Time of Transition
IN PRINT ARCHIVE CIR Summer 2000
|Time Of Transition: The Future of The Global Economy|
|by Michael Hughes|
Recent events in financial markets suggest that this is a period of transition for the global economy. This transition represents a change from a high debt environment to a more sustainable set of financial conditions, and from a low growth and high inflation environment to a high growth and low inflation era. There is also a change in industrial structure from a period of product innovation to process innovation. Finally, we are changing from a government dominated to a consumer-oriented society.
By considering each of these changes, we can define a vision of the future which assists with the design of an investment strategy.
High Growth and Low Inflation
Product to Process Innovations
Product innovation gives rise to emerging companies and industries. The investment lesson of the 1990s has been that investors should have paid more attention to emerging industries than emerging markets.
An examination of long-term economic cycles shows that in the recovery stage emerging industries dominate. They create new markets in which there are relatively few competitors. Economic growth rates begin to accelerate from the low rates recorded during the depression stage of this long-term cycle. Emerging industries play a central role in stimulating the revival from depressed economic conditions.
However, the products of emerging industries change the behaviour of other companies, allowing them to make the transition from old to new product life cycles. Hence, a period of economic prosperity can ensue with the breakthrough of new lines of activities and companies re-engineered to take account of new technologies. This is the phase we believe we are now moving into, and as such the impact of process innovation should be dominant. Some of the old economy sectors should now be viewed more positively in the expectation that individual companies should begin to transform themselves.
The empowerment of consumers has come from a variety of sources. The current generation of consumers is much more demanding than those of the past. It is also the generation that came to depend on government for health services, education and welfare support. The government is now backing away from these obligations. This encourages consumers to demand greater value for money, especially in areas such as health and education. The next generation is building on these values and demanding that goods meet environmental, ethical, and even religious standards.
On top of all this, technology is enabling consumers to have greater choice. Prices can be compared quickly and easily, companies can be communicated with directly rather than through an intermediary, and new products and services can be designed with individuals rather than markets in mind. The consumer is therefore taking control and exercising buying power as never before.
One of the consequences of this is that companies need to have relevant positioning and standards to receive the benefits of this consumer shift. Companies with strong brands and global presence clearly have advantages. Hence, the shift in the incidence of profitability to such companies suggests greater stock-specific risks to equity investors. Companies can only succeed at the expense of others failing, the implication of which is that for any equity portfolio the stock risks are higher.
In order to control the overall level of risk in a portfolio we recommend the use of bonds. Bonds offer diversification benefits in such an environment and help to reduce the overall level of portfolio risk.
Michael Hughes is the director of Baring Asset Management in London, England.