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The Great Migration Of Capital... …...and its consequences for the world of investment In search of greener pastures: The Great Zebra Migration of the Kalahari Why Western Capital - increasingly redundant in be appreciated and appreciate thesoOld World - more – in the New Wo Michael Power, Strategist, Investec Asset Management Santiago de Chile, March 2012 The Lament of Old World Capital "There's a feeling I get when I look to the West, And my spirit is crying for leaving." Led Zeppelin's Stairway to Heaven YOUR The grass is increasingly GREENER on Rebalancing the world’s “savings versus growth” mismatch THE WEST 75% Share of Mobilized Savings THE REST 25% Share of GDP Growth to 2020 FOUR BIG QUESTIONS: TO WHAT DEGREE WILL… 1. 2. 3. 4. …Western savings help finance the Rest’s growth? …the Rest’s governments let Western savings in? …Western governments let Western savings out? …the Great Migration of Capital occur, to where and via what route? THE REST 75% THE WEST 25% Introduction: Why capital is, by its very nature, restless The grass is increasingly GREENER on YOUR side Capital needs "grass“ to grow “It comes down to a point so obvious that it is rarely put into words. The basis of farming and hence the whole historical development of human societies is GRASS.” Michael Cook, A Brief History of the Human Race Like cattle, its etymological cousin, capital can neither appreciate nor prosper without grass In capitalism, grass – pasture – is profitable demand, market appetite where capital can sell its output for prices that allow it to cover – and then some – its cost of capital The life-blood of capitalist evolution is nomadic capital Economics = oikonomia (Gr: household management) : from oikos (Gr: a clan identified by its pasture rights) + noma (Gr: to search for pasture) Capital and cattle both derive from kephale (Gr: head, sum of money) Capitalist economics traces capital’s relentless search for ‘profitable’ pastures Capital that overgrazes "dies of starvation" or commoditizes Pasture that cannot cover the cost of all the capital that feeds upon it is OVERGRAZED Disciplined owners of such capital will migrate it in search of greener pastures So capital recycles and prospers PROGRESS ADDED VALUE Lifecycles: the Laws of Thermodynamics made flesh and blood OLD AGE The S or Gompertz curve MATURITY ADOLESCENCE The Product Lifecycle – the S curve’s first derivative – focuses on the rate of growth YOUTH TIME/QUANTITY SOLD VALUE ADDED True profit is only made after deducting the cost of capital True profit The prospective investment’s lifecycle ‘Value’ investing ‘Growth’ investing …greener pastures... Crossing the Valley of Death to... The cost of capital charge ...pastures new... ...nomadic capital flows in search of… The point of commoditization From overgrazed opportunity… TIME/QUANTITY SOLD Why Western Capital is increasingly restless The grass is increasingly GREENER on YOUR side The US and Europe: Following Japan’s national life-cycle? Demographic positioning vs. share of working age population reflects stage of economic lifecycle reached Nations, like people, eventually retire, or “Japanise”… Source: Societe Generale From the overgrazed, slow-growing pastures of the West... Many Western industries show signs of commoditization e.g. autos, airlines, mortgage banks Domestic ‘grass’ is short and scarce – low returns on stocks and bonds… …as well as slow-growing – “New Normal’ GDP growth rates… … resulting in redundant Western capital, languishing in bond markets or as cash on corporate balance sheets ($2trn in US & Europe Inc.) ...to the plentiful, fast growing pastures of the Rest Investment opportunities flourish in the Rest: Indian mobile telephony; African retailing; Latin American mining; Indonesian consumer products; Central Asian oil; Chinese cars… New world competition is rising but many Western brands still have an edge there Car Sales: Old World versus New World Higher GDP growth means faster ‘grass’ growth Burgeoning middle classes make realised demand profitable so commoditization is rare Source: Scotia Bank Bottom Line: The Old World is no longer a teenager! Europe and the US near commoditization: net of new debt, the US has not grown since 1999! Western Policymakers: Desperately trying to grow the grass... To offset overgrazing and slow GDP growth, Western Governments: subsidize consumption fiscally (via pump-priming demand) and… over-fertilize production monetarily negative real interest rates) (via Perverse result? Overgrazed pastures are now flooded Some Western ‘islands’ remain above water – Northern Europe, parts of US, Canada, Australia… …but much of Western capital is increasingly unrewarded, redundant and restless… VALUE ADDED Government “irrigation” designed to promote new growth True profit The prospect’s lifecycle …greener pastures... Crossing the Valley of Death to... The cost of capital charge The point of commoditization ...giving rise to pastures new... State-financed From overgrazed Irrigation… opportunity… TIME/QUANTITY SOLD Flooded pastures have created a new form of “Liquidity Trap"... 1. 2. 3. 4. 5. 6. Tarp Fiscal Stimulus Twist QE1 QE2+ 3yr LTRO 1. 2. 3. 4. 5. 6. 7. Swamped cash market Cash-flush banks Sodden bond market Cash-rich corporates Negative real interest rates S&P500 at mid-1990 levels Negative equity risk premium The Art of Rainmaking: Has someone else tried this before? Teotihuacan, Mexico City Tlaloc – he who makes things sprout The Art of Rainmaking: Peruvian-style? The Hummingbird, Nazca, Peru Wiracocha – when he cried, his tears were rain The TheArt ArtofofRainmaking: Rainmaking:American-style? Chilean-style? Isla da Pascua, Chile ‘Helicopter Ben’ Bernanke – the New– God of Fertility? Makemake the God of Fertility Pennies from heaven? Or too much of a ‘good thing’? QE: Quack Economics… or seeding the clouds with artificial rain? “The US will suffer the kind of crisis Europe experienced in 2010, but magnified.” Barry Eichengreen The ECB's QE: Flooding Europe's pastures via LTRO I & II Many Eurozone politicians mistake the sugar highs of LTRO for solutions of solvency Rain dances all designed to make Western ‘grass’ grow again Desired result? HIGHER ECONOMIC GROWTH CallingPraying the Bluff Rain Gods: doesn’t believe in them? to of thethe Rain Gods …orWho playing the Rain Gods? Ben Bernanke Mervyn King Masaaki Shirakawa Mario Draghi Gold’s finger-pointing: The West is monetizing furiously! As central bank balance sheets balloon, monetary debasement intensifies Some New World Central Banks are already crying "Havoc!" Is the Wealth of the West increasingly an Embarrassment of Riches? The grass is increasingly GREENER on YOUR side Savings are still heavily concentrated in the Old World… The Old World owns 75% of the world’s mobilized savings… Source: MGI The world of equities is also dominated by the Old World Source: MGI …and those Old World own 90% of the world’s equities Yet Western equities have been ill-rewarded since the 1990s... Optimists see …not that this dismal those savings track record as have cyclical. prospered PERHAPS IT IS (S&P 500) STRUCTURAL… Source: MGI Demographics may be responsible for US underperformance... The M/O Ratio: those in their 40s (M) vs. those in their 60s (O) Declining labour force participation… Stagnant job growth since 2000… Valuations appear correlated to demographics Evidence of a structurally declining equity bias also exists... Lifecycle savings theory recommends a move towards fixed income as aging occurs Source: MGI …with equity weightings declining especially in Europe… If investors remaining in equities detect this ‘leakage’, will they sell too? Source: MGI Meanwhile declining home bias leads to leakage abroad… Domestic drain: flow to bonds due to demographics. Foreign drain: seeking superior growth Will Western Governments try and prevent capital outflows? On guard against financial repression out of the WEST The West? The Rest? Carmen Reinhart The grass is increasingly GREENER on YOUR side How Western politics may endanger the nutritiousness of its grass The grass is increasingly GREENER on YOUR side Not surprisingly, the West is now less welcoming for equities The West’s grass is becoming overgrazed, lower quality and slower growing The New Normal: a structurally bleak outlook for the West Mixing DEBT with… Deleveraging Downgrades Default Devaluation Demography Democracy Acropolis now: When demography meets democracy… Is the Greek Demos exposing the Achilles’ Heel of Democracy? Could Lyndon Johnson's Great Society Program bankrupt the US? Entitlement spending rose 11 times when real GDP only rose 3 times Source: Mary Meeker OECD debt burden has quadrupled since 1980 One-sided Keynesianism : are all “We Mature democracies nearly Keynesians now.” “Thealways boom, not the spent RICHARD NIXON in theisgood times…time1971 slump, the right Since 1960, a andfor always spent inatthe bad; austerity the US surplus AUSTERITY NEVER Treasury” only happened JM Keynes REALLY at the peak of the dot.com HAPPENED bubble US debt growth has accelerated …and Democrats 1776-1992 Republicans… George Washington to George Bush I: $0 to US$4 trillion Make that “Ten trillion dollars later…” 1992-2008 George Bush I to George Bush II: US$4 trillion to US$8 trillion 2008-2012 Barack Obama: US$8 trillion to US$16 trillion Dismal longer term outlook tied to sacrosanct entitlements US entitlements will exceed US tax revenues by 2025… Source: Mary Meeker Austerity is coming: embrace it or it will “embrace” you QED: With Consumption 65%+ of Western GDP, expect a “New Normal” of 2% GDP Growth Austerity in the US may be coming in the next year… Why not invest some of your capital in Growth Markets instead? The grass is increasingly GREENER on YOUR side Growth: Old World New Normal; New World anything but! Two-thirds of global growth until 2030 will come from EMs NEW OLD WORLD WORLD Old World drenched in debt; not so the New World OLD WORLD NEW WORLD The two best financial cartoons of 2011? Where would the Man from Mars invest on Planet Earth? Gross Debt/GDP 2010 Long term debt vs debt/GDP DEMOGRAPHICALLY OLD WORLD HIGH DEBT LOW GDP GROWTH DEMOGRAPHICALLY YOUNG WORLD LOW DEBT HIGH GDP GROWTH IMF Projected 2010-15 GDP growth rate Source: BofA Merrill Lynch Investment Strategy, IMF; bubble size public debt in USD trillions By 2030, Old World 68% to 27%, New World 32% to 73% NEW WORLD OLD WORLD NEW WORLD OLD WORLD Financial Asset Growth since 2000: New World beats Old x 4! OLD WORLD: CENTRAL BANK LED GDP GROWTH NEW WORLD: ACROSS-THE-BOARD DRIVEN GDP GROWTH Financial Asset Growth to 2020: New World beats Old x 2.5! $trillion, from 2010 to 2020 Global Financial Assets: from 198 to 371 (+87%) Developed Markets: from 156 to 260 (+66%) Emerging Markets: from 42 to 111 (+164%) Starting with only 21% of global financial assets, the New World will generate 40% of the growth Old World Capital: All cashed up, not sure where to go? US Inc: Cash as % of GDP “Corporates are just not interested in large scale investment in developed world...” MARTIN WOLF of the Financial Times the The best of the West: Migrating in search of greener pastures The upswing of the 'S' curve: the sweet-spot for capital COMPETITION low PROFIT MARGINS high FRONTIER MARKETS VOLUMES low PRICING POWER excellent rising Stage where the still good grass is EMERGING greenest: most MARKETS nutritious and rising fast fastest growing still strong intense squeezed OLD WORLD high weak Where in the world would a global multi-national want to be? How will Capital cross the River of Risk to the New World? GEOGRAPHY Risk off Risk on CASH Risk off Risk off BONDS ASSET CLASS CREDIT THE WIDER THE GAP, THE GREATER THE VOLATILITY, AS ASSET CLASS IS AMPLIFIED BY CURRENCY. CREDIT ASSET CLASS WHEN RISK IS TAKEN OFF THE TABLE, THE PULL-BACK IS MORE DRAMATIC. EQUITIES EQUITIES Risk on Risk off Risk on GEOGRAPHY Risk on By “crossing the river by feeling the stones” (Deng Xiao Ping) Stepping stone asset classes used to cross the River of Risk to the New World LOCAL CURRENCY EMERGING MARKET DEBT EMERGING MARKET CREDIT EMERGING MARKET CURRENCIES EMERGING MARKET EQUITIES FRONTIER MARKETS ASIA NATURAL RESOURCES AFRICA LATIN AMERICA GLOBAL FRANCHISE China’s “circuit and bump” approach to growth continues CHINA UPDATE WHAT HARD LANDING? 2010 GDP growth: 9.4%; 2011: 9.2%. Q4 11 GDP growth: 8.9%; Q3: 9.1% Wednesday 18th January China’s new “China-centric” growth model emerges CHINA UPDATE More domestic, less foreign, still heavy on fixed investment, consumption edging up Counter-cyclical fiscal policy was concentrated on infrastructure CHINA UPDATE China followed Keynes’s Infrastructurebiased advice precisely China obeyed the ‘Keynesian catch’: CUT SPENDING IN BOOM CHINA UPDATE “GFC” Fiscal Stimulus Stimulus Withdrawal 2010 & 2011: Boom time austerity Old fashioned economics: If boom brings inflation, apply brakes CHINA UPDATE Interest rates were raised… Reserve ratios were also hiked to rein in lending growth CHINA UPDATE …and Reserve Ratios at the Banks hiked… 2011 The brakes worked! Inflation has fallen… CHINA UPDATE Food inflation fell post-the Chinese New Year parties to 3.2% in February In tandem, new home sale growth declined… CHINA UPDATE …and property price increases have also cooled CHINA UPDATE Chinese developers now see glimmers of light ahead CHINA UPDATE Bottom line: Soft landing achieved, new take-off happening CHINA UPDATE Commodities: 2011 did not repeat the 2008 pattern CHINA UPDATE China’s copper and coal imports show no hard landing… CHINA UPDATE Neither do China’s oil imports … CHINA UPDATE The steel sector did hit a pothole but is now airborne again… CHINA UPDATE The single most important chart to Latin America today CHINA UPDATE By 2022, In 2012, every year China’s China will economy will grow by $6tr, grow by a a Japan, Mexico (2011 (2011 GDP GDP $1.2tr) $5.8tr) Source: Dragonomics UNDERSTAND THE POWER OF COMPOUNDING! CHINA UPDATE “The most powerful force in the universe is compound interest”. ALBERT EINSTEIN China’s 2012 Dollar GDP growth is Measured in RMB, forecast at 15%+: 2012's forecast China 8.5% nominal GDP GDP 8.5% growth growth + 3% rate is larger than inflation + 4% 2011’s 9.2% RMB/USD appreciation Conclusion: Let it be - Capitalising on capital's nomadic nature “Capital is nomadic and would naturally migrate to wherever greener pastures have been cultivated. Mr. President, in this beautiful country of yours, the pastures are very green.” Sam Jonah at the 2000 opening of Tanzania’s Geita Gold Mine versus “Nomadic capital never sets down roots, never builds communities, it leaves behind toxic waste and embittered workers. If we do not build an economic growth that helps sustain communities, cultures and families, then consequences will be severe.“ Anita Roddick, Founder of the Body Shop Why China is the New Wall Street: capital wants to graze there China: the New Colossus? NEW SHANGHAI YORK Give me your tired, your poor, Your huddled CAPITAL masses yearning to breathe free, The wretched refuse of your teeming shore. Send these, the homeless, tempest-tost to me… 2012 1883 . Tomorrow's Greener Pastures are in today's Nuevo Mondo "Following the light of the sun, we left the Old World."“ CHRISTOPHER He blew, he flooded, he manifested his gifts, To the west, to the east, to the open space, Until he brought forth pure seeds, Until roots took hold. The Separate Rose, Pablo Neruda, Easter Island, Chile Man has his limitations. He cannot defy the Laws of Nature indefinitely GRACIAS
