The death of passive investments

In the next 10-15 years, I believe, that the passive, static investments (e.g. the classic 60-40 share-bond portfolio) will only achieve negative real return. It has numerous reasons, however, the most important is that I see signs of a structural trend turning around. From the end of the 80s – as I have already written about it – Asian and Eastern European labour has flooded the world economy, which, as anticipated, pushed wages down in the developed countries. This way, inflation remained low and for this reason, interest rates could be lowered worldwide. On its own, this already resulted in significant savings on financial expenses for companies, and because of the cheap labour, profit rates have already risen anyway: capitalists earned more, while workers did not.

However, it seems that we have ‘ran out of labour’ globally (as I wrote about it earlier), so I think that this decade-long and capital market favouring tendency is about to turn around. The above-mentioned trend has brought low interest rates, high pricing (e.g. P/E, EV/EBITDA) indexes, all in all, expensive bonds and shares, while profit rates also increased. Thus, profits grew faster than GDP did, and these high profits were sold with higher and higher pricing multipliers in the stock exchange. This used to be the seventh heaven for investors: shares grew a lot (since profit and the P/E rate used for its pricing were rising at the same time), while their money in bonds also appreciated due to the decreasing interest rates.

What will happen when this trend comes to an end? The few is valuable, so labour gets appreciated, and wages have to be raised, which, on the one hand, leads to decreasing profit, while on the other hand, calls for more corporate investments because the expensive labour will certainly be partially replaced by machines. Meanwhile, the rising wages lead to higher prices, and all in all, faster inflation, which will require increased interest rates (however, central banks, since they are not used to this, will not believe in inflation and for this, they will ‘chase the curve’, exactly like they did in the 70s, and it will fuel inflation). The higher interest rate will, however, mean lower price indexes for shares, yet, profits will not grow as much as the GDP. This means that in the next 10-15 years, the average annual profit growth will hardly be above zero, while price indexes will keep declining, and this way the nominal returns of shares cannot be more than zero either! Bonds will have a hard time too in a rising yield environment, so savers will go through difficulties and suffer real losses.

This also means the fading of the Piketty-hype: since more will stay at the workers, wealth inequalities (that have been caused mainly by the above-mentioned processes since the 80s) will decrease and so will the savings of those with significant savings. Workers will relatively become richer in comparison to capitalists.

From the 1990s and the end of the Cold War, capital markets have experienced a two-decade-long recovery, similar to the one after the end of WWII until the middle of the 60s, during which share prices increased tenfold in the USA. However, after that until the early 80s, shares did not make any profit at all, and I believe that we are ahead of a similar period now. In such environment, passive/static portfolios will not work and only those will make profit who can make use of the 1-2-3 years recoveries and crashes. This will not be easy and, by definition, the majority of investors cannot succeed.

All in all, I believe that in the next 10-15 years, opportunistic and quite often cash-based strategies will be fortunate, however, right now we are going through a transitional period when zero interests/QE are fuelling asset prices, while wage inflation is slowly about to arrive. For this reason, the next 12-24 months are the finale of the bull market, probably, and will last until the wage inflation becomes apparent. After that, the inflation/interest rate increase will take over the QE/zero interest rate. This is almost like turning with a tanker: it is extremely slow but inevitable and primal…

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