder whether investors here and elsewhere should expect much from their financial markets when they expect so little from their economies.