Structural and cyclical trends we observe

When we suggest we are in a structural change as opposed to a cyclical one, we often quote the muted role of interest rates currently observed in DM.

Interest rates are often the dominant variable that determines economic activity in a normal business cycle. However, at one point the debt load becomes so large the DEBT itself becomes the dominant variable that affects economic growth! History suggests this occurs on average every 30 years.

It is not an accident this debt was accumulated by primarily households and governments in DM. The former were borrowing to maintain their quality of life whilst real wages were not increasing due to the birth of a globalised labour force.

Governments were forced to borrow as trade and budget deficits were allowed to continue under the illusion they would eventually sort themselves out.

Eventually the market decided to take action as the politicians were not doing much.

Real GDP growth is not likely until the issue of the debt is resolved. History suggests restructuring is usually required to resolve this problem.

We note the continuous pressure on real wages and the growing % of GDP of profits relative to wages do not seem to be cyclical trends, but fueled by globalisation. This force is so powerful we only see this reduced by protectionism - which of course will create a whole set of new problems with less advantages.

A cyclical trend we have observed over the last decade has been the declining price/earning ratio of DM equities. This occurs every 15 - 20 years on average and is often triggered by a shift in capital to real assets from financial assets. It is therefore no surprise when p/e ratios started to decline in around the year 2000, commodities started to rise and the USD started to decline. We expect this to change over the next 5 years (we feel differently about the USD as we think its role in the future will be different to its role in the past. Another financial asset (ccy) will take more advantage of capital flowing to financial assets as confidence returns to the financial system). This would be extremely positive for equities, especially if they are able to maintain their high level of profitability from being the most flexible participant in the economy, hence the one that can most take advantage of globalisation.

Our biggest fears are increasing tax burdens from debt laden governments, and our obsession with the mean reversion property of profit margins we have observed throughout the last 100 years, which are currently at record highs. Is globalisation allowing this to continue?