First published in the Financial Times on 10th June 2014.
Is there too much capital? Asset prices are at record highs – be it london property or stock market indices – yet still the surpluses rise. What is happening?
Eighteen months ago, Bain published an insightful document called A World Awash With Money. It stated that “financial assets are nearly ten times the value of the global output of all goods and services”. In other words, the financial economy has swamped the real economy. Bain believes this will continue – as China, India and other emerging markets grow, it estimates total global capital will increase by a further $300tn by 2020, or 50 per cent from current levels.
There are many reasons for this torrent. Central banks in the west have relentlessly stimulated the world’s money supply since the 2008 financial crisis. Lower tax rates and the post-cold war peace dividend have increased capital available for investment. High energy prices mean the oil producers have been generating huge surpluses, looking for a home. The “great doubling” of human resources, thanks to Asia entering the capitalist system, has vastly expanded workforces and markets in the past two decades.
The internet, robotics, big data and other technological advances have hugely increased industrial productivity. Offshoring, automation, deunionisation, financial engineering and deregulation have all contributed to a boom in corporate profit margins. And corporations are still using lots of leverage – certainly much more than they did 15 years ago. Non-financial business debt in the US is 80 per cent of gross domestic product – its highest level since the 1930s.
So funds have piled up all around the world – with institutional investors, on company balance sheets, in the bank accounts of rich individuals, and as dry powder at private equity shops. Meanwhile, the desperate search for yield among savers continues. Many remain risk- averse but find negative real interest rates for cash on deposit equally grim. Inevitably this leads to misallocation of capital. Cheap money is encouraging share buybacks and too many overvalued tech start-ups. In China, where overbuilding and loose lending are rampant, there are ghost cities; in Japan wasteful infrastructure spending. Even savvy investors are paralysed, not knowing where to deploy their capital.
In a world with no scarcity of finance, then assets in limited supply are bid up in price ever further. Fast-growing companies, rare chunks of real estate, fine art, businesses with high and sustainable margins and quasi-monopolies. Given the stratospheric prices being paid now for such desirable nuggets, their prospects for future performance must be doubtful unless there is further earnings multiple expansion, or the equivalent. Valuations have probably never been higher relative to traditional metrics.
Weight of money seems the principal driver of asset price appreciation in this era. While the statistics suggest corporate profitability is at high levels, on the ground I see more competitive business conditions than ever before. Costs are inflating and rivals are more prevalent. Unsurprisingly our firm experiences more bidders in auctions for attractive companies than ever before. One suspects that some acquirers are doing deals for the sake of it. It cannot help that the level of corporate transactions has not recovered as expected: in the UK in the first quarter of this year, merger and acquisition activity was at a record low. Instead of selling out, owners were doing initial public offerings on the stock market.
Perhaps stock prices have reached a “permanently high plateau”, as Irving Fisher said in 1929. After all, there are more pensioners and savers than ever, with greater savings. Our ageing world needs greater income from its investments. But climbing profits stem at heart from new inventions. Many experts reckon the commercial world is not producing as many breakthrough innovations as in the past. And capital investment remains lacklustre – research and development spending has not benefited from all the cash mountains. Nor have jobs: In 2013, the Fortune 500 recorded a profits increase of 31.7 per cent, but a rise in employees of just 0.7 per cent. If this asset peak is not to collapse, there must be more corporate investment to drive sustainable profits and job growth. The wall of hot money will not last for ever.