The End of Growth and Its Implications
For traders, the subject matter is largely irrelevant and most probably confusing. For professional investors and advisers to them, along with accountants, attorneys and public officials, it is a must-read.
The paper's principal point is that the nominal and real economic growth rates that were the norm in the developed countries over the past 100 years and in the largest developing countries of the past 20 years have permanently decreased from the 3%-4% real level in aggregate to 2%-3%.
Please note that the developing countries are what the media have come to refer to as the BRICs -- Brazil, Russia, India and China -- but the group encompasses more properly the 10 developing countries that are members of the G-20. They are Argentina, Brazil, China, India, Indonesia, Mexico, Russia, Saudi Arabia, South Africa and Turkey.
This alone is a profoundly important issue for investors to be aware of now. The primary meme advanced by the financial media concerning the growth rates in both the developed and developing countries, including the U.S., is that the shift toward lower growth since the 2008 financial crisis is a temporary phenomenon and a residual effect of the legacy issues that still linger, especially on the balance sheets of the U.S.-based money centers, due to the enormity of that crisis. The prevailing opinion is that monetary and fiscal support will enable these economies and capital markets to return to the previous norm of higher growth within the next few years as the legacy issues are resolved.
Further, the OECD states that increases in real economic growth will occur only in the non-OECD and non-G-20 member countries, especially the smaller Asian countries, which are typically referred to as emerging markets.
There are three germane points for income investors and long-term growth speculators to be aware of now.
First, the upward drift in equity valuations that has largely been caused by economic growth in the developed and largest developing countries is no longer there, and it is not coming back.
That doesn't mean that growth in revenue, earnings and stock prices in these areas is no longer possible, but it does mean that the "free lunch" drift provided by previous higher levels of aggregate economic activity is not going to be there, and growth will have to be achieved organically through increases in productivity, accelerated adoption of technologies and displacement or replacement of human labor.
Technology being used to increasingly replace human labor is an issue I have written about on multiple occasions over the past several years, most recently a few weeks ago in the column "The Robots Are Coming."
Second, speculators who are interested in capturing growth in equity values that is supported by economic activity, the drift, need to acclimate themselves with the truly emerging market, and that will require going beyond the BRICs. The important point here is that the primary meme advanced by the financial media continues to be that growth will come from the BRICs. The OECD says otherwise.
Third, income investing is going to become very difficult. The stocks of companies that typically pay the highest dividends (utilities, real estate investment trusts, consumer staples and telecommunications) are going to be negatively affected by the reduction in real economic growth rates and the resulting need to focus on reducing internal costs, just like companies in sectors that are typically associated with growth.
As this plays out and investors, speculators and company executives begin to realize that the drift is not returning, it is probable that income that used to be distributed by way of dividends will instead have to be reinvested in technologies that reduce expenses.
It is prudent at this time for income investors to assess the performance of their dividend-paying stocks, realize any gains that are outsized in relation to their sectors, and shift capital into similar issues that have underperformed.
An example of this would be selling Kroger (KR) and Safeway (SWY) and replacing them with Unilever (UL) and General Mills (GIS) as I wrote about last week.
Editor's Note: This article was originally published at 5 p.m. EDT on Real Money on July 22. Sign up for a free trial of Real Money.