What's an investor to do in an environment in which many investment professionals and economists are declaring that strong business growth is a thing of the past, and that the only way companies will be able to grow their bottom lines will be through cost-cutting or acquisitions of other companies because organic top-line growth is pretty much finished?
The power of inflation, even at low levels, to destroy the purchasing power of money requires some exposure to investments which can help mitigate that destruction of purchasing power (see this previous discussion). Fixed-income yields have of course been extremely low, and over long periods of time it can be demonstrated that fixed income investments lose out to inflation, even in periods when rates have been higher. Some exposure to the growth potential of businesses is essential for individuals who hope to avoid the slow erosion of their purchasing power over time, let alone for those who hope to grow their wealth and increase their purchasing power over the years.
The power of inflation, even at low levels, to destroy the purchasing power of money requires some exposure to investments which can help mitigate that destruction of purchasing power (see this previous discussion). Fixed-income yields have of course been extremely low, and over long periods of time it can be demonstrated that fixed income investments lose out to inflation, even in periods when rates have been higher. Some exposure to the growth potential of businesses is essential for individuals who hope to avoid the slow erosion of their purchasing power over time, let alone for those who hope to grow their wealth and increase their purchasing power over the years.
But investors in recent years have been bombarded with talk of a new reality in which the pattern of long-term growth can no longer be hoped for in the future. This new paradigm has been famously dubbed the "New Normal" by many pundits, a phrase and a concept attributed to Bill Gross of Pimco and explained in this "Investment Outlook" that he published in September of 2009. There, he states:
Well, the surprise is that there's been a significant break in that growth pattern, because of delevering, deglobalization, and reregulation. All of those three in combination, to us at PIMCO, means that if you are a child of the bull market, it's time to grow up and become a chastened adult; it's time to recognize that things have changed and that they will continue to change for the next -- yes, the next 10 years and maybe even the next 20 years. We are heading into what we call the New Normal, which is a period of time in which economies grow very slowly as opposed to growing like weeds, the way children do; in which profits are relatively static; in which the government plays a significant role in terms of deficits and reregulation and control of the economy; in which the consumer stops shopping until he drops and begins, as they do in Japan (to be a little ghoulish), saving to the grave.
More recently, Richard Lehmann, an astute analyst of income investment whose opinions we respect, published a newsletter which takes up a similar dour outlook for future growth, but somehow finds a way to deliver some bullish comments at the same time (his analysis can be purchased at his website here). Entitled "Why I'm Bullish," he argues that the economy is facing a period of low growth, saying: "the major drivers in our economy today are deleveraging, deflation and demographics, the three D's that spell economic malaise for the foreseeable future." Because of these three factors, he believes, "rapid growth years will not be coming back for another decade or so."
However, Mr. Lehmann finds some room for optimism, arguing that even if firms cannot hope for much top-line organic growth, they can at least buy some growth through mergers and acquisition, and they can at least grow their bottom lines through the cost-saving technologies and the savings that will come as older workers retire and are replaced by younger workers (who will start with lower wages and probably fewer employee benefits, he seems to imply without directly saying it).
He also argues that another silver lining to this gloomy outlook is the possibility that interest rates won't go up as much as many fear, since low-growth environments should not have much inflation (this is an argument which we believe has some flaws, as we disagree with the "Phillips Curve" connection between economic growth and inflation, and instead side with the monetarists who say that inflation is a product of monetary supply and demand and that inflation can be created in a low-growth economy: witness the "stagflation" of the 1970s).
So, with all these experienced market observers declaring a "New Normal" for 10 or 20 years, should investors resign themselves to a future in which "rapid growth" is just a fond memory of a long-lost past? Are we witnessing the "death of growth investing"? The recent slaughter of the share prices of the market's "growth darlings" seems to put an exclamation point on the arguments of those who, like Bill Gross, have declared the end of such growth.
We would disagree, and -- as long-term growth investors who have been at this in a professional capacity for many years -- we find our own reasons to be bullish in the face of these dire pronouncements:
- First, we disagree with the idea that the end of growth in the economy is a foregone conclusion, or that the days of "childlike wonder" are gone and we all have to become "chastened adults." We believe that innovation drives economic growth, not demographics, not consumption, not easy money or credit, and certainly not government stimulus. While we agree that bad government policy and excessive regulation can and do impede innovation and growth, we do not believe human beings will ever stop innovating, and that generations coming up behind the Baby Boom generation will prove to be every bit as innovative as the great innovators of that generation.
- Second, although bad government policy and intrusive regulation are real and present obstacles to growth, investors should remember that these policies and regulations can be changed, and that even just a few positive but simple changes can unleash tremendous growth in an economy. The recent history of the past several decades is replete with examples of economies in which just a few positive changes sparked outbursts of pent-up innovation and growth, in countries such as China, India, New Zealand, Israel, and many more. Some of these countries are still far from ideal in terms of regulation or government interference, but even small improvements saw big results: the same can happen in the US where pundits who predict a growthless "New Normal" for 20 years are ignoring the fact that things can change for the better long before 20 years go by.
- Setting aside these first two points, which challenge the long-term "New Normal" or "death of growth" thesis, and granting for the sake of argument that we could face such a gloomy lack of strong growth for an extended period, we still believe that investors should consider the fact that there will always be exceptional companies which can experience tremendous growth, even if the majority of companies are stuck in the kind of non-growth described by Mr. Gross and Mr. Lehmann above. This was true during the 1970s, and we believe it is still true today, even if we are facing a "New Normal" for the wider economy at large.
- Finally, we would point out that during periods in which such growth is generally harder to come by, those businesses which do manage to distinguish themselves as having rare innovation and top- and bottom-line growth will fetch an even greater premium than they might be able to command in a more positive economic climate. In fact, we would argue that the very reason that the prices "ran away" on some of the stocks which recently suffered a punishing "momentum correction" was that those companies were showing outsized growth relative to the broader market-at-large (at least in revenues, although some of them have yet to "flip the switch" on earnings profitability, as we discussed in this previous piece).
In summary, we believe there are good reasons to be bullish on true growth-stock investing, even in the face of the declarations of a "New Normal," or the end of "rapid growth years for another decade or so." We also believe that there are not too many market participants voicing these types of opinions right now, and that the generally gloomy and pessimistic environment we are currently experiencing may be an opportunity for investors who can select companies with exceptional growth potential.
