The Aftershock Investor: A Crash Course in Staying Afloat in a Sinking Economy (11 page)

The inflation and flat stock market of the 1970s (due in large part to declining productivity growth) was a harbinger of future problems, but not enough to offset almost a century of solid growth. Gross domestic product (GDP) growth was still fairly good, even in the 1970s. Except for the period of the Depression, down cycles were limited. Any down cycles during the century were relatively modest and were far outweighed by the good to great up cycles.

All of this enormous growth in the economy provided a strong basis for solid, but slow, growth in the stock market, which helped people like Warren Buffett and others do very well (see
Figure 3.1
).

Figure 3.1
Stocks versus Six Month T-Bills and Gold, 1965 to 2011

What $100 invested in 1965 would be worth today.

Source
: Bloomberg.

Then, beginning in the 1980s, all that slow and steady growth driven by real fundamental economic drivers was replaced by rapid growth driven by another kind of driver: rising bubbles. As we reviewed in Chapter 1, during this time we saw the rise of the . . .

• Stock market bubble
  
• Real estate bubble
  
• Private debt bubble
  
• Consumer spending bubble
  
• Government debt bubble
  
• Dollar bubble
  

However, since 2000, these bubbles have been stagnant and have started to fall:

• The Dow and the Standard & Poor’s (S&P) index have been essentially flat, while the Nasdaq fell 50 percent.
  
• Real estate has not recovered much since hitting bottom in 2008 and 2009.
  
• Private debt and consumer spending is still mostly down, with only marginal improvements.
  
• Meanwhile, gold (which, later in the Aftershock, will also become a bubble but is not there yet) is up more than 500 percent since 2000.
  

How does CW account for the changes described above? They say, “Don’t worry, be happy. Just be patient and eventually everything will get better.”

What in the world is giving CW so much sustained confidence? The answer is . . .

Inherent in CW is the deep faith that the U.S. economy possesses a reliable “natural” growth rate. This is somehow fundamental to our very existence and will never end. Hence, anytime we deviate from that natural growth rate and go into a recession temporarily, we will also, at some point, usually quickly, automatically return to our natural growth rate. That means that we can count on always having a rebound after every recession or, more to the point, after the recent financial crisis. This is also the fundamental basis for CW’s thinking about investments in stocks, bonds, and real estate. CW says the economy has a natural growth rate and, hence, stocks, bonds, and real estate all have a natural growth rate, too. That is why buy-and-hold investing is at the heart of conventional investing: Just get in and hang on, and eventually that natural growth rate will kick back in.

CW makes no acknowledgment that we could be in a bubble economy or that the world could be in a bubble economy. All bubbles eventually pop, and they don’t automatically reinflate. There is no “natural” growth rate that we can always count on to pull us through. Something has to actually
cause
a recovery; we don’t just get one automatically if we wait long enough, like winter turning into spring.

The United States does not have a natural growth rate that is in effect at all times and will always save us. In fact, there never has been a natural growth rate—not for any country, not in the past, and not in the future. There is simply no such thing as “natural” economic growth. All economic growth has to be caused by something; it doesn’t just happen automatically. That is why not all countries experience economic growth all the time.

Real (nonbubble) economic growth is driven by two forces: population growth and productivity growth. These two are related to some extent because higher agricultural productivity will lead to a larger population. However, our focus should be on productivity since we are primarily interested in becoming wealthier
per person
, not just having a larger economy with lots and lots of poor people. So,
productivity growth
is the source of economic growth. Hence, economies will grow only when productivity grows. An automatic increase in productivity is not natural or automatic. It has to come from changes in the way we produce goods and services. This involves changes in the way we do business, and that often involves changes in government and changes in technology.

China is a great example. What was China’s “natural” growth rate in the 1960s? What was its “natural” growth rate in the 1990s? We all know China’s growth rate was much higher in the 1990s than in the 1960s. Hence, there is no “natural” growth rate for China (or for any other country). It varies—quite a bit actually—depending on governmental and business actions. Growth was higher in the 1990s for China because they had made numerous important changes in the way they conducted business and in the way their government worked. Entrepreneurship was encouraged, free markets were encouraged, and more input from foreign investors and businesses was encouraged.

So, if China, or any other country, wants its economy to grow, it will have to continue to increase productivity. Yes, some of that productivity will continue to improve due to changes made in the past, but eventually the impact of those past improvements will diminish and economic growth will plateau if people don’t continue to make
more
improvements in productivity.

This may sound a lot like us telling you “there’s no free lunch,” and that’s true. But it has enormous importance for how many economists are looking at the economy. Many economists are assuming that any downturn in our economy is simply a diversion from our “natural” growth rate. In fact, you will even see that term used in many financial and economic articles. Nobody asks the most basic question: Where is that growth coming from? Instead, they simply assume it is always there and that our economy will naturally bounce back into growth mode. They are assuming that productivity is naturally growing all the time, even when economic history clearly shows it is not and that there is no “natural” or automatic growth rate.

Rather than staying the same or accelerating, productivity growth in this country and in the other major industrialized nations in Europe and in Japan has been slowing dramatically. Productivity growth in the last quarter of the twentieth century was much slower than in the first three quarters. These are long periods of time. That’s how real productivity improvement works. It is a very long-term process.

By the way, you should almost completely ignore the government “productivity” statistics or “output per man-hour.” Not that they are biased or wrong, but they don’t give you a true idea of
real
productivity growth. For example, productivity by that measure can be improved enormously by simply stopping all research and development. That is a dumb measure of productivity.

So, instead of looking at misleading government figures of output per man-hour (although not intentionally misleading as much as just bad information), let’s look at
real
productivity growth over a very long period of time. That’s the only way to look at it, since significant productivity growth is a relatively slow process. For example, when we look at the productivity growth of food production in the United States over the longer term, we see that two centuries of advancements have made it possible for the number of people required to grow food to drop from 90 percent of the U.S. population to just 3 percent. Now that’s real productivity growth!

Across many sectors, we had that kind of robust productivity growth in the United States for many decades. However, beginning in the 1970s (just before the bubbles started to inflate in the 1980s), overall productivity growth began to slow significantly (see
Figure 3.2
).

Figure 3.2
Slowing Productivity Growth (Using Total Factor Productivity)

Productivity growth was very rapid until the early 1970s and then grew very slowly afterward.

Source
: John Fernald, San Francisco Federal Reserve.

Here is another way to look at productivity. Under normal conditions, income generally goes up when productivity goes up. As
Figure 3.3
shows, real income growth (“real” because it is adjusted for inflation) has slowed dramatically since 1970. The lack of large increases in real income is another indicator that productivity has not significantly grown since the 1970s.

Figure 3.3
Real Median Family Income 1950–2009

Slowing growth in real family income after 1970 is another indicator of slowing productivity growth.

Source
: U.S. Census Bureau.

By focusing on the big picture of productivity—which is the real fundamental driver of economic growth—it is easy to see that the CW idea that we are merely in a market “down cycle” that will soon be followed by an “up cycle” is wrong. This is not a short-term down cycle; it is a longer-term productivity slump and the more bearish analysts have it right when they say we are not going to get out of this economic downturn anytime soon.

But even the bears are wrong, too. They are correct to see doom and gloom ahead, but they don’t see what is behind the doom and gloom, only that things are bad and will get worse. Having the
correct macroeconomic view
about stalled productivity growth is what separates the brains from the bears, and from CW, as well.

Without a doubt one of the best, if not the best, CW investors is Warren Buffett. He is truly a CW master and his incredible success attests to that. If you invested $1,000 in his investment firm, Berkshire Hathaway, in 1990 it would be worth almost $30,000 by the beginning of 2000. That’s pretty impressive.

However, after the beginning of 2000, his growth slowed considerably. Assuming you invested at the beginning of 2000, before the Internet bubble burst, a $1,000 investment would grow to about $2,300 at its peak in 2007 just before the housing bubble burst. That’s still very good growth but nothing like the earlier growth of the booming 1980s and 1990s stock market. And, if you invested that $1,000 at Berkshire’s peak in 2007 it would be worth about $900 today (see
Figure 3.4
).

Figure 3.4
Berkshire Hathaway Performance, 1987 to Present

The price of Berkshire’s stock (Warren Buffett’s firm) did extremely well in the 1980s and 1990s, and very well until the financial crisis of 2008, but has struggled since then.