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The “New Normal”


January 14, 2013

The “new normal” is a relatively new buzzword making its way around the financial services community. Generally, it is being used to foment the idea that equity returns are low and will remain low, perhaps forever. I think most of the noise about this subject is being made by bond fund managers, which, of course, strengthens the case for bond funds as a long-term investment vehicle.

It is easy to fall into this camp as one looks over the U.S. investment landscape over the last ten years or so. It’s not a pretty sight. We have been through two substantial bear markets, the last being in 2008 as equity markets reflected the “Great Recession”. It is easy to lose sight of the fact that each bear market was followed by a stock market recovery. But taken together, the U.S. stock market has been going up and down and sideways.

First, about March 2000 we had the stock market correction following the “technology boom” excesses. Before we could recover from that downer, we experienced a further down leg caused by the Enron accounting scandal around October 2001. Then we had a nice recovery as the stock market regained the lost ground.

About the time the stock market had fully recovered, around March 2007, the Great Recession kicked off with its accompanying stock market slide. By October 2008 the stock market hit bottom and started recovery. We again regained what was lost when the market started to show some weakness as the fiscal cliff /national debt issue came to the fore. And off course, the pall of a stubborn unemployment situation presided over the whole mess. To many, the situation was and still is total gloom. It seemed as if we were still mired in the Great Recession.

We weren’t. Businesses had a wonderful recovery, with greatly increased productivity and profits. They just didn’t hire many more people. But that is what increased productivity is all about: the same or fewer people doing the necessary work and producing the same or even more output.

U.S. gross domestic product (GDP) has risen only moderately. The New Normal prophets of doom reason that, if output only increases one to two percent per year as projected, the stock market should only rise by that amount. And that is all the return the stock investor should expect.

What is wrong with that logic? The big thing is that we are not investing in the “whole stock market”. We are investing in mutual funds, most of which are “global”. The fund managers usually pursue a “bottom-up” stock selection strategy. They are looking for great companies, regardless of where they are located. (“Top down” is when the fund manager decides in advance how much they will allocate to each country and/or industrial sector and seeks out enough companies in which to invest the allocation.) I have found that good fund managers will, over extended periods, beat the market average.

The other difficulty with that logic is that it avoids the global perspective. Good companies are born of good ideas for meeting consumer demand. Good company managers implement and market those good ideas. Does anyone out there really believe that the world is out of people with good ideas and the smarts to implement those ideas??? Even if the flow of good ideas from one country may slow, there are people from other countries eagerly waiting in the wings, ready to strut their stuff to attract investors. And don’t forget, there are many different consumer markets scattered over the globe. They all have demand of varying types and amounts that need satisfying (Everyone doesn’t like octopus). The whole world economy does not rely on the U.S. consumer as it may have in the past. Many other countries are rolling out their new middle classes with their consumer demands. Also, everything I read concludes that technology and the internet are changing the world faster than at any time in history. Barriers to entry in many industries are dropping. More business opportunities!

Note also that many of the more successful companies have global operations. They may have headquarters in country A (where tax rates are low and government tries to attract business by making nice to the “rich”). They may obtain their raw materials from country B where the supplies are abundant and inexpensive. They may transport those materials to country C for fabrication because country C has a well-schooled, hard working work force who are eager to join the middle and upper classes. What are high wages to them might seem poor in other more developed countries. It is all relative. Finally, those finished goods are transported world-wide to wherever there is a market with demand and the means to pay.

In conclusion, I don’t consider myself a cock-eyed optimist. Yet I see a world of investment opportunities and fund managers eager to seek them out and invest my money in them. The free market will still cycle, but that is the economic breathing of capitalism. It shows the patient is alive, vigorous and wants to improve and grow. It also presents buying and selling opportunities for investors.

The investment “trick” is to be sufficiently diversified that one can sell some of what is up in price to buy some of what is down in price.

We do that.

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