Imagine you have travelled back to February 1981.
Anwar Sadat is President of Egypt. Hosni Mubarak is a boring bureaucrat serving as vice-president. Sadat’s assassination (and Mubarak’s miraculous survival) is still nine months off. The peace treaty Sadat had signed with Israel’s Menachem Begin in 1978 had earned him a share of the Nobel Peace Prize and the enmity of many of his countrymen and peers in the Arab World.
In America, Ronald Reagan had taken his oath of office just a few weeks ago, on the same day that 52 American hostages were released by the Iranian students that had taken over the US Embassy. According to many of the hostages, one of their captors was named Mahmoud Ahmadinejad. Whether he was actually part of the takeover or not, we did not know then that he would later become Iran’s puppet president.
The Dow Jones Industrial Index closes February 6, 1981 at 952. It includes companies such as Eastman Kodak, Inco, American Can, and US Steel. The thirty year US Treasury Bonds yield 12.8%, while the Prime Rate stands at over 19%. A conventional thirty year fixed mortgage can be had for 15.1%. The US Federal Debt stands at about $950 billion, which represents about 35% of GDP.
The Soviet Union is America’s great foil and includes in its empire the Ukraine, Kazakhstan, Turkmenistan, Kyrgyzstan, Uzbekistan, Tajikistan, Belarus, Lithuania, Estonia, and Georgia. The Soviet Block includes puppet governments in Poland, Czechoslovakia, Hungary, Bulgaria, Romania, and East Germany. Berlin is divided. The United States has just boycotted the 1980 Moscow Olympics. The 1984 Olympics have been awarded to Los Angeles. The Soviets are deeply mired in Afghanistan where they wage a cruel campaign against civilians, booby trapping toys with bombs and blanketing the country in mines.
Goods made in China are hard to come by and generally consist of hand-worked silk, ivory, and jade. US dollars are not permitted in China. Beijing and the Great Wall are closed to Westerners. There are few cars in China save a handful for top communist party officials. There are no sky scrapers of note in Shanghai or Guangzhou. It has been eight years since Nixon’s visit to China.
The internet has not yet been invented. There is no email, no texting, no chatrooms, no Facebook. A few folks have ponied up to acquire heavy mobile phones they connect to their car battery. People write letters and reports on typewriters. They use calculators and adding machines. GPS is only available to the military and is spotty at best. When people want to research information they turn to an encyclopedia or library.
There are three major network broadcasters as well as PBS. In some communities, there might be an extra TV station. 24/7 television has not yet been invented, and only a few people have cable. HBO has been around since the 1970s, ESPN for two years, and CNN for one, but all with limited access. There is no MTV, FOX, and CNBC. Most people get their news from local prime time newscasts or the local newspaper. Several communities have at least two daily papers. Local DJs rule the radio waves. Clear channel has not consolidated local radio.
We can agree that life was quite different in 1981. Yet now imagine that you were an economist or adviser in 1981 helping a foundation, a pension, or a future retiree plan for the next thirty years. What might you have considered?
You’d probably start by being concerned about fixed income. After all, with Treasury yields in the low double digits, you know that bonds will barely keep pace with inflation that has been running 11-14%. And if anything, bond yields and inflation both seem destined to keep rising. Who would want to lock in money at 12-15% for thirty years? So you would be cautious about fixed income.
Of course, given high inflation and interest rates, who in their right mind would allocate much to US stocks, an asset class that had been returning only about 8-9% per year for the previous thirty years? Investing in stocks in 1981 seemed to many investors to be a sure way of locking in real investment losses.
There were only a few “hedge funds” in existence, they were not yet accessible to most investors, and few investors would have placed money in them anyway. One could trade commodities or REITS but the markets were not very transparent, affordable, or well understood.
What Would You Have Predicted?
So if you were sitting with an investment committee or a family in 1981, how many of the geopolitical, economic and social changes that occurred between 1981 and 2010 would you have predicted? Would you have nailed the demise of the USSR? The advent of the internet, email, text, chat, and all that they entailed? Would you have guessed that you would have a computer strapped to your belt with more communication and research power than any combination of electronic devices that existed in 1981?
Would you have predicted that the Dow would transcend 14,000 once and 12,000 a few times? Or that most trading on the major markets would be driven by computer algorithms? Would you have guessed that 30 year bonds would for a time be discontinued, then reinstated, and that they would yield only about 4.2% as 2010 drew to a close? Would you have dreamed that a 30 year mortgage could be had for about 5%? Or that even those with near perfect credit scores would have difficulty actually securing such a deal?
Would you have predicted that Japan would rise as America’s greatest economic adversary, then stagnate? Could you have guessed that backward, communist China of all places would become our primary economic partner/competitor? Would you have anticipated the rise of the European Union, the successful issuance of the Euro, and the uncertainty that now stalks the very arrangement? Might you have imagined that the World Trade Center would be gone, US troops would be fighting in Afghanistan and Iraq, and that the nightly news would speak regularly of Mosul, Kandahar, and Kabul? Could you have dreamed that a black man from a family of mixed race, nationality, and religion would be president of the United States?
Could you have imagined that the Fed would be busy trying to stimulate inflation to something higher than the current 1.5%? Would you have expected that the US Debt would stand well over $13 Trillion? That somewhere around 1 in 10 US houses would be vacant? That serious discussions would be underway regarding how states and municipalities can declare bankruptcy? That over 20 million Americans who are part of the workforce would not be working?
Could you have conceived of Microsoft, Google, Facebook, Verizon, Apple, Hyundai? Would you have guessed that only nine of the thirty Dow Jones Industrial component companies in 1981 would still be in the DJIA in 2010? Could you have anticipated that five of the 2010 DJIA companies would be financial services firms when none were in 1981? There had been six financial companies in the DJIA in 2008, but Citigroup rose and fell from grace in the years between 1981 and 2010.
How Should We Look Forward Today?
Since we are in the business of helping prepare for the future, we cannot simply throw our hands up because forward-looking predictions are so difficult to make. We must find that balance between predicting what might happen and humbly knowing that we cannot. And in that place of balance, there are certain truths that form a foundation on which we can build a strategy for going forward.
• The companies that will drive innovation over the next thirty years have not yet been created.
• Some of those companies will be domestic and some will be foreign.
• Countries guided by the rule of law and citizen engagement will outperform those that lack either one.
• There will be bubbles and they will pop and people will lose a lot of money.
• Governments and companies that manage their debt loads most effectively will outperform those that do not.
• Through globalization, currency markets will continue to rationalize, driving the world toward a single currency, a stabilized basket of currencies, or relative constancy between a handful of dominant currencies.
• The demographic, social, and technological trends of the last thirty years will be quite different from those of the next thirty years.
• Governments that tax too much stifle innovation and growth which ultimately stifles civil society and promotes economic malaise.
• Governments that tax too little stifle civil society and encourage economic disparity, which ultimately stifles innovation and growth.
• Commodities and land are likely to remain constrained resources for the next thirty years.
• The global population is growing.
• People want to feed their families and provide them with access to health care.
• It can be more lucrative to own a company than to loan money to it.
• It can be much safer to loan money to a company than to own it.
• There will be governments that abuse their people.
• There will be people who abuse their governments.
We realize of course that the statements above do not render an asset allocation blend optimized for the next thirty years. But they do remind us that the next thirty years will be driven by themes we can expect and specifics we cannot.
So as investors plan for retirement, finance foundations and endowments designed to last in perpetuity, craft estate plans, and ensure the health of defined benefit plans, we must think critically, embrace uncertainty, and craft a course of action that anticipates both worst case and best case scenarios. If the last thirty years have taught us anything, it’s that both will most certainly happen.
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