High Level Investment Factors & Drivers
- Demographics & Growth
- Politics, Regulation & Economics
- Price & Value Investing
Demographics & Growth
Firstly a fact. Demographic (population) changes are an area of long range forecasting that is very accurate (compared with Economic forecasts). This arises because a country's birth rate impacts population growth for +50 years, death rates are gradually falling and cultural factors mean the future birth rate is also falling.
According to UN (United Nations) figures global birth rates have fallen from around 5.2 (per woman) in 1950 to, 4.5 in 1970 , 2.7 in 2000 and in 2.4 2010. They forecast a further fall to 2.0 in 2050, that is below the 2.1 population replacement level. Thus the UN forecasts the global population will start to fall after 2050.
What this means is in Europe, Russia, Japan & to a lesser extent North America, we already seeing a stable or falling population, combined with a rapidly increasing average age and declining proportion of working age citizens.
In China and indeed most of SE Asia and S America, rapid population growth is ending. Indeed in China the population and the proportion of working age citizens will fall rapidly from 2015-20. i.e. Very soon.
When a country's population starts to fall, especially the working age population, this leads to labour market (wage) inflation. Historically this has happened due to disease or wars. This predictable increase in income for the working age labour market means their consumption will increase and industry sectors which supply this consumption will benefit. As will sectors which service the aging population profile.
A major sector to watch is the food industry. In the near term (10 years) the global population will increase, but also wages will rise far faster (as they already are in SE Asia). So the population will not only consume more food, but also consume far more processed/expensive food and meat. Processed food and meat require, 10 times the agricultural land area versus staple grains and vegetable production, to provide the same calories. This means increased food price inflation and profit for the food industry.
This population demographic means future economic growth will be focused more on countries with rapidly expanding working age populations and relatively stable or slow growing non-working age populations (children & pensioners).
In the period 1990-2010 the so called BRIC (Brazil, Russia, India & China) countries met this criteria. Looking at those same BRIC countries during the period 2010 - 30, only India retains the same demographic advantage. Instead other countries in Asia (Indonesia, Philippines, Malaysia, Cambodia, Burma, Turkey) and Africa, will take their place. Also growth is likely to be good in countries who are able to replicate the same demographic advantage via immigration, the USA being a notable example.
A favourable population demographic will not benefit all countries. That is countries which have other underlying economic impediments like the lack of a strong legal framework,poor education standards,corruption and poor infra-structure will not prosper (Please see subsection on Geography).
In summary companies and sectors which are able to benefit from this demographically created growth, are likely to do well.
Where will economic growth come from in the next 10 years ?
Countries that grow need to have a favourable mix of factors nurturing that growth. Not all factors are essential, but a majority need to be present for growth to be sustained.
These growth factors are:
When you look in detail at these "factors for growth", it is evident that much of Europe will continue to suffer from very low growth. i.e. Poor demographics, high energy costs, government bureaucracy, mediocre infrastructure and labour market skills.
I envisage however N America doing quite well with low fuel prices (from shale oil/gas), immigration mitigating demographic concerns and reasonable strength in other areas.
I see strong growth in Asia within countries who are addressing their legal system/corruption issues, infrastructural challenges and labour market skills. That said I see growth in the next 10 years increasingly coming from ex-China Asia, due to China's demographic challenges. India's position will depend on whether its government finally deals with its poor infrastructure and legal system, including significant issues with corruption.
I also envisage strong growth in many African countries, but like India it will depends on how they improve their infrastructure, legal systems and labour market skills.
For most of S America I see their potential for growth will be held back by continuing infrastructure and legal system challenges and the fact S America is now coming to the end of its growth boosting "demographic advantage".
As an investor looking at geography I always try to avoid countries with legal system and corruption risks. Otherwise you can lose everything. This especially impacts investments in S America, Africa and India.
The impact of technology on growth and investment opportunities over the next 10 years is likely to focus on the impact of the internet on industries that have historically acted as intermediaries.
The internet has enabled market participants to deal with each other directly using a cheap web enabled "virtual market", as opposed to a formal intermediary organisation or body.
In effect buyers and sellers are dealing with each other directly on a so called peer to peer (P2P) internet platform, as opposed to paying a intermediary to act as a clearing house or agency.
Over the next 10 years this process will gain further momentum with traditional intermediary industries rapidly declining.
Industries such as retailing especially of homogeneous products (branded goods) are being heavily hit. As are "clearing house industries" such as travel agents, insurance brokers, retail & corporate banking, recruitment agencies, real estate agencies, betting shops/agents. With technical innovation this will spread especially in mass market financial service areas (like wealth management).
Intermediary type companies who are not using a P2P type solution to service their clients are likely to perform badly. So avoid investing in them.
In summary I would avoid investments in Financial Services, Agency type industries and Retailing (unless the product/service being sold can be clearly differentiated and the intellectual property adequately protected).
When looking at investment opportunities it is good to look at how innovation works. That is innovation is very rarely a straight line of upwards motion. Instead the economy learns more from its failures than it does from its successes. Indeed success often triggers the process of eventual failure.
The important thing to consider when looking at innovation is it is constantly happening and thus the current position will always change.
In many ways innovation is governed by the economic concept of "creative destruction". That is for example the success of a product (like say the IPhone by Apple) will be so profitable, that it leads to competitors to develop alternatives (Samsung's Android Smart phones) and thus the market monopoly is broken. Innovation is a cycle.
An innovation turning point is commonly signalled & triggered by an over shooting of the price (you could call it a bubble). That over shoot creates incentives for competitors to come in with new innovations.
In summary when looking at innovation investment opportunities it is vital to look at where the innovation is, within the cycle. Investment gains are most likely to be achieved soon after a innovation bubble has burst, which is when the learning from failure process begins and new ideas,processes & products are developed.
Politics, Regulation & Economics
Recognising the political,regulatory and economic environment and future direction allows you to identify investment opportunities and avoid mistakes.
In politics I see three main areas of focus in the political environment. These are a strong anti Bank and Financial Services attitude arising from the financial crisis, a huge rise in government borrowing and finally environmental concerns surrounding global warming.
In writing about the above I am identifying political trends, rather than stating those trends are the valid concerns.
Taking each area in turn.
1) The anti-Financial Services attitude in politics is taking the form of a tough and ever changing regulatory environment. This is especially true in Europe, but also is mirrored in America and Asia albeit to a lesser degree. In addition special Financial Service taxes have been developed. This environment makes investment in any Financial Service type company very high risk. Effectively if a company in the sector does well it is seen as a target to tax or regulate. In summary I would avoid all Financial Service type investments.
2) The rise in official government debt generally is worrying to say the least. If you factor in future unfunded state pension obligations and the growing demographic problem mentioned above, government debt is already at levels which simply cannot be repaid, without social turmoil. In effect for most of the developed world, debt is at a level where a default of some kind is inevitable.
However governments do not usually actually default on debt, instead they inflate their debt away by printing money and encouraging inflation. This tendency is already taking place with so called Quantitative Easing (QE) policies, starting to look more like pure money printing. Already the Central Bank's do not require interest to be paid on QE purchased debt, very soon it will become evident that the QE purchased debt will be forgiven as a loan when the bonds mature (the last step of QE = pure Money Printing).
The inflation needed to reduce debt levels, means your investments need to be in assets which can increase their market price. That is principally Equities. Your investments need to be in companies who can readily increase their product prices.
3) Environmental regulation brings with it investment opportunities and areas to avoid. Here I look at investments in for example the recycling / waste management area and beneficiaries of infrastructural projects lead by the green agenda. Also look at industries that will enjoy comparative cost advantages, due to less onerous environment regulation or taxes. For example the reduced energy costs the USA manufacturing sector is starting to enjoy, due to the Shale gas industry pushing their energy input prices down.
Price and Value Investing
When I look at investing I always need to remember the basic rule that price is everything.
Investing in shares is not like buying a product or service !
When you buy a car you will consider its performance, style and reliability in addition to its price and resale value. For investments the quality of the product is really secondary (you don't gain any value from looking at a share certificate or the number of shares you own displayed on the screen of your laptop), instead the only value of a share is how much you are likely to be able to sell it for in the future, plus any dividend you may be paid in the interim.
Thus the key to share investment success is buying shares that are under valued and then selling them on when they become fairly valued or indeed over valued.
The above may seem obvious, but most investors instead buy shares in good/well run companies because they are good companies rather than looking at whether the current share price over values the company. This is very important given (as we discussed in the Innovation section above) share prices commonly over shoot on both the upside and downside.
The key to investing is too look at whether the current share price represents good value for a company given future profitability and the assets it currently holds.
This approach is what I call looking at the longer term intrinsic value of a company versus its current share price. With a heavy focus on whether the share price is over shooting to either the up or downside.