‘Hitch your wagon to foreign demand’: SMU’s Cox

In terms of investment opportunities, the next decade won’t look anything like the past quarter century. But that doesn’t mean there won’t be investment opportunities, said economist W. Michael Cox, speaking today to investment professionals in Washington, D.C.

“There are investment opportunities in any economy,” said Mr. Cox, professor of finance at the Southern Methodist University Cox School of Business.

Addressing a standing-room-only audience at the Investment Management Consultants Association’s annual conference, he presented six drivers of past economic growth in the context of current investment opportunities.

The technology evolution that drove markets from 1987 through 2007, which included the growth and development of the Internet, will continue to be a factor, but at a much slower pace, Mr. Cox said. “There has to be a technology slowdown because we’re on the backside of a wave, and right now, we don’t have any push from the front side,” he said. “It’s not a matter of tech stocks falling from here; it’s just a matter of stocks’ not having the same oomph they had before.”

He advised turning to alternative investments as the best way to navigate around a slower-growing tech category. The globalization factor that helped drive growth over the past few decades remains alive and well, Mr. Cox explained. “China is a huge manufacturing base and India is leapfrogging past manufacturing to the servicing age, and that servicing is getting more sophisticated,” he said.

The ultimate upside of globalization, he added, is a growing middle class and rising consumerism.
“We’re going to see 3 billion new middle-class consumers this decade and companies that tap into this rapidly growing demand will find a gold mine,” he said. “Hitch your wagon to foreign demand and pay particular attention to service companies.”

In comparing the past few decades to the next decade, Mr. Cox, said: “Inflation was bad in the past, but inflation is part of the solution in a recession.”

“In practice, a little inflation is good for the economy, and inflation would be higher now if the Fed could have gotten the money supply higher,” he said. “I think the Fed wants to see inflation in the 4% to 6% range.”

Investing in that kind of environment, he said, involves a focus on areas that tend to do well in an inflationary cycle, such as real estate and managed futures. “You want to avoid the kinds of companies that can’t quickly raise prices,” he said. “Bonds and broad market indexes tend to underperform in inflationary periods.”

Consumerism as an economic driver requires a more selective approach to investing, Mr. Cox said. “A more frugal American has showed up, and austerity is now in vogue,” he said. “But people will still buy new goods when they’re out there.”

The consumerism area in particular, he said, requires a sophisticated professional capable of studying consumer behavior. “This will not be a decade to just throw darts at a dartboard, and avoiding it by sitting in bonds is too expensive,” he said.

The easy money of the credit system is also a role reversal from the past, and investors will need to allocate accordingly, Mr. Cox explained. “The Fed policy has been ineffective because you can put money into the system, but that doesn’t make banks loan it out,” he said. “The returns this decade will favor large companies that are able to raise cash via nonbank strategies.”

The role of government in the past, compared with the present and future, couldn’t be more stark, according to Mr. Cox. “Between 1987 and 2007, in terms of government, it was a matter of less is better,” he said. “Things were deregulated, privatized, and taxes were cut.”

For a sense of government’s role in the future, Mr. Cox said one need only look at what caused the financial crisis.

“There has never been a stock market crash that was not caused by government, and government caused the most recent financial crisis by pressuring lenders to make subprime loans,” he said. “Government has now tried to spend its way out of this economic recession the same way Japan did, and Japan is now on its third lost decade and their debt is now 40% of the government’s budget.”