Historian 0 – 4 Facts

Thu 24 Jan 2019

By Brian Dennehy

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Market commentary

Last weekend an acclaimed historian, one to whom I love to listen, proclaimed that Brexit tribulations are derived from the 2008 crash of Lehman Brothers and the subsequent policy responses. I hear this regularly trotted out as an explanation. At best it is lazy analysis, and worst it is plain wrong. Here I explain why, and why it is important.

Last weekend an acclaimed historian, one to whom I love to listen, proclaimed that Brexit tribulations are derived from the 2008 crash of Lehman Brothers and the subsequent policy responses. I hear this regularly trotted out as an explanation. At best it is lazy analysis, and worst it is plain wrong. Here I explain why, and why it is important.
Global social trends are driving politics and, most importantly for us, markets and market risks. To understand our very own “B crisis” means understanding those global trends. But what is behind these trends?
Media headlines highlight rumbling hysteria. In the UK the myopic, of all persuasions, blame Brexit. In the US, President Trump is of course the problem. Macron in France, and so on, country by country, each apparently having a unique problem - but the reality is that there are common drivers for this disquiet.
Way back in January 2007 we said of the US and France in particular:
“there are a very large number of individuals that have not participated in the boom of recent years, and they are a significant voting block for Presidential hopefuls…”
Evidence of disquiet was clear back then, in 2007 - before Lehman’s went bust, many years before the term Brexit was invented, and when Donald Trump was an irritating TV show host.
Let me start with these first two charts, which we first showed back in 2016. They reflect the growing grumpiness-cum-anger throughout the developed world, and help us better understand the bigger picture that triggers such a reaction.
Lack of broadly-based economic growth creates a sense of being underpaid and under-appreciated among the many, while the few flaunt their wealth and (allegedly!) don’t pay their way.
But no one writes an angry tweet proclaiming “I have a sense of being under appreciated”. Instead they will rant against migrants, “the rich”, “the establishment”, the EU, the Chinese, central bankers, and the mother-in-law. Angry, emotional people don’t often think about why they are angry – they just lash out at convenient targets.
Yet the evidence explaining that anger could not be more stark. The first two charts below relate to
the US economy since 1960, but reflect trends throughout the developed world.
What they show is that as profits grew and grew (chart 1), the share paid to workers fell and fell (chart 2).
Chart 1
Chart 2
Growth in profits was fuelled by high spending baby boomers, and the use of debt (whether by consumers or companies). Confidence grew, and financial markets boomed.
Then the baby boomers got older and started spending less, and they began retiringaround the turn of the millennium, reducing the growth potential of economies.  But debt of all kinds kept going up. As debt piles up, so do the interest payments, and payments of interest acts like oxygen being sucked out of the economy.  While this was happening, company profits kept going up – the rich were still getting richer.
The twin problems were debt and demographics. That was and remains clear. Plus new technology was limiting job opportunities.
Just in case you are still unconvinced, here are two more charts.
Chart 3 below shows that the bottom 90% of wage earners enjoyed an increasing share of US wealth - until 1987. Now those in the top income bracket (the top 0.1%) are as wealthy as the whole of that 90%.
Chart 3
Chart 4 below shows the share of income growth in periods of economic expansion.
For example, in 1949-1953 the bottom 90% of households enjoyed nearly 80% of the income growth. By 2009-2015 the top 10% of households captured 80% of the income gains.
A huge reversal.
Chart 4
Rather than reforming and restructuring our economies, the politicians ducked the problem.  Instead, unelected central bankers took centre stage, taking part in a vast financial experiment to keep markets afloat – not to keep economies afloat, but markets.
A stated objective of quantitative easing (QE) was to push markets higher. This was meaningless for the greatest number of voters and tax payers in the developed world - and increased still further the wealth gap in society – but, and this is important, these charts make clear that these trends were already entrenched.
What has happened since 2008 is that the consequences of increasing inequality throughout the developed world have become much more visible, particularly through the ballot box, though also on the streets, such as the French “yellow vest” protests from November onwards.
Why is this important? If you are reading this in the UK and feeling a tad grumpy and frustrated, you can console yourself that you are not alone! This is a problem throughout the developed world.
More seriously, as an investor you must expect greater volatility in markets for some years to come, because these social trends are not going to change. On the one hand, the demographic problem will only naturally resolve itself over a predictable number of years. On the other hand, the authorities (whether elected politicians or unelected central bankers) would have to make very radical and very painful choice to deal with debt. No existing government in the developed world will do that – this will eventually change, but not for some time.
This volatility will create investment bargains, so be ready for those. In addition, look to key parts of Asia for greater potential – this is The Asian Century.


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