The natural response to the market rally of the past two months was to sigh in relief. Maybe the nightmare was over. Maybe, just maybe, we’d paid our dues, gotten the message about risk, suffered through the exception that proves the rule, and now can we please go back to the “normal” investing world?
In that world, the U.S. economy grows at about three percent annually after inflation, the U.S. is the world leader in economic might, and the long run the normal return for U.S. stocks is about six percentage points over inflation, as Jeremy Siegel documented in Stocks for the Long Run. But maybe that’s not what normal is any more.
The “new normal” is a phrase coined by Pimco’s CEO and co-chief investment officer Mohammed el-Erian, and it refers to an extended future of slow growth, especially in the U.S. and the West, and a shift in economic leadership from the U.S. to developing nations. He’s been saying pretty much the same thing for a while now, as he did in his video interview here on MoneyWatch.
But he elaborates in this review of Pimco’s annual brainstorm , and in this article in Business Week, a sobering look at the world after the financial collapse after Lehman Brothers folded on Sept. 15. If you had any doubt that the crash was something that your portfolio or this economy could easily recover from, take a look at these two charts from el-Erian’s letter. The charts show the annual rate of growth of industrial production in the world’s leading economies and of global trade.
In his MoneyWatch.com interview, el-Erian called what happened in the third quarter of 2008 a “global economic heart attack.” It seems like a fair reading of the chart.
El-Erian predicted that emerging markets would lead the way in the recovery. ”It’s not a question of whether you were knocked down in this crisis. It’s a question of who will be fastest to get back up.” His argument was that the first up will be the creditor nations, the net savers, not the countries hobbled by outrageous structural deficits and foreign borrowing. That means Asia, obviously, not us.
Before the crisis, the standard argument was that American investors needed to move more of their money into international investments, to hedge against a potentially weakening dollar and to capture the growth centers in the rest of the world. Right on logic, bad on timing. China’s Shanghai Composite lost about half its value between January and November last year; India’s Sensex dropped some 60 percent before bottoming out this past March.
But as el-Erian seemed to predict, the emerging markets have recovered first and strongest (if indeed the recovery is for real). As the world recovers its appetite for risk, the Chinese market has risen more than 50 percent from its low, and Indian stocks are up about two thirds.
The strong rebound in Asian emerging markets doesn’t prove that the “New Normal” is here to stay, of course. Any declaration of a new era risks sounding like folly a few months later. In a way, it’s the ultimate statement of “It’s different this time,” and those are usually dangerous words. You certainly don’t want to fling all your money into foreign stock fund or ETFs — let alone emerging markets — even if you buy el-Erian’s thesis.
But look around: the Dow is still off 40 percent from its high; 6.6 million are collecting unemployment; taxes are fated to rise; regulation is set to tighten; GM, AIG and Fannie Mae are essentially wards of the state. It may be a bit much to assume that things will simply return to where they were before the financial crisis. And if you’re looking for a story as to what comes next, now you have it.
