By Nikunj Dalmia
The stock market is telling us that this pandemic is a natural disaster that will come and go and so therefore it is taking a bit more sanguine view of this crisis than what the public mood in the media headlines are, says the author of Ten Rules of Successful Nations and Head of Emerging Markets and Chief Global Strategist, Morgan Stanley.
Because of the pandemic what do you think will be the shape of the world, what will revive, what will survive and what will flourish?
I make a couple of points here at the outset. One, let us also put the pandemic in its proper context which is that this is possibly the third major pandemic over the last century. It could be the biggest since the Spanish flu of 1918 to 1919 and the point I will make is that those pandemics at that point of time were very lethal, debilitating for the global economy and yet very soon after those pandemics were over, very little was remembered about those episodes. The 1918-1919 Spanish flu which many people now have been brushing up their history to learn more about was followed by the roaring 20s, the big boom in the global economy.
Similarly, if we look at the 1957-58 Asian flu or what happened in 68 with the Hong Kong flu, the casualties in both those flues were greater especially the share of population that what we have had today and yet very few people who have even lived through those episodes remembered what happened during those two episodes. So to put this in context that we are living in this extraordinary moment it feels as if this is all that there is and how the world is going to be reshaped by these episodes, my suggestion here is to keep history in perspective and to recall what happened in those episodes. In fact, there is a great Russian proverb on this which is that ignore history and you lose an eye, you follow it too hard and you lose both. So keep a healthy dose of history in mind but also remember that patterns tend to change and we will move on.
So I am not looking at this pandemic as something which is going to fundamentally alter the world over the next five or ten years. Having said that, there is one thing about this pandemic which we have seen so far. Many of the trends that were in place before the pandemic broke out early this year, have been further accelerated by this crisis. So those trends were any way going to play out like de-globalisation or digitisation. Those are trends that I was looking to play out over the next five, seven, ten years instead they have been telescoped in time and possibly played out in five or seven months. Those for me are the two defining features of this pandemic. History teaches us that not to get too carried away by the moment and the second lesson is that many of the trends that were already in place have merely been accelerated by this extraordinary crisis.
“I am not looking at this pandemic as something which is going to fundamentally alter the world over the next five or ten years.”
The factors which you have maintained in the past and you have mentioned in the book, are based on your understanding, experience, empirical evidence and data which you have back-tested. Whatever assumptions have been made in the past were centred around interest rate cycle. But currently the interest rate cycle and liquidity scenario are very different. Would the assumptions that worked in the past play out now?
No. If you look at it, this is a point that I have been making now for many years, if not decades, which is that we are in an era of progressively easier and easier money and this concept of moral hazard has been almost kicked out of the financial markets. So talking about interest rates, a seminal moment was 1987 when we had the big stock market crash of 1987 and that was really one of the first times that a central bank explicitly intervened to prop up the market.
After the stock market crash of ’87 in October, Greenspan cut interest rates quite aggressively and since then we have had this pattern where every time there is a crisis you end up getting lower and lower interest rates with central banks rushing to rescue. So this era of lower and lower interest rates, much more intervention by central banks is something that we have seen since the 1980s and that just took another leap forward following this crisis and the extraordinary amount of stimulus that central banks have put to work. I do not think that this is something which is a new phenomenon. This phenomenon of asset prices being inflated by lower and lower interest rates and more and more central bank liquidity and greater rescues by governments in general is a pattern that has now been on for many decades.
In your book, you have said “the question to ask is never what will the world look like if the current trends hold, it is rather what will happen if the normal patterns hold and cycles continue to turn? What are you trying to bring out here?
The point that I am trying to make here is that we get very caught up in the moment and the consistent pattern that I have seen over the last few decades is that every decade there is some new theme, some new pattern which emerges and the last decade those very patterns that were enticing everybody all of a sudden look out of fashion. This is a consistent pattern that I have seen over the last few decades.
Currently we are all enthralled by the large tech companies and think that the virtual economy is bound to take over the world and technology is all that matters and I think this very lopsided view of the world and is possibly over done. I like the definition of a bubble which is that it is a good idea taken too far. My point is that a decade ago, we could not get enough of emerging markets, BRICS was the hottest theme in the world, India too and as recently as 2010, we thought 8% economic growth was our birth right and look where we are today! So that is what I say, yes you have cycles but cycles have a life. Most trends tend to peter out within a decade and as we look at this decade what seems very hot now is extremely unlikely to be hot by the time this decade rolls off.
In the book and specifically on various forums you have mentioned that one should be wary of the golden decade of America. Do you think the peak America theme which you argued and which you have been making may not play out as anticipated as per the script?
First, over the last decade, I have been very optimistic on America. In fact, the first book I came out with in early 2012, its main thesis was that I was in search of all these breakout nations in the developing world but the true breakout nation was going to be America given its tech prowess.
One of my biggest regrets in life is that I did not organise my investing career more in accordance with what I had written in Breakout Nations where I broadly said that the emerging markets are overhyped, the commodity boom is very long in the making and it is really the tech prowess and America that is likely to lead. That is roughly how things played out over the last decade. So here we are after an incredible boom in America, the stock market performance of America, the dollar performance and even the economic performance over the last decade have been exceptional. The point I make or I have been making in some of the forums over the last few months particularly before the pandemic broke out was that America is looking very extended versus the rest of the world in both financial and in economic terms.
Now following the pandemic, that theory is only more valid in the short term because of America’s tech prowess we have seen that the American stock market has been very resilient. The tech companies in America continue to generate extraordinary returns but if I objectively look at the metric that I mentioned in the book, America’s score is more mixed, in fact it does not score well on many of those scores. It went into this crisis with a relatively high debt level especially compared to other major powers such as Germany. There is a lot of complacency in America that because they have their reserve currency, the dollar, they can afford to print their way out of trouble and can afford to spend as much as they want. I am always concerned when countries begin to get that complacent.
We also have the phenomenon where in America today, the stock market compared to the rest of the world is at a 100-year high and so that is also looking very stretched and then you have the extreme political polarisation in America and that has shown through in the handling of this pandemic, in the performance of the American government. If you look at it, the caseload per million or death rates per million are relatively high in America compared to many other developed countries in the world. All these things do not really reflect that.
Remember, this is coming from somebody who has been very optimistic on America and even as recently as this March, April I wrote an essay for Foreign Affairs titled The Comeback Nation to just set the narrative correct, which is that America has a history of proving the pessimist wrong. It did so last decade as well when everybody had written off America. Even today, the narrative in a lot of the America press is one of American Declinism and I was saying that the last decade has been so good for America that the coming decade is not likely to be as good. It is like almost arguing something which is two steps removed from what the current narrative is.
If Ruchir Sharma has to plan his investment for this decade, how will he plan it?
I think it is time to relook at emerging markets. I have been quite sceptical of this asset class over the last decade or so and been speaking about that but I think that generally places like emerging markets and even Europe are looking much more attractive to me for the next five or 10 years if we can afford to have that patience and that time horizon. Why do I say that? One, is the US dollar. Typically these international investments tend to do much better in a weaker dollar environment. I think the dollar has made a very important turning point over the last few months and has clearly peaked after an incredible run over the last decade. That should generally help international investments. Global stock markets outside the US do much better in a weaker dollar environment.
Also, the fact that in some of these emerging markets the valuations are very cheap and this is possibly the most provocative thing that I will say as I have been a long term bear on commodities and I think that commodities are setting up for a much better decade given the amount of supply discipline. A rationalisation of excess supply has taken place in the commodity sphere after a very poor decade. So I think that investing in commodities for the first time is looking very attractive to me in many, many years. So that is where I would like to put more of my money — internationally in emerging markets and I am a backer of commodity investments which are looking so neglected out of fashion today.
“For the global economy which grew at a rate of let us say 4% on average everything else unchanged, 3% becomes the baseline in the years ahead.”
The first part of your book is dedicated to population growth, something which you have argued and mentioned previously also. Now if the population in the world is contracting, who will do heavy lifting because you need a large nation, a large country or populous country to perhaps generate demand?
The point I make in the book is that the world working age population growth rate has fallen from around 2% a year for much of post World War II history to now as low as 1%. That automatically means that the global economy is likely to grow at least 1% slower than where it has been growing over the last few decades. Remember the two drivers of growth in equal measure; one is the number of people coming to work and two how productive they are. So one engine is now running at half steam compared to where it was for much of post World War II history. It just means that for the global economy which grew at a rate of let us say 4% on average everything else unchanged, 3% becomes the baseline in the years ahead.
Now the question is that in this environment we all have to revise down our growth expectations and even countries like India, where the explosive population growth rate of the 60s and 70s, have slowed down. The working age population growth rate in India now is in fact dipping below 2% for the first time in possibly nearly a century. This is a very big seminal shift that is going on and something which is underappreciated that political narrative in countries like India is still very much on how to control the population growth because that is the mindset we grew up with in the 60s, 70s and in the 80s when population growth was very high. But now the population growth rate is slowing down across the world. There are nearly 50 countries in the world where the working age population growth rate of people between the age of 15 and 64 entering the labour force is in fact contracting. So this is a huge shift. In terms of who will do the heavy lifting, once again it is emerging markets and countries like India that still have a relatively better demographic profile even if the growth has slowed down a lot, countries in Africa and Middle East.
I mention in the book that having a good demographic profile is a necessary but not a sufficient condition for generating high economic growth because these countries which have generated high economic growth in the past were able to use the demographic dividend and convert into something, principally in East Asia. But in places like Middle East or in Africa, they were not able to do that. So having a good demographic profile is a good starting point for generating high economic growth but not a sufficient condition and if you look at the other nine rules which tie in much more to productivity.
In your book, you have mentioned why dollar matters because it is still the currency of choice for global business and other transactions. Do you see a big change happening in the US dollar as the reserve currency?
If you look at economic history, the life of a reserve currency typically tends to be a century. This goes back to the 16th, 17th century when the Spanish ruled and then obviously the British Pound being so dominant in the 19th century. So that is the average life of a reserve currency because then the empire or that financial hegemon begins to get too complacent and runs out of steam and something happens to cause the decline of that major financial empire.
The US dollar has been the world’s main reserve currency for a century now. So you can argue that on a very rough timeline, the dollar is also reaching a phase where it could possibly begin a decline. The only issue is that there is no clear alternative to the US dollar just now. So as a financial superpower, the dollar remains really powerful compared to the rest of the world. The share of America in the global economy today is just under 25% but the share of the dollar in the world’s global foreign exchange reserves is close to 65%. It is a huge disconnect between America’s economic power and its financial power as indicated by the strength of the US dollar in global FX reserves and the 90% of all transactions in the world today involve the US dollar on one side. It is hard to see what is an alternative because the Chinese currency still is punching well below its weight because China has so many restrictions on its capital flows and the trust that the international community has in that financial system is still not as high as the size of the Chinese economy.
The Euro remains under question because of all the fissures that keep showing up in Europe periodically. So you have the popularity of some marginal investments in the dollar and the millennials in particular like the Bitcoin as the new alternative but there is no real alternative to the dollar. So the best I can say is that the dollar seems to have peaked out on a cyclical basis. It is very stretched and even during the course of its reserve currency of the last century, the dollar has gone through cycles where it has been in an uptrend for five, seven years and then it goes in a down trend for five, seven years.
We have had a very strong uptrend over the last five, seven years and over the next five to seven years I would expect to see some sort of a downtrend in the US dollar given how expensive it is, how stretched it is and the fact that the rest of the world to me is looking like a more attractive investment opportunity than the US but to call the end of the US dollar as a reserve currency is far too premature because I just do not see the alternative apart from these marginal forces that are there like gold and Bitcoin. So I do not see the end of the US dollar as a reserve currency but I do see a cyclical phenomenon where because the dollar is so expensive and just like in the last 100 years of its dominance, it has gone through ups and downs, we could be in a downward sloping cycle for the next few years.
How should one read the kind of surge in market capitalisation that we see in Amazon, Apple, Alphabet or Netflix? The market cap of some of these companies is greater than a couple of countries put together?
Yes, there is a bit of a bubble phenomenon in these so-called hyped up growth stocks including these stocks that you mentioned and that happens periodically. We are in one of those instances. I think that the moment interest rates begin to rise, particularly long term interest rates, this bubble will burst, the question is when? I think inflation in the global economy may come back quicker than what people think currently. Today inflation expectations are very low but I think that in the next couple of years, inflation could come back and it could prick this bubble. This is a trend very long in the tooth. I personally would not be putting money in these very large cap tech stocks at this stage even though in the middle of the last decade I remember when I was first speaking about these acronyms coming into fashion like FAANG, very few people in India were aware of it and now it has become common parlance. I would keep away from that part of the market.
On the other hand, some of the more beaten down sectors such as commodities and even some places such as financials are looking more interesting around the world. There are still spots in the virtual economy such as gaming that I would want to invest in because that is where a lot of the future is moving but some of these incumbents, these very large cap tech companies I would be very wary of investing at this stage. That is my cautionary tale as far as the overall market is concerned. But the market in general is doing what it is doing which is that overtime the market will keep churning. What appears like the complete truth today will it end up changing a year or two from now and that churn will continue. Today the stock market is telling us that this pandemic is unlikely to be a permanent phenomenon, it is a natural disaster that will come and go and therefore the stock market is taking a bit more sanguine view in general of this crisis than what the public mood in the media headlines are.
