My argument for 2019 is that there is no obvious story of support for financial markets hence investors are now feeling disoriented and thus we come to experience volatility as “nothing makes any sense… and the mind latches on to catastrophic scenarios”, to quote Harari.
Investors in 2019 are likely to be confronted by the notion of “nominal reality”.
One of the customs of central banks, government agencies and any other entity making pronouncements on economic growth is to quote real data – that is actual or nominal data less the current rate of inflation. The missing information is the nominal data.
Shift in landscape
Australia sends 75 per cent of its exports to Asia so the performance of China is paramount for us locals. China today is growing at circa 6.5 per cent, the same as it has been in prior years, give or take a real per cent or two. The big issue from my perspective is that prior to the GFC in 2009, nominal growth was double-digit (think high teens), inflation was high and interest rates were managed – in this instance kept artificially low.
It was easy street in terms of borrowing (at a very low real cost of money) to invest into an economy growing at double digit rates, nominally.
The make up today of the 6.5 per cent growth is very different. Nominal growth is now 9.8 per cent (about half of where it was at the recent peak of 20 per cent-plus in 2011-12) and inflation is tamed. This looks good according to economic theory but requires significant adjustment on the part of the companies operating in this new environment.
Quick question for corporate bosses: would you prefer nominal growth of 10 per cent and inflation of 7 per cent to achieve 3 per cent real growth, or nominal growth of 4 per cent and inflation of 1 per cent to achieve the same real growth rate?
The former situation can be likened to driving a company on an 8-lane motorway.
There is plenty of room for a company’s strategy to hit a “bump in the road” without crashing into the safety barriers. The latter situation is more akin to driving on a dual carriageway with the same “bump in the road” potential. In this latter situation, however, the probability of hitting the crash barrier is significantly higher.
To make matters more intriguing, our dual carriageway is peppered with disruptors, industry PacMen, radically altering the business norms of their industry and chewing up competitors.
The rationale for writing on this topic of nominal as opposed to real growth rates, what I have coined as “nominal reality”, is to better understand and explain why companies of all shapes and sizes (think Apple, Starbucks, Tiffany’s, Daimler, Lend Lease and Zillow as large, recent examples) are suddenly and unexpectedly hitting the crash barriers with significant damage to their share prices.
Nominal growth rates globally are declining to a point where the operating space on the corporate front line is very narrow and precarious in its outcomes as a result.
We may applaud generational low interest rates, but they come at the cost of lower economic growth for the foreseeable future.
Lower growth leads to lower returns – be happy with mid-single digits!
Harry Cator is the executive chairman of DMP Asset Management.