by John Mauldin
In the past few years, I wrote a lot about the unprecedented credit crisis I foresee. I call it “The Great Reset.”
I have to add, it isn’t what I think the future should look like or what I want to see. But almost the entire developed world has painted itself into a corner.
It might not be terrible. I don’t expect another Great Depression or economic upheaval, but the change will be profound.
We will have to adapt our portfolios and lifestyles to this new reality. The good news is big changes happen slowly. We have time to adapt.
I don’t see any plausible path to stopping the world’s debt overload without a serious crisis, much less paying it off. So I foresee a tough decade ahead.
The Case for a Worldwide Debt Default
Here’s a quick rundown of our debt situation and how I think it will play out in the next decade:
- 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 optimistic assumptions. The developed countries are all going the same direction: toward higher deficits.
- After the next recession (and there is always one coming), the US deficit will be well north of $2 trillion. The total debt will quickly rise to $30 trillion. It will almost certainly be in the $40-trillion range before 2030.
- Barring a big interest rate drop, simply paying the interest will consume much of the tax revenue. (Fortunately, I expect interest rates to drop by a large degree. 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 will upset a lot of people. 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 on receiving those pensions. And taxpayers likewise make plans.
All of this will have significant investment implications.
Investing Rules Will Change
Let me say this loud and clear: Your strategy probably needs to change. The methods that worked well recently won’t cut it in the new era I think we will enter soon.
Bear markets that don’t occur in a recession (like last December) have V-shaped recoveries. Bear markets that happen in a recession have long recoveries.
The next one, because of the massive debt, is likely to see an even slower recovery.
Friends don’t let friends buy and hold. At a minimum, you need some type of hedging program on your equity portfolios.
The recent flurry of IPO filings by “unicorn” companies like WeWork are ringing alarm bells. The venture capital investors who financed these businesses thus far are ready to exit.
They’re doing so because they think the risk-reward equation is as favorable as it will ever be. Possibly they’re wrong, but I don’t think so.
We have reached the “distribution” stage. Insiders and professional investors become net sellers while the small investors who missed most of the bull market finally jump in. History says it won’t end well for the latter group.
As the economy weakens into recession and public markets retreat, I think we’ll see two strategic trends.
First, active management will make a comeback as investors realize prices can move in both directions.
Second, the best opportunities will leave the public markets entirely. We already see this unfolding as the number of listed companies declines.
There is just no reason for most successful companies to accept the hassles and expense of an exchange listing. They can raise all the capital they need from that small number of investors in whom most of the wealth is now concentrated.
That doesn’t mean investment success will be impossible. You’ll have opportunities, but you may have to hunt for them and act quickly when you find them.
That’s what active managers do, and not just in stocks and bonds. I foresee many opportunities in real estate as well as new technologies.