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The Limits of Capitalism and Investor Returns in the Next Decade

It’s that time of the year again — everyone’s publishing their “Predictions for 2010.” I”ll try to do something different, and instead focus on one integrated big-picture prediction for capitalism and investor returns over the entire “2010s” decade.

Neuropsychologist Denise Shull described the market’s mood going into 2010 as “cautiously optimistic” on CNBC on Dec. 31. I think her characterization sums it up nicely — both individual investors and pension and endowment funds have high hopes of repairing the damage done to their portfolios in the 2000s. For the average American, plus-or-minus a few hundred thousand dollars in their portfolio will make an enormous difference in their post-retirement spending habits. And, these 60-somethings’ ability to spend vigorously will be a necessary component of a robust economy in the early 2010s, as this demographic makes up an ever-larger fraction of the US population over time.

I believe the optimism Shull describes will persist for several more years, and investors will be generally pleased with what 2010 brings. I expect additional gains on the major indexes of as much as 20%, although the Fed’s unwinding of its quantitative easing/low interest rate policy (which may begin as early as March, but no later than June) will result in tepid, and possibly negative, US equity returns in the second half of 2010.

Once the Fed announces that it has unwound most of its financial market intervention — which it will execute faster and more skillfully than many predict — I expect US stocks will receive another tailwind, so look for the first half of 2011 to bring an additional round of good returns for investors. There will, of course, be volatility along the way, but in general:

  1. banks will continue repairing their balance sheets,
  2. credit will become increasingly available,
  3. the residential and commercial real estate crises will ease,
  4. corporate profits will grow (but driven less by top-line revenues than analysts would like to see), and
  5. there will be slow but steady gains in employment.

I believe real GDP growth of 3.0-3.5% in 2010-2011 is possible, although we’ll also see interest rates creep higher, driven by both perceptions of economic strength and expectations of moderate inflation, an undesirable but necessary consequence of the Fed’s loose monetary policy in 2008-2009.

Over the longer term, I foresee difficulties for the US economy and financial markets, however. Some of the most important drivers of prosperity from 2003-2007 will not be in play in the 2010s:

  1. enormous federal deficit spending,
  2. an unprecedented use of leverage,
  3. consumption propped up by extraction of equity from residential real estate, and
  4. relatively low energy prices.

Moreover, unemployment beyond 2011 will get stuck above 5% — I predict at least 7% — which, combined with the implicit tax of $4-$5 per gallon gasoline (as oil pushes past and remains permanently above $100 a barrel), we’ll see consumers much more reluctant to spend as freely as in the past.

In addition to putting a direct drag on the economy, permanently higher energy prices are going to serve another function — they will draw attention to what I’m going to refer to as “the limits of capitalism,” a perception I predict will become increasingly prevalent in the latter years of the 2010s. By the “limits of capitalism,” I mean that the planet will not be able to sustain an American-style standard of living for 3-4 billion people.

We’ve already strained the planet to its limits with less than one billion participants in the “first-world” economy (the US, Europe and Japan). Although China has been admirably pro-active in curbing air pollution during its amazing sprint towards a market economy, analysts agree that the pace at which they are bringing power plants online and increasing the use of automobiles will result in much more pollution. India and Brazil are just one step behind with their own China-style booms, and Russia — if it ever institutes a true rule of law — may be only two steps behind. And air pollution is not the only threat — the oceans are under great strain, as are supplies of fresh water around the world.

I predict that by the end of the 2010s, popular opinion will reluctantly accept that the Earth will not be able to provide adequate food, water, energy and raw materials to sustain a global consumer-based lifestyle. And markets will take this news very hard. The main goal of 20th century-style “progress” and “prosperity” — to expand markets and convince citizens to devote their lives to the wage economy — will have to be replaced by a new mindset. These changes will be accompanied by extreme political and social turbulence, which will further detract from national prosperity. So, while I expect that in the short term the US will largely recover from the 2007-2009 financial debacle, I predict that the second half of the next decade will be one of diminished expectations, at least in terms of the economic and financial metrics with which we traditionally measure societal happiness and success.

In an upcoming post I’ll elaborate on this theme, and provide more specific predictions regarding how these changes will affect one industry in particular: the active money management industry.

Categories: Market Commentary