Three Reasons to Moderate Your Optimism

Three major challenges in front of us

Some investment challenges are virtually set in stone. Take for example the demographic outlook. Whether we like it or not, the populace at large is ageing quite fast, and there is little we can do about it. In this Absolute Return Letter, I will focus on a few such issues and what the implications are, namely:

1. The (excessively) high returns of recent years, and why that will result in lower returns going forward.

2. The new world order which is forming in the wake of Russia’s invasion of Ukraine and the rise of China, and what that implies for investors.

3. The ageing of the populace at large, and why future equity returns will be lower as a result.

It may surprise you that I have made no mention of inflation. While I do believe inflation will prove stickier than most think, I also believe that the problem can be addressed through various policy programmes; however, that is stuff for another day. This month, I will focus on issues that are next to impossible to address.

Concern #1

Let’s begin with #1 and why the high returns of yesteryear will lead to lower returns going forward. If you have followed my work for some time, you will be aware that I believe household wealth – particularly US household wealth – is elevated when compared to GDP. For reasons I have discussed numerous times before, in the long-term, one cannot grow faster than the other. The long-term mean value in the US is approx. 380%, i.e. total US household wealth should be approx. 380% of US GDP for the system to be in balance. Now, as you can see in Exhibit 1 below, as of the latest count, US wealth-to-GDP is 562%, almost 50% above its mean value.