Wealth Clarity Blog

My entire career as a financial advisor has played out in the shadow of a bull market.  Take a look at the chart below. (Dow Jones Industrial Average 1982-2007)

The Dow rose from roughly 1000 at the start of my career in the 80’s to over 14,000 two years ago.  Sure, there were recessions and corrections along the way, but it is clear that wealth creation was consistently propelled forward by a very strong and unique set of financial and economic factors.  Those of you in your 40’s and early 50’s have experienced the same economic circumstances.

But, over the past eighteen to twenty-four months the world changed, arguably forever. 

Essentially, capitalism overdid it.

The greed of several large financial institutions, the increasing appetite by individual and institutional investors for more and more return without properly considering the risks involved, the lack of oversight mechanisms that could stop or even foresee the ultimate disaster at hand, and an economy built on consumer spending beyond our means.  These issues weren’t limited to the U.S., but instead impacted the world.  

This isn’t to suggest we’ll never wealth create again. But it does mean the rules have changed.  Wealth creation will require new thinking and a new skill set. We won’t be able to use the same assumptions we relied on the past twenty five years:  stable appreciation, double digit returns, and what many have referred to as the “Goldilocks Economy”–not too cold, not too hot, but just right.

So where do we stand now? 

That, of course, is the big question.  And there is a lot of confusion and uncertainty.  I recently got some insight into the current economic environment I’d like to pass along.

I was invited to join a teleconference hosted by PIMCO, a leading global asset management firm, and their well-known Co-CIO’s Bill Gross and Mohamed El-Erian. They may not be familiar names, but the financial community listens to them closely. 

Old Normal → Transitional Period → New Normal

The basic ideas of the PIMCO presentation were the following:

1) The economic world has changed.

2) There is a growing level of uncertainty about the direction of the global economy and the direction we are heading.

3) We are shifting to a period where returns will likely be lower and long term assumptions about portfolio allocations will continue to be challenged.

4) We have left the old world, but have not reached the new world.  We are in transition. 

The Old Normal was the period we’ve all experienced for the past 25 years:  The world’s economic growth as measured by nominal GDP (Gross Domestic Product without taking into consideration inflation) grew in the 6-8% range.  As Gross and El-Erian laid it out, this growth was possible because of:

• Declining interest rates (since 1982)
• Low inflation (since late 70’s)
• Increasing financial leverage
• Increasing financial innovation
• Decreasing regulation
• Increasing globalization

But now, Gross and El-Erian say, all of that is changing.  We are transitioning to a New Normal. 

What is the New Normal?

This current moment is a time when we’ll be seeing, and in some cases are seeing:

• De-risking and de-leveraging
• Re-regulation
• Possibly slight de-globalization
• Decreasing investment returns
• Slower economic growth (possibly one half of what we have seen in the past)

As Gross and El-Erian see it, several forces are driving this New Normal:

• Housing market:  Cheap financing and speculation are gone; home ownership is declining from a high of 70%; and unemployment in associated industries could linger for a while. 
• Savings rate:  We are moving from a period of high consumption and zero or negative savings to positive savings, and moving higher.
• Global forces:  The world’s growing concern about accepting our Treasury securities and currency in exchange for goods and services, and other parts of the world replacing the U.S. as the engine of consumption growth.

So what does all of this mean for any one of us individually – especially to people with assets to protect and grow?

There’s a lot to say.  I’ll take it on in my next blog post, “Adjusting to the New Normal.”