A Whole New Ballgame

August 2016

 

Famous investor Sir John Templeton is often quoted as saying "the most expensive words in the English language are ‘This time it's different'". Templeton's point was that the patterns of history repeat and we should not forget lessons learned from past experience. He was able to gain a wealth of experience over his 95 years.

Sir John's life spanned a very interesting period, from 1912 to 2008. He experienced rapid industrialization in England and America following two world wars, as well as the Great Depression in between. This was also a period of rapid population growth and large productivity gains. The economy was booming after WWII for most of the time Templeton was investing.

But another famous investor and noted economist, John Maynard Keynes, also is often quoted. He is reported to have said: "When the facts change, I change my mind. What do you do?" Keynes lived from 1883 until 1946. He was a major factor in developing government policies to deal with the Great Depression. Judging from his many written works, it would appear that Keynes believed the Depression represented a fundamental change in affairs – so much so that he devised a whole new economic theory to deal with it. For Keynes, the Depression really was "different this time".

So, considering the turmoil and uncertainty in today's political economy and capital markets, who should we believe, Templeton or Keynes? Are we simply progressing through a normal economic cycle? Is this just a replay of well-established historical patterns that will have a predictable outcome, or is something really new and different taking place? If there is real fundamental change happening, how will it affect the economy and investments?

We hear a lot these days about the business cycle and the fact that recessions do not happen when the central bank pursues an easy money policy and the yield curve is not inverted (short term rates higher than long term rates). The theme is "don't fight the Fed". In fact, the stock market has moved in sync with the Federal Reserve's monetary policies ever since the 2008 financial crisis. But the problem is that there are several other major economic factors that really are "different this time". The situation today is unlike anything Sir John experienced during his 95 years.

First, the indebtedness of the world's major developed economies is unprecedented. And the level of debt is increasing. In some countries, like Japan, the amount of debt is considerably more than the total size of the economy. At the same time, interest rates have never been lower – repeat, never. In fact, for the first time, we now have negative interest rates in a number of countries. Some investors are buying government bonds knowing they will receive less money at maturity than they originally paid.

There are less obvious changes as well. Population growth has levelled off and the average age is increasing. More people are retiring than are entering the labour force. At the same time, social benefits keep increasing and are at unprecedented levels, but there is inadequate provision to fund these benefits. In other words, governments have promised pensions, social security, and healthcare benefits that they cannot possibly pay when the bills eventually come due.

How could this happen? And why is the current predicament unprecedented in history? Consider that Otto von Bismarck only created the welfare state (in Germany) at about the time Keynes was born. It has been growing steadily in one direction ever since in western democracies. As population, productivity, and the economy kept growing, benefits to those retiring or receiving healthcare could be paid by the current workers. But benefits have grown even larger (i.e. Obamacare) while the economy has slowed, employment growth has not kept pace, and the aging population means more and more people are starting to claim their entitlements. And freer trade has seen jobs migrate to low-wage developing countries while new technologies are transforming whole industries. For example, Sir John did not live to see the commercialization of human genome sequencing.

We are going through major fundamental economic and social change – things really are quite different this time. However, throughout history, innovation has always led to a better standard of living, higher productivity, and a resumption of growth. But the period of transition is what economist Joseph Schumpeter called "creative destruction". So, while Sir John might claim that this time is no different since we have seen creative destruction before and economic models will evolve to reflect our changed world, we must heed the advice of Lord Keynes and recognize that the world has changed and we must change our thinking accordingly. For instance, we should lower our return expectations and focus on managing risk. There are lessons to be learned from the experiences of both men.

Terry Fisher is an Investment Advisor with CIBC Wood Gundy in Toronto. The views of Terry Fisher do not necessarily reflect those of CIBC World Markets Inc. CIBC Wood Gundy is a division of CIBC World Markets Inc., a subsidiary of CIBC and a Member of the Canadian Investor Protection Fund and Investment Industry Regulatory Organization of Canada. If you are currently a CIBC Wood Gundy client, please contact your Investment Advisor.