Is growth worth it?
“Enchanted Forest.” Photo: Dave Meier. Source: Picography
We live in a deflationary time. Excess investment in productive capacity has provided more and more goods at cheaper and cheaper prices. Global trade and technology means that the marginal cost of labor minimal. Even professional services will be affected by globalized labor. The Microsoft-LinkedIn merger means that there will be millions of human “Clippies” waiting for us inside our Word or Powerpoint files, offering to do our animations and graphics or edit our documents for just a few dollars.
“Clippy.” Source: Wikipedia
Falling prices for goods and services around the world means that future money is more valuable than it is right now. It’s the opposite of an inflation problem. It’s why interest rates are so low right now. It’s also why safety is so important. Deflation creates credit issues for everyone except sovereign borrowers. In an age of deflation, countries can print their own currency without the normal inflationary worries.
The increased value deflation puts on future cash flow is why companies that can squeeze a little growth out of a depleted economy’s toothpaste tube have such high valuations—some of them eye-popping.
(The 40 “PE” for US Treasuries is just the 2.5% yield on 30-year bonds inverted, so that it is comparable with stock market price-earnings multiples.)
This helps explain why growth companies have outperformed value for the past several years. Deflation puts a premium on growth, because future cash will be worth more, if deflation continues. That of course, is the rub. Nothing continues indefinitely. As a Greek writer noted 2500 years ago, the only constant is change. No one steps into the same river twice.
Investors, policy-makers, and businesses have placed their bets that the economy will change back towards “normal”—towards 2% inflation and 1.5% economic growth. When we read the Fed’s minutes and speeches, it’s clear that committee members are concerned that inflation will pick up soon and they will have to raise rates rapidly to avoid falling behind the curve. They fear this would be disruptive.
But the that was the issue 20 years ago. Resources would get scarce and push prices higher, lifting inflation and inflation expectations. Now excess capacity is lowering prices, leading to deflation and putting a premium on growth. And what if deflation intensifies? We know things will change. But which direction with they go?.
Science fiction writer William Gibson says, “The future is already here—it’s just not evenly distributed.” With inflation and deflation both vying for significance, we don’t know what future that will be.
Douglas R. Tengdin, CFA
Chief Investment Officer