- Central banks didn’t manage to tighten at all up to 2020 and this led to high inflation and economic stagnation.
- Developed countries’ currencies significantly depreciated while emerging markets gained in strength due to their high productivity levels.
- In 2020, financial markets became rational again as eventually, fundamentals have to come first.
I somehow managed to go to the future to the 16th of June 2020. However, I was only there for a few seconds and only managed to check on Investiv Daily.
I found an article that explains with perfect 20/20 hindsight what has happened in this decade and how everybody was blind to what was going on. I’ve copied the article here in order to give you a look at how the next few years will play out.
This article is copied without permission but as I published it in the future prior to the actual publication of today’s article, legally I am actually the owner so no permission needed.
What Has Happened In The Last Decade?
The last decade began with the world crawling out of the worst recession since the Great Depression back in the 1930s. However, in order to speed up economic revival, central banks embarked on an unprecedented easing spree. Interest rates went down to zero and stayed there for too long. Central banks also loaded up on bonds and pushed their balance sheets to unheard of highs.
Figure 1: Aggregate balance sheet of large central banks in trillion $ and % of GDP. Source: Citi.
With 40% of GDP created out of thin air, it’s clear in hindsight that the situation wasn’t sustainable. Consider also that productivity growth rates for the countries in the above chart have been between 0% and 1%, with the exception of China.
China was a unique case because the inflated balance sheet wasn’t a result of quantitative easing but more a necessity of creating enough liquidity to cover the huge trade surpluses and foreign direct investments into the country in order to keep the currency stable. It’s also important to note that the Chinese economy grew at a high single digit rate during the whole decade and the People’s Bank of China trimmed its balance sheet and raised rates immediately at the first signs of overheating.
Figure 2: PBOC’s balance sheet has stabilized. Source: Bloomberg.
Contrary to what China did, the ECB and the FED just rang the bells that they would tighten but then did next to nothing. The EBC continued to buy everything it could buy and inflate assets prices to the max. Purchases went so high that there wasn’t anything left for the individual investor to buy.
Figure 3: ECB purchases of European securities. Source: Citi.
Despite the ECB announcing in 2017 that it would cut its bond buying program by the end of 2018, it was clear that that was something easier said than done. With government debt at 132% of GDP in Italy, 179% in Greece, 130% in Portugal, and 99% in Spain, it was clear that any increases in interest rates would soon spark a new debt crisis. Therefore, interest rates in Europe had to be kept artificially low for as long as possible.
The FED, on the other hand, started to slowly increase interest rates.
Figure 4: Federal funds rate. Source: FRED.
However, higher interest rates in the U.S. soon lowered demand for credit and led the country into a recession. In order to prevent a recession in 2018, the FED took interest rates back to zero and bought more bonds in order to bring more liquidity to the markets. This spurred inflation and interest rates shot up even as the economy was contracting.
The last years of the decade were the worst years as something unpredictable happened. Developed countries entered into stagflation. Stagflation happens when the economy contracts and the inflation rate is high. This disables monetary easing and leads to a painful deleveraging process until increased productivity pushes the economy forward.
Many lost confidence in their central banks as it finally became clear that printing money couldn’t go on forever. Thus, with currencies depreciating in the developed world, the world soon came back into balance thanks to the growth and increased demand from developing countries. Stock markets are just now slowly recovering from the high inflation period and high interest rate period, and we have seen gold prices stabilize at $5,000 per ounce.
What Will The Next Decade Bring?
Well, I’m happy to see increased focus on productivity, education, and knowledge as the motors of economic growth and social wellbeing. Capital has returned to flow into the economy in order to get satisfying returns from some kind of output and not just from leveraged financial assets as has been the case in the last 10 years.
I’m very positive about the future, happy to see dividend yields at a realistic level of 5%, and the average price earnings ratio of the S&P 500 at 10. This creates a pretty efficient market where proper analysis and fundamentals is what determines returns and not stock buybacks or passive investment schemes as was the case until a few years ago.
– End Of Article From June 16, 2020 –
Commentary & Conclusion
I know what you’re thinking, why didn’t I just look for the stock that went up the most by 2020? That’s a question I ask myself too. I’ll do that next time and let you know.
However, I’m happy to see that the monetary bubble finally imploded as it was simply unsustainable to have such low interest rates and liquidity put into the system without any consequences.
Given what happened, the point of the story is: be well diversified and prepared for anything. The current monetary experiment has no historic precedent and no matter what others say, nobody knows what the outcome will be in the next five years.
The only thing an intelligent investor can do is to be prepared for anything. Think gold stocks, emerging markets, emerging market currencies, commodities, quality stocks, growth stocks, etc. A portfolio with different assets will deliver good long-term yield and will also give you less volatility during the coming economic and financial turmoil.