A wider narrative is needed to fully frame risk for longer term investors

I read Dan Bortolotti’s “3 Reasons to ignore market downturns” last week and the more recent Jonathan Chevreau’s “If you can’t take the pain of plunging markets, don’t watch”.

They both pass some genuinely rationale advice…if you have a long term portfolio structured cognizant of risk then there is no point in reacting to a boundary you have already accepted you will cross numerous times.   But just what are the boundaries that you have accepted and just what are the risks since it is the context in which the statement is made that matters?

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Is the balance sheet recession over? Financial sector debt…

Financial sector debt (and as noted consumer debt) has fallen significantly since the crisis:

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Yet, if we look at the financial sector assets with respect to non financial sector credit market debt, we start to see an interesting picture:

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Debt and the risks of debt to expected returns..

This  is the historic picture of debt accumulation in the US relative to nominal GDP growth:

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This is another perspective:

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Real GDP growth since 2000 according to BEA data is some 1.57% per annum (2000 to 2011), which covered a time when debt accumulation exceeded nominal GDP growth. Continue reading

Growth dynamics have changed a bit and are in between times…

Historical equity returns reflect past growth dynamics, dynamics which may be either weaker or in transition, or both – indeed, dynamics in mature economies are weaker, and combined global dynamics are in transition.  Return expectations need to be cognisant of these structural drivers of return.

The main drivers of growth are well known: a) population growth and employment participation rates, b) capital investment and c) increases in total factor productivity, or rather efficiency gains from the combination of a and b. Continue reading

“It’s time to reset your investment assumptions”..says the Globe and Mail. But is it, and should it be up or down?

Is it really time to reset your return assumptions downwards? A Rob Carrick articlein the Globe and Mail suggested that it might be so.

Revising return assumptions down after poor stock market returns is a Bete Noire of the financial services industry.  All other things being equal, and depending on your paradigm, you should be revising them up after a period of poor returns.

But you cannot revise upwards if your return assumptions were too high to start with. If you have relied on historical average returns or risk premiums to set return expectations you have also more than likely failed to adjust for cyclical and structural risks in markets and economies. Continue reading

“Counting on the Fed to perpetually float returns is a mug’s game”

When looking at the current health of world stock markets, it is critical that we bear in mind the structural paradigm in which we observe: the only reason the financial system remains in place and markets are “healthy” is the vast amounts of government and central bank support.   The title to this post comes from Richard Fisher President of the Federal Reserve Bank of Dallas:  He also makes the following comments: Continue reading

The impact of deflation on capital…..

I have commented on a number of occasions about the risks to returns on equity capital, as an offset to nominally attractive valuations, in a deflationary/deleveraging environment: reduced investment, existing capital depreciated and or written off, resulting in lower potential growth and lower returns on equity capital.  An excerpt from a recent ITEM Club Winter 2011/2012 forecast highlights the real world dynamics of this risk in situ: Continue reading