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Where did all the growth go?

Low economic growth has become part of the modern investing landscape and in many cases, growth is no longer a conscious policy goal. GAM Investments’ Julian Howard explores the causes of this and considers how investors can prepare portfolios for an extended epoch of stagnation.

14 February 2023

Seeking positives from the abortive Truss administration of last autumn has become something of a minority sport but one quote from the previous UK Prime Minister’s time in office is well worth dwelling on: “I will not allow the anti-growth coalition to hold us back. It’s always more taxes, more regulation and more meddling. Wrong, wrong, wrong.” This new frustration over an apparent lack of enthusiasm for economic growth is being mirrored in the business world, with entrepreneur James Dyson recently exhorting the UK government to “…incentivise private innovation and demonstrate its ambition for growth.” Both Ms. Truss and Mr. Dyson are right to highlight that lower growth has become a fatalistically accepted part of the modern economic landscape. The period from 1990 to the end of 2007 saw average 12-monthly real GDP growth rates of 2.3%, 3.0%, 1.5% and 1.5% in the UK, US, Germany and Japan, respectively. But from 2008 to the third quarter of 2022 these same averages had slumped to just 1.2%, 1.8%, 1.0% and 0.5% with little fanfare. This matters not just to politicians and entrepreneurs but to investors too of course, since corporate profits and bond yields – and therefore returns to capital – both hinge in part on actual and expected economic growth. The key questions therefore are: what is suppressing growth and what can investors realistically do about it?

The causes of lower economic growth are numerous and complex, with entire academic careers (Summers, Krugman et al) devoted to better understanding the phenomenon of so-called ‘secular stagnation’. Some of these drivers are well known and intuitive. For example, the idea that demographics will lower aggregate demand makes natural sense. In Japan for example, 2021 saw the least number of births in more than a century, causing handwringing in policy circles and driving the political agenda as the economy continued to underperform. Similarly, Europe suffers a low birth rate that hurts both economic growth and public finances as the working age population that shoulders most of the tax burden dwindles. The continent enjoys the dubious honour of being the oldest in the world, with a median age of 43, fully 12 years older that the rest of the planet’s on average. Another classic cause of low growth is wealth inequality. According to the World Inequality Database, the world’s top 10% individual wealth owners control a remarkable 77% of total global wealth. Setting aside the moral and social implications of this extreme statistic, inequality is plain bad for growth for the simple reason that the wealthy have a far greater propensity to save than consume versus those at the opposite end of the income spectrum who tend to spend most of what they earn in a daily fight for survival and perhaps some simple life pleasures.

Figure 1: Was getting better, but now getting worse – wealth inequality is a key cause of low growth

Source: World Inequality Database. Missing data in early years extrapolated. For illustrative purposes only.

Debate continues to rage over how these trends might play out and whether disaster can be averted. In terms of demographics for example, policy responses could theoretically include more net immigration or investment in automation to support shrinking working age populations. Inequality could be addressed with better education and more balanced tax regimes which encourage creative destruction and enterprise over rent-seeking and ‘winner-takes-all’ business models. Success so far has been elusive amid political entrenchment. Immigration remains a sadly unpopular concept while owners of even modest amounts of capital unsurprisingly dislike new taxes. Furthermore, emerging forces are making the prospects for much-needed reform even more remote. Chief among these is surely the socio-political shift away from growth as a desirable policy goal. According to The Manifesto Project, data scrapings of OECD (a rich country association) party manifestos since the 1970s reveal a steady increase in anti-growth sentiment and a conversely steady decline in pro-growth sentiment. An argument could be made that the trend really took off with the 2008 global financial crisis stimulus programmes which sought to avert a social calamity along the lines of the 1930s Great Depression. Then 2020 saw further government intervention as individuals and businesses were effectively paid to cease economic activity for long periods as part of the Covid-19 response. Most recently 2022 saw energy subsidies for consumers across Europe announced amid the war in Ukraine. Electorates have clamoured for all of these instances of state intervention but the first two interventions in particular have left a lasting negative impact on growth and fiscal budgets. Unsurprisingly, some politicians and many businesses have begun to identify an ‘anti-growth coalition’ getting in the way of a return to higher growth trends. A further, partly related, obstacle to growth comes from the clumsy response in some quarters to rising geopolitical tensions and post-lockdown supply chain disruption. Recent legislation including the controversial Inflation Reduction Act in the US has sought to promote an ‘America first’ policy which will see distortive government subsidies applied across a range of US industries including green technology and chipmaking. America’s allies are rightly dismayed at the enormous global duplication and wasted growth potential that will arise from a misguided attempt to create less globally dependent US supply chains.

Figure 2: Anti-growth – electorates have become increasingly sceptical of GDP growth as a policy goal

Source: Manifesto Project, The Economist. December 2022. For illustrative purposes only.

The entrenched and indeed escalating nature of these unhappy developments leaves little grounds for optimism, but investors still need to pragmatically decide on what kind of long-term portfolio structure can thrive in such an environment. The low interest rates that will be the logical corollary of the low growth future described would likely benefit those assets characterised by long-run expected cashflows, for example growth stocks including US technology. Accounting teaches us that the net present value of a given series of cashflows is worth more if the prevailing discount rate is lower. Or put another way, if cash rates become more unappealing as central banks inevitably loosen monetary policy in response to low growth, it makes sense to extend investment horizons to generate better returns. A low growth backdrop will also place a natural premium on assets which carry higher potential levels of growth. This implies structural allocations to emerging markets and China which are still on a relatively growth-rich development journey versus western markets which for the most part have enjoyed post-industrial maturity for decades now. All of these equity investments will be vulnerable to unwelcome moments of volatility, 2022 being a prime example when technology, emerging market and Chinese stocks all sold off simultaneously. And many investors will rightly seek some smoothing from any repetition of this episode, which can be achieved in portfolios via a consistent and diversified capital preservation sleeve that exhibits low correlation to main capital markets, in our view. Differentiated fixed income approaches, highly selective alternative investments and carefully executed tactical asset allocation all delivered at low cost will be vital to the task of absorbing volatility from the specific equity investments described. So while the long term growth outlook looks bleak, it is surely not as bleak as failing to prepare for it.

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Source: GAM, unless otherwise stated. The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is not a reliable indicator of future results or current or future trends. The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice. There is no guarantee that forecasts will be realised.

Julian Howard

Chief Multi-Asset Investment Strategist
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