“Why Deleveraging Still Rules Markets in 2013″

Originally published by Bloomberg on January 27, 2013 Read the original article.

Here’s an excerpt:

I have structured my investment themes for 2013 in two ways. The first is geared toward the current “risk on” climate, even though I doubt it will endure. The other is a “risk off” scenario that I believe will unfold once investors recognize the unsustainability of what I call the Grand Disconnect between robust securities markets and subdued economic reality.

The investment scene in the U.S. and elsewhere is dominated by a number of forces: the deleveraging of private economic sectors and financial institutions; the monetary and fiscal responses to the resulting slow growth and financial risks; competitive devaluations; the fixation of investors on monetary ease that obscures weak real economic activity; and central bank-engineered low interest rates that have spawned more distortions and investor zeal for yield, regardless of risk.

10 Years

The deleveraging process for both of these sectors has begun, though it has a long way to go to return to the long-run flat trends. I foresee about five more years of deleveraging, bringing the total span to about 10 years, which is about the normal duration of this process after major financial bubbles.

I’ve consistently forecast average real U.S. gross- domestic-product growth of about 2 percent in this age of deleveraging. Since the process began in the fourth quarter of 2007, the average growth rate has been 0.5 percent; it has been 2.2 percent since the recovery started in the second quarter of 2009. And note that recoveries from recessions are typically much stronger growth than long-term growth, which averaged 3.6 percent from 1950 through 1999. Yet since 2000, when the up- phase of the long cycle ended and the down-phase commenced, real GDP growth has averaged 1.8 percent annually.

The average current rate of growth is far below the 3.3 percent it takes just to keep the unemployment rate steady. With 2 percent real GDP growth, the jobless rate will rise a little more than one percentage point a year. No government — left, right or center — can endure high and rising unemployment. As a result, the pressure to create jobs will remain strong. And so will the huge federal deficits that have been created by increased spending and weaker tax revenue.

Once deleveraging is completed in another five years or so, long-term trend growth of about 3.5 percent a year will resume. Biotech, robotics, the Internet, telecommunications, semiconductors, computers and other relatively new technologies promise tremendous productivity and economic growth.

For now, however, the impact of private-sector deleveraging is severe.

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