History never repeats itself; but it often rhymes.
This simple fact explains why so many financial analysts, market strategists and portfolio managers like to study past economic cycles and market reactions before taking investment decisions. By studying financial and economic history, market participants are able to anchor beliefs on solid facts. For this very reason, and like most other economists and market commentators, we like to look at History to form an opinion of the present, and the future.
But having said that, we are also very conscious of the fact that we are living in exciting times, with an accelerating pace of innovation, or what Schumpeter called, “creative destruction”. In recent years, we have witnessed, and will continue to witness:
The combination of all these factors might help explain why History, in recent years has “failed to rhyme”. In fact, it might very well lead to the conclusion that ‘things are different this time’.
- A Technological Revolution
The technological revolution we are living through is multiplying Man’s intellectual strength (just as the first industrial revolution multiplied Man’s physical strength). Resources that, until recently, had been locked away in the World’s best libraries are now open for all to see; facts and figures which just ten years ago took dozens of hours to gather are now no further than a mouse-click away… Information can be shared almost instantaneously at no cost across any distance.
- A Financial Revolution
The financial revolution is putting capital within reach of an ever growing number of aspiring entrepreneurs. it is also unlocking wealth from places where, until recently, it laid dormant (real estate, small businesses…).
- Healthcare Revolution
The healthcare revolution allows an ever increasing number of people to live longer, and healthier lives. At the same time, it has started to restrain the rate of population growth in a number of countries, sometimes with dire consequences.
- The Emergence of Emerging Markets
Emerging market countries are finally emerging. Gone are the worries about the next harvest and whether a widespread famine would wipe out the population. Instead, large populations can now aspire to levels of wealth and consumption that, until recently, had remained the privilege of a lucky few.
- Changes in Business Models
Companies increasingly look to outsource any function in which their value added and returns do not meet certain thresholds; even if that outsourcing takes place across borders, or across continents. The trust is so prevalent that companies in the US or Europe have no qualms with outsourcing some of their vital functions to China, or India, or Brazil...
- A Lifestyle Revolution
We are experiencing a lifestyle revolution as an ever shrinking percentage of total income is spent on essentials (food, clothing…) and a growing share of income is spent on leisure, conspicuous consumption etc
Looking at the above trends in 1998, we reached the conclusion that our times were truly extraordinary times and decided to create GaveKal to study, and understand the important changes our economies, and countries, were going through.
Arguing that ‘things are different this time’, we freely admit that we might end up drawing the wrong conclusions, say silly things and establish relationships where there are none. These are the risks when one ventures into uncharted territory. We accept these risks gladly, for we are convinced that the first step to successful investing is an understanding of the current world.
Ever since the start of the late 20th Century’s great global expansion, many politicians, economists and media commentators have been issuing dire warnings about the economic retribution which surely lies ahead after so many years of overindulgence in consumption, speculation, and borrowing.
But the Prophets of Doom have predicted their day of reckoning, like Jehovah’s Witnesses, at the beginning of almost every year since the mid- 1980s. And every time their predictions have turned out to be wrong, they have merely redoubled their warnings about the terrifying instability of the world economy. Instead of accepting that this argument had been refuted, they have insisted that financial or political manipulations have simply held off the collapse, thereby guaranteeing an even more wrathful Dies Irae when the reckoning finally arrives.
In arguing that postponing economic problems automatically magnifies these dangers, the Jehovah’s Witness economists have misunderstood the most important virtue of a liberal, competitive economy – the fact it automatically encourages billions of intelligent, motivated and creative individuals to seek out solutions to whatever economic challenges the world may present. In a competitive global economy, therefore, time is on the side of stability, not against it. If governments refrain from tackling potential problems, in the way in which America, for example, has refrained from tackling the “unsustainable” trade deficits or Britain has refrained from tackling the “dangerous” level of mortgage borrowing, this does not automatically increase the potential danger. In a liberal, competitive world, a problem postponed is not necessarily magnified. On the contrary, a problem postponed is a problem well on the way to being solved.
Another, less philosophical, reason to ignore the Prophets of Doom has been their failure to understand the underlying forces which have powered the expansion of the global economy since the early 1990s. Specifically, there have been five: firstly, the collapse of communism, which has given 3 billion new consumers and producers the opportunity to enjoy the economic benefits of capitalism. Secondly, the spread of free trade, which has allowed these new capitalists to participate in the global economy for the first time. Thirdly, advances in electronic technology, which have cut communication costs almost to zero. Fourthly, a revolution in finance which has given consumers a freedom to manage both their assets and their borrowings, in a way that was once only possible for large multinational companies. Finally, the rediscovery of active demand management, which has allowed central banks to keep economies growing as close as possible to their long-run productive trends.
While some of these structural changes may seem to increase the risks in financial markets, their interaction has actually made the global economy more stable than ever before. For example, the shift of manufacturing employment from America to China has created huge trade imbalances. But the same globalisation process has made global trade imbalances easier to finance, and the shift from manufacturing to services in the US and in other advanced economies has made them more stable than ever before. This greater stability, in turn, has reduced the risks of household borrowing; and the freedom of households to borrow has made consumption more stable in the face of economic shocks, such as the collapse of technology shares or the terrorist attacks of 9/11.
Economists (ourselves included) are still far from understanding the full implications of all these changes – or of weighing them up against new long-term dangers such as climate change, demographic decline and widening disparities of income. And the reality is that History is not as much of a guide as it once was; today, we have to draw ever more on logic, and the help of our friends and clients to understand the world that we live in, and invest profitably.