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Remember Harry Dent? The Tampa-based investment adviser and author first popped into the public consciousness back in 1992, the year Clinton beat Bush Sr. and Roberta Bondar became the first Canadian woman in space. Dent’s book, The Great Boom Ahead, made the bestseller lists with a fascinating idea: the ’90s would be one of the most blessed periods in the economic history of the American Empire. At the time, it was a radical suggestion. The smart thinking back then was that the U.S. economy was slipping into the abyss, that the 1980s represented the last hurrah of American capitalism, the crash of ’87 was the beginning of the end, and the savings and loan crisis — the sub-prime meltdown of its day — was the final nail in the coffin. Bookstores carried all kinds of titles warning of a great reckoning. One author even suggested the U.S. government would be broke by 1995. What happened, of course, was that the U.S. government swung into surplus and the Dow Jones industrial average marched up to 11,723 in January of 2000 — a record.
So much for conventional wisdom. But when it comes to retirement planning, it’s all about looking out over the medium- and long-term. The big trends matter if you’re going to make your money last for decades. So it’s likely worth giving Dent a listen. He’s not afraid to make big calls. And he did get it right about the world’s largest economy back in the ’90s. So what’s he saying today?
Dent based his career-making prediction on the fluctuations in economic activity that follow on generational differences. People tend to ramp up earning and spending in their 20s and 30s; they reach a peak in the mid- to late-40s and then taper off spending through their 50s and 60s. This ebb and flow creates a market cycle that affects earnings and stock prices. When Dent noticed that the boomers — the single largest demographic group in the history of the United States — were about to hit peak earning and spending years, his call was almost easy. “Everyone was saying America was done, but we were saying, ‘No, the boomers are going to hit,’ and we were dead on,” says Dent.
After that, Dent continued to offer investment advice through his subscription service and newsletter, and to write books. Fame is a fickle thing, however. When he wrote another tome suggesting markets would recover from the 2001 crash and reach another new record high by the end of this decade, it wasn’t as well received. Sure, the Dow recovered and hit a new high in October of 2007, as predicted. But the point value — 14,165 — was less than half what Dent expected. Had he lost the old magic?
Not quite, says Dent. He just made the same mistake everyone else did this decade — he underestimated the strength of the bull market in commodities. “Everyone was saying in the early part of this decade that the stock market was ‘undervalued,’” Dent says. “And that was true from the perspective of corporate earnings growth, which was just as much in the 2000s as it was in the ’90s. But the stock market has grown less than half as much as we thought it would, because of the rising price of oil and the adverse geopolitical environment. We were actually following that second call dead-on until oil rose to $78 in 2006. But that’s when we said, ‘Hey, we’re missing something here. What aren’t we seeing?’”
When Canadian Business contacted him in early summer, Dent was busy banging out a new book — due at the publisher in December — that will present a new call based on his revised outlook. Be warned: it’s not pretty. Dent has turned 180 degrees on the stock market over the next decade. He is warning investors that high commodity prices are about to combine with a peak in boomer spending to simultaneously deflate the stock, oil and housing bubbles — and plunge world markets into a decade-long funk.
Dent isn’t alone. A new theme in investment advice seems to be that markets will be volatile in the decade ahead. The reason? A restructuring of the world order, as the United States recedes in terms of geopolitical and economic power, even as the rest of the world — especially Brazil, India, China and Russia — expands its footprint. This readjustment will come at the same time as large numbers of baby boomers retire. No wonder almost no one is predicting sunny days ahead for the stock market.
But don’t panic. Dent has provided investors with directions to help them pick their way through the coming turbulence. In terms of investment strategies, you’ll need to be radically defensive at times; you’ll want to concentrate on wealth preservation rather than returns; you’ll need to realize that volatility, not growth, will be the order of the day. And if there is one caveat investors want to keep in mind, it’s the same one that’s found in mutual fund bumf: Past performance is no guarantee of future returns.
Paul Marsh is an emeritus professor of finance at the London Business School. He recently co-authored a paper on the equity risk premium — the difference in expected return between stocks and bonds — and suggests that it is going to be less than what it has been in the past. One likely reason, Marsh says, is that much of the original research on the equity risk premium was done on the U.S. market since 1926 and, in particular, during the anomalous period following the Second World War.
Why anomalous? Once the soldiers returned from war, rapid suburban expansion and technological advancement followed. Many key markets adopted the greenback as the currency of choice, and that drove demand for dollars. There were setbacks, of course: Dent points out that a generational spending peak in 1968 contributed to the dismal U.S. market performance that lasted until the early ’80s. But the postwar era after 1950 and especially after 1982 was generally a good time for U.S. assets. But how long could it last? Now that researchers have begun looking closely at equity risk premiums around the world, and over longer time horizons, they are finding that the historical number is actually lower than the 6.5% to 7% many have assumed. “In the space of just eight years, the consensus has come down by 2% to 3%. And I attribute that to the new research,” says Marsh. “We had a period that was too good to be true.”
Marsh suggests that moving forward, the equity risk premium is closer to three percentage points over the risk-free rate — typically, the coupon on three-month U.S. Treasury bills. Considering the rate on those is about 2% right now, after taking out management costs, investors could expect about 5% per year in total return as realistic over the long term. That is roughly half the double-digit returns investors got used to in the ’90s, and suggests a very different future for many who are planning for retirement. “Optimists have triumphed in the past, but it is hard to make the argument that we’re always going to be surprised on the upside in the future,” says Marsh.
So is the American era over? Sherry Cooper, executive vice-president and global economic strategist for BMO Financial Group, recently sent a special letter to clients outlining her take on the future of Canada’s biggest trading partner. “We are in the midst of a sea change in U.S. hegemonic influence in political, financial and economic spheres,” she writes. “American financial, economic and political power has peaked.” She points to structural problems that can be traced back to America’s post-U.S.S.R. roles as global policeman, “importer of last resort” (a Cooper phrase) and global provider of high-quality financial assets — roles, ultimately unsustainable, that require massive military spending on the one hand and, on the other, large-scale borrowing to maintain high levels of consumption.
In his new book, When Markets Collide: Investment Strategies for the Age of Global Economic Change, Mohamed El-Erian, the respected co-CEO of Newport Beach, Calif., bond fund manager PIMCO, suggests that if investors hope to reduce the risk “of sudden and large losses,” they need to understand the “new destination” for the world economy. Like Cooper, El-Erian expects to see U.S. influence shrink as global trade decreases owing to higher energy prices. Inflation will be supported by continued pressure on natural resources and the diminishment of “cost-effective” labour offshore. Economic clout will continue to transfer from oil-consuming nations to oil-producing nations (and their sovereign wealth funds). El-Erian recommends a globally diversified portfolio. Dent is perfectly in agreement. “This is all about the plateauing of American economic power,” he says. “After Iraq and Bush, we have overextended ourselves.”
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