Hey Guys, I know that my articles are usually in some pretty well-defined borders, but I wanted to talk about something I find incredibly interesting this time, but that also has a decent amount of relevance to investing. I wanted to also apologize for the late post - it’s been a super hectic time, with college apps, and catching basically every flu going around… Regardless, we’re back, and I hope you enjoy!
Most valuation models (including the lauded DCF one) are specifically built with the idea that in a growing economy, a well-run corporation should be able to increase to some level of infinity. Similarly, our entire economic system is built on this promise of never-ending ascension. Unfortunately, that assumption is built on faulty foundations - ones that we’ve already seen fail…
Most crucially, besides valuing companies, the argument for purchasing a wide-ranging index fund like the S&P 500, is that as the US economy grows so too will the companies within it. So as we can see, any challenges to this model immediately makes stock picking paramount, while making it much more difficult to actually do so.
We see that the economy of Japan has been stuck in this endless loop of zero growth for the past 3 decades, and is arguably the best case study in what happens to a stagnating economy. Honestly, investigating Japan’s economy probably deserves its whole own article, but as a quick overview, most of the fundamental prerequisites for economic growth have stagnated.
The demographics are the most obvious culprit, with the population aging at a ridiculously rapid rate, and the population only maintaining its value somewhat because of an ever-extending Life Expectancy. In fact this only expands the problem as more of society’s resources go towards maintaining a non-working portion… Effectively, one of the reasons our own economies continue to grow is because the population does. More people means more production, consumption, and effectively there is a larger pie. Normally, the low-birth problem is addressed through immigration, but once again, Japan suffers from a lack of availability.
Finally, usually because of inflation, and the growth of the price of goods, there is at least nominal GDP growth (if not real), but, the consumer mindset in Japan is one where any price increases are seen horribly, and there is also a work culture where asking for a raise is unacceptable. As such, you get stuck in a cycle of low or no price or wage growth, and thus a stagnating economy.
Another option to stipulate economic growth is to print lots of money, and lower interest rates to incentivize spending. Unfortunately, Japan has already conducted a similar monetary policy… Interest rates are incredibly low, and have increased the money supply but the growth of the economy has not followed. Instead, they exist in a weird parallel universe that I still don’t totally understand. Government bonds yield near zero - so I personally don’t understand how there hasn’t been a much larger exodus of capital into say USD to purchase US bonds which yield closer to 4-5% and are arguably safer. Similarly, I don’t understand how they can continue to print money, but have persistently low inflation…
Yet, we see some version of these problems elsewhere. Western Europe faces similar demographic challenges. Their economies have also similarly not grown for the past 15 years, although at least in their case it’s more up and down than a straight line. France’s GDP for example has gone between 2.93 Trillion in ‘08 and 2.937 Trillion in ‘22. The interest rates on the European continent are similarly low, and the economy similarly dependent on those low rates despite the low growth… Especially concerning is that these low rates also lead to speculation, inefficient businesses, and a system ripe with leverage.
Now, all of this is to highlight what I think are just incredibly interesting real world phenomena that make the economies we live in, and thus the worlds we invest in more challenging. However, I also wanted to give you guys an idea about some theories as to dangers for the American economy, and how to invest within them despite the fact the US ostensibly does not suffer from many of the issues mentioned above, and has had consequently impressive growth over the past 15 years (which although arguably on the back of crazy monetary policy, is much more sound than what occurs over the pond).
This problem is that of innovation. Although humanity has always been known for its innovation, the usual value of innovation is that it markedly improves efficiency or the quality of life of those using it. Throughout the 19th and 20th centuries, we benefited from massive advances like cars, planes, refrigeration, radio… Since the 80’s our only big innovation has been in communication, the internet, and better ways to do other things that already existed. Effectively, the marginal benefit has started going down. I’m fascinated by the idea that unless we improve automation or biotech to the point where something like sleep/work becomes obsolete, it will be very difficult to achieve the same improvements to quality of life, and thus economic growth.
This brings me to the final point - that any sensible investment strategy has to include some international exposure. The developed world will eventually prove itself plagued by the same saturation that affects all great civilizations, but, given other places continue to lack basic access to water or sanitation, it doesn’t take a rocket-scientist to figure out that economic growth is likely to rapidly improve as already existing technologies are gradually introduced. One of the most interesting ideas I’ve ever read comes in the form that the developed world will eventually derive most of its growth from using its existing capital to invest in the growing economies of the world, creating a weird symbiotic relationship where the old owns the new, but where without the new, the old would collapse (I would seriously recommend looking at Jeremy Siegel's Stocks for the Long Run if you want a better idea on this).
I hope all of these ideas have sparked some kind of interest in you and given you some ideas on the world of investments. I know it’s been a while, and I’m really sorry about the late article - life has been super hectic recently as I said, but we’ll be returning with more traditional stuff back on schedule next week!
By: Mateo Gjinali
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