The Baby Boomer Investing Era Is Coming to an End
(Bloomberg Opinion) - We are in the middle of an investing environmental shift and that means investors have to be positioned for this change.
In recent decades, monetary policy makers have focused on keeping inflation at bay, making government bonds an ideal investment for a world of falling interest rates and stable prices. Policymakers now see their main task as warding off downturns and boosting growth and inflation. Central bankers came out and said that governments need to do more to stimulate growth with fiscal policies. The way to invest in unexpected bursts of fiscal incentives could be assets that have largely fallen out of favor in recent years, such as equity stocks of financial and non-US companies and possibly commodities.
To think about investing in this new landscape, it is helpful to consider the origins of the old landscape. High inflation in the 1970s paralyzed the US economy and caused social and political turmoil. Rising residential property prices and high mortgage rates depressed the baby boom generation as its members reached their prime for household and family education. As mentioned in the book "Great Expectations: America and the Baby Boom Generation", in 1970 half of the country's population could afford to buy a new house at an average price. By 1980 this percentage had dropped to 13%. To bring economic prosperity to the boomers, inflation had to be slowed down.
It has taken some time, but monetary policy has evolved to achieve this. Paul Volcker became Chairman of the Federal Reserve in 1979 and raised interest rates to curb inflation. A tax rebellion in California led to the adoption of Prop 13, which slowed property tax growth and limited government spending. The Republicans won elections up and down based on an agenda for small governments and low taxes.
This shift, combined with the starting point for valuations in the early 1980s, made government bonds an ideal investment. At their peak in 1981, 30-year government bonds yielded more than 15%. Inflation would fall below 5% within two years, making bonds far more than inflation. Over time, investors realized that the Fed was focused on fighting inflation and was ready to create recessions for it. In good times, investors tended to get a reasonable return on government bonds that outperformed inflation, and in bad times, bonds grew substantially as inflation and interest rates fell.
Bond ownership worked so well that in March, when stock markets collapsed, the yield on 30-year government bonds actually kept pace with stocks over a 40-year period.
However, as we have seen in recent years, especially this year, things are moving in a different direction. Both Democrats and Republicans have made it easier to downplay budget deficits. Rhetoric is one thing, but we saw when the Cares Act was passed in March that it meant it, with trillions of dollars in fiscal incentives used to offset the economic damage done to Covid-19. As a result, the recession that began in February could end in just two months. The White House has signaled that it still wants to see additional incentives of up to $ 2 trillion.
The Fed, chaired by Jerome Powell, has made it easier to talk about using fiscal policy to combat downturns. After the European Union mistakenly turned to the austerity measures after the great recession, it is now also focusing more on fiscal incentives. Joe Biden, whose lead in the presidential election continues to grow, has spoken about the need for trillions of dollars in new spending to meet this moment.
This linchpin makes sense because the economic challenges of the millennial generation, now in their twenties and thirties, are somewhat the opposite of what baby boomers of the same age faced. Instead of struggling with high inflation and high interest rates, the challenges have been low wage growth and a labor market that is too often far from full employment.
As in the early 1980s, financial assets are largely not valued for this shift. Long-term government bonds yield less than 1.5% because investors either assume that inflation will never meet the Fed's inflation target of 2% or are willing to deliver negative real returns in a low-growth world accept. The technology stocks investors demand are growing more at the expense of legacy companies and industries than from a robust growth environment. Shares associated with the latter, such as financials, foreign companies and commodities, have much lower valuations.
But it is these latter investments that are more compelling in a world where fiscal incentives are the preferred tool for economic policy makers. Bonds were the big winner when central banks suppressed inflation with monetary policy and fiscal policy was used sparingly to manage the business cycle. If the new world includes more fiscal incentives, unfavorable stocks and commodities geared towards faster global growth could be the big winners.
This column does not necessarily reflect the opinion of the editors or Bloomberg LP and its owners.
Conor Sen is a columnist in the Bloomberg Opinion. He contributed to the Atlantic and Business Insider.
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