[Professional Blog] Is the Global Economy Stuck?

Some days, it sure feels like it.

The world’s capital markets may have mostly recovered from the drubbing they took in 2008 and 2009, and the credit-inflated bubble seems to be firmly in our rear-view mirror. But as the six o’clock news reminds us on a daily basis, there’s still a whole lot going on in the world for us to worry about.

Unstable countries in possession of nuclear arsenals. Government debt spiralling out of control. Unemployment stubbornly hanging around levels we haven’t seen in decades. In fact, it’s hard not to get a little depressed, and start wondering if we’ll ever get back to the booming economy of the “good old days.”

Ah, the good old days! Remember what the markets – and investor confidence – were like in the late 1990s, when Nortel was king, we all felt like financial wizards, and it seemed that the world was just waiting to gobble up the latest dot-com sensation and make us all millionaires?

Today’s shell-shocked investor could easily be forgiven for thinking that, now that global markets have almost returned to the heady highs of 2000, it’s time to cut and run, sell everything and get out of Dodge while the getting’s good. After all, this is surely just another mini-bubble, right? The world’s economy is never really going to go back to the days of its go-go glory?

Not so fast. Before we decide that the end of the world is just one more bear-ish analyst’s report away, let’s take a moment, take a deep breath, and take a closer look at the facts.

The truth is, the world’s economy, perhaps best reflected in gross domestic product, is more than double what it was in the year 2000. Yup, you heard me – in spite of “the worst recession since the great depression” and two stock market crashes, the global economy has somehow managed to grow from US$32 trillion dollars in 2000 to US$64 trillion dollars in 2010. What’s more, it’s estimated that it could reach US$300 trillion by the year 2030.*

So why are we all still so scared that the worst is yet to come?

Part of the answer may lie in the way we’re hard-wired. As human beings, we have evolved a tendency to focus on risk and danger. That’s what kept us alive in the days when a morning stroll meant taking a chance that you were going to end up as breakfast for a sabre-toothed tiger.

As a result, we’re far more likely to focus on the possibility of danger (for example, the remote chance that we’re on the verge of total economic collapse) than we are on the likelihood of good news (e.g. the much greater odds that tomorrow will probably be pretty much just fine). Mainstream media reflects this bias (some might even say they exploit it) by focusing on stories that involve risk, disaster and an overall sense of impending doom.

That impulse is made even more powerful when there is some actual evidence to back it up. As an investor, for instance, you’ve probably noticed that stocks haven’t exactly been stellar performers over the last decade.

The S&P 500 index, which tracks the 500 largest companies in the United States, hit 1,500 points in the year 2000. As I write this article, that same index is at 1,319 – down more than 12 percent despite the doubling of the global gross domestic product over the same period of time.

What gives? Were all the stocks in the U.S. somehow not invited to the party? Or is something else going on?

There’s no question that a lot of the growth in the world’s economy has come from the so-called emerging markets – places like India, China and Brazil. In these countries, hundreds of millions of people are being lifted out of poverty as their economies grow. But while the growth of developing nations has been spectacular, economies in the developed world have been growing as well.

So why aren’t stock prices reflecting this fundamental strength?

The answer is simpler than you might think. At their most basic level, stocks in the U.S. and other industrialized nations currently do not reflect the size and earnings of the companies they represent.

Take Microsoft as an example. Today, Microsoft stocks are 20 percent cheaper than they were a decade ago. Yet the company’s earnings are substantially higher than they were then, and its balance sheet continues to swell with the roughly US$2 billion dollars a month it generates in cash flow.

Unfortunately, the stock market isn’t fuelled by pure mathematics. It’s driven by the rather less scientific laws of supply and demand. After the bruises they’ve suffered over the last few years, investors are far more wary to get back into the market. This means that the demand for stocks goes down, and when demand goes down, prices are sure to follow – even for companies like Microsoft, which have arguably never been healthier.

One thing history has taught us is that, eventually, these bargain prices will overcome our fears, the demand for stocks will go up, and stock prices will return to being a reflection of the underlying fundamentals of the companies they represent.

The only question for the individual investor is whether they want to return to investing in equities now while the prices are still in the bargain bin, or whether they want to wait until everyone else jumps in, and stock prices go back to where the underlying fundamentals say they should be.

To put it another way: the fact that stocks haven’t generated significant returns over the last decade doesn’t mean they won’t over the coming decade. Over the last 200 possible ten-year periods in the markets, only 13 of those periods have seen the S&P 500 produce a negative return (with the ten years from 2000 to 2010 being the latest).

For all 12 of those negative periods that are now behind us, the ten years that followed each downturn produced exceptional returns for investors, with numbers that were far above average.

It remains to be seen whether the next ten years will replicate this cycle, and turn out to be terrific years for investors. But based on the disparity between the stubborn growth of the global economy and the stuck-in-time prices of most stocks, it looks to me like history is about to repeat itself.

* Reported in "Super-Cycle Report" published in November 2010 by Gerard Lyons of the London bank Standard Chartered.

Alan MacDonald is an investment advisor with Richardson GMP Limited. Alan helps investors with over $500,000 of assets make smart decisions about money. He is the co-author of “The Copperjar System, Your Blueprint for Financial Fitness” available on Amazon.

For more information please visit www.alanmacdonald.ca or email Alan at Alan.Macdonald@RichardsonGMP.com.

All material by Alan MacDonald. Alan MacDonald is an Investment Advisor at Richardson GMP Limited. The opinions expressed in this article are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP or its affiliates Richardson GMP Limited, Member Canadian Investor Protection Fund.

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