My colleague Citadella pictured the following future in his ‘The death of passive investments’ piece published this weekend. We have run out of global cheap labour, which will lead to increasing (wage)inflation, higher interest-rate environment, and corporate profit gains lagging behind GDP increase in the next two decades. The gap between workers and capitalists will close, meaning that income disparities will be reduced. All of this will result in decreasing pricing (and asset price/result multipliers) in capital markets, and this environment means only mediocre bond market returns for savers.
The real economic scenario above and its impact on asset prices is consistent, logical, and even quite possible. However, there are two global processes, one structural and one cyclical, that Citadella did not pointed out. Depending on their speed and extent, they can dampen and significantly change the above-mentioned scenario. One of them is that gigantic deflationary force that from the end of the XXth century until our present days manifested in the cheap Eastern European and Chinese labour could now be, in the first half of the XXIst, materialized as the automatization-digitalization-robotization (ADR) revolution. The other is that the currently tight labour market is one of the results of that the global economic cycle is approaching its peak, and it is not too far from recession.
The ADR revolution is seen, expected, and understood by many, however, it is rather difficult to predict how fast and at what intensity it will take place – and this is the ‘million-dollar’ question. It is more than likely that ADR, just like the innovation and spread of technology in general, follows the Moore’s law, which basically means that it increases at an exponential rate. Furthermore, while the number of people moving away from Chinese villages to cities is limited, this deflationary force does not have a headcount limit! The ADR process is further accelerated by the tight labour market and the resulting wage inflation pressure and the cheap money. Companies are eagerly investing in development. In China, they even receive state aid. (It is recommended to read the following article: ‘Inside China’s Plans for World Robot Domination’ source: Bloomberg)
The other process arises from the cyclical nature of the economy. The shortage of labour caused by the global economic recovery has reached a point where an above-average wage inflation could take place until the next recession. This has already showed up in our region, while in the developed countries, it is only incipient. It means that in the short-term, until the economic cycle turns around, we can follow the road Citadella talked about. However, in the mid-term, after the systematically occurring recession, the productivity increase resulting from the expansion of the automatization-digitalization-robotization revolution could be spotted. This could, in contrast to the one outlined by Citadella, lead to relatively lower inflation path and interest-rate environment, stagnating or even increasing income disparities, and more favourable GDP and corporate profit growth. In such environment the performance of shares is excellent. The key question, however, is the speed of the ADR revolution. Some believe that we are over the first inflection point, while others do not attach much significance to it. The truth is somewhere in-between.
Source: twitter.com, Gluskin Sheff
Make no mistake, at the current levels and value basis, share markets are not among the most appealing investments. However, after a correction, beginning from lower perceptional levels, I am not that pessimistic about long-term prospects.