How To Win In The New Economic Framework — Daniel Arbess

The compass is spinning, and investors are being turned upside down. But there is a path to stability, and it starts with changing our perceptions about the big picture. The U.S. sovereign credit rating is downgraded, yet investors are piling into Treasuries. Growth-market governments and their consumers are doing great, but markets are bailing on commodities and companies that are profiting from them. Rudderless investors are relying on the Federal Reserve the way they relied on the rating agencies before the 2008 crisis.

It’s time for market players and policymakers to calmly analyze global developments, look beyond the daily headlines and reposition themselves for the new economic framework now governing the investment landscape.

Granted, there are excellent reasons for the market mayhem. U.S. economic data has been tepid; the Fed expects the economy to be so weak that it doesn’t see raising interest rates for years; the U.S. has suffered the historic indignity of having its credit rating downgraded; and the European debt crisis is intensifying. Sentiment is terrible as the reality sinks in that the trillions in stimulus have not done much to revive our economies, and they have in fact transformed severe fiscal problems into intractable ones. In the U.S., markets are realizing that the recent debt ceiling trauma is really only the tip of the iceberg of much more chronic fiscal problems that will prove extremely contentious over the next few years. Across the developed economies people are beginning to see government initiatives since the 2008 financial crisis for what they are — at best, temporary patches that are becoming less effective with every minicrisis. And we are now approaching the “fire wall” in Europe — the point when the sovereign debt crisis becomes systemic in the way the private sector debt crisis did in 2008.

But the markets’ worst fears of sovereign debt collapse won’t be realized. The U.S. can ultimately print-to-pay if it has to, though at a steep cost to the dollar and the next generation’s standard of living. Europe, on the other hand, can’t monetize debt — yet. But this is well on the way to happening, as it is in the interests of the richer northern countries to underwrite the peripherals and enable their own export-led economies to continue benefiting from a cheap euro. Germany will keep the pressure on the PIIGS (Portugal, Ireland, Italy, Greece and Spain) for austerity, but ultimately it will blink and continue lending them its balance sheet. The PIIGS will chafe at austerity, but they too will likely blink and accept some constraints of fiscal federalism. On a consolidated basis, Europe’s debt-to-GDP ratio is lower than that of the U.S. and should be manageable once the politics are straightened out.

The world isn’t ending. The rubber band stretches, but it won’t snap. It’s messy, but governments, economies and markets are incredibly resilient.

为什么市场如此混乱?因为三years after the ’08 crisis, they are still analyzing investments according to the precrisis framework, without adjusting their bearings to the whole new framework unfolding in front of them.

In the new framework, “riskless” and “risky” assets are trading places. The core assumption of the old framework — that the fault line of risk is between emerging and developed markets, and between riskless currencies and government bonds and “risky” commodities and equities — is becoming obsolete. The pivotal distinction in the new framework will be between debtors (U.S., Europe) and creditors (Asia). Creditors have purchasing power, while debtors are constrained. Creditor nations have strengthening currencies, while debtor nations have weakening ones. China and other creditor-nation consumers will buy more from debtor nations with weakening currencies, and rising exports will help the debtor economies recover. As the debtors deleverage their balance sheets, consume less themselves and export more, and the creditors do the reverse, the global economy will gradually return to balance.

Understanding this new framework points the way to more-stable markets. The government bonds and currencies of challenged debtor countries should be viewed with caution by investors. But companies in the debtor countries are doing very well, especially the ones exploiting weak currencies and selling to creditor countries and their growing consumers. Just ask the consumer electronics company whose second-quarter earnings beat all expectations because earnings in China and other creditor countries grew at an astonishing pace. Or the fashion house whose stock keeps going up even in these difficult markets because China’s share of global luxury demand is expected to rise from 14 percent today to 44 percent in just the next ten years. Across the board, S&P 500 companies selling to the creditor economies are growing revenues twice as fast as those more narrowly focused on the debtor economies.

Currency adjustments are a key enabler in the new framework. Lost in the recent noise is the fact that China is quietly revaluing its currency, bringing the renminbi to its highest level since 2004. This gives China’s consumers even more firepower and helps U.S. and European exporters. Meanwhile, as all signs point to further long-run weakness in the dollar, it seems inevitable that money printing will be part of any resolution of the U.S. debt crisis. Why would investors buy U.S. Treasury bonds for a return of 2.4 percent, to be repaid in dollars that will be worth less when they mature, when they can buy commodities and the stocks of companies selling products to governments and consumers who have plenty of wealth to pay for them?

Recalibrating the compass requires focusing on fixed points on the horizon. This is a historic, generational rebalancing process, and companies, policymakers and the investors who position themselves correctly for it right now will be winners in the next decade. Those who don’t will be lost in history.

Daniel Arbess manages the $3 billion Xerion investment strategy at Perella Weinberg Partners in New York.