Home Forums Hunting & Shooting Hunter's Campfire What Yellen's Friday Comments Mean to Investors

Yellen's “High-Pressure Economy”, Causes And Implications On Equities & High Yield Investing

Rida Morwa
Seeking Alpha
Oct 15 2:39 PM

In a speech on Friday, Chairwoman Janet Yellen said that "The Federal Reserve may need to run a "high-pressure economy" to reverse damage from the 2008-2009 crisis that depressed output, sidelined workers, and risks becoming a permanent scar". She also flagged the dangers of lasting damage to an economy that are caused by serious downturns, and that policymakers need to act "aggressively" when responding to a major setback. She called for more research into a host of economic conundrums to assist central bankers around the world. Her concerns reflect the difficulties central banks around the world are having to kick start the Global Economy despite record low interest rates and negative rates in certain countries around the world.

What prompted Jannet Yellen to raise these concerns?

Despite years of monetary easing, the U.S. economy has recently showed signs of slow-down as a series of economic reports are pointing to a decelerating U.S. economy. Just this week, The IMF (International Monetary Fund) has revised its US economic growth forecasts sharply downward for this year. The forecast for 2017 was also revised downward. It expects the US economy to grow only 1.6% this year, which is 0.6% lower than its July forecast and 0.8% lower than its April update. The IMF observed that the economy has lost momentum. The IMF is not the only one expecting a deceleration in US economic growth. In a release on September 23, the New York Federal Reserve reduced its forecast for economic growth in the 3rd quarter to 2.26%, compared to 2.38% earlier. It downgraded its 4th quarter GDP outlook to 1.22% from 1.37%.

Looking at the Global Economy, the IMF also reported that activity remains sluggish with growth estimated at 2.9% in the first half of 2016, slightly weaker than in the second half of 2015 and lower than April 2016 projections. Just this week it was released that Chinese exports in September dropped 10% from a year earlier, a much worse performance than expected, and imports contracted 1.9%, painting a picture of weakening foreign and domestic demand. The IMF said it now expected global growth to rise slightly to 3.4% next year.

Why it is increasingly difficult to kick start the Global Economy?

The difficulties to kick start the world's economy could be attributed to a slower population growth in the developed world and an aging population. Indeed, today we are living in a world which is much different than that of the last century where demand for goods and products was supported by high population growth and more young people in the workforce. The world is heading to a demographic situation that will be a first in human history: there are about to be more elderly people than young children. The proportion of elderly adults around the world is rising, while the proportion of younger children is falling. But within a few years, just before 2020, adults aged 65 and over will begin to outnumber children under the age of 5 among the global population. And these two age groups will continue to grow in opposite directions.



Source: UN

In a high-population growth environment, the impact of throwing in cheap money around would quickly translate into economic improvement; but with less young workforce around, this task is proving to be much more difficult. Let us have a look at Eastern Asia (example Japan) or Western Europe for example where population growth have stalled or declined in some areas. These economies have been seeing a notable deflation which is evidenced by lower real estate prices, difficulties in starting new businesses, and declining demand for goods and products. This is despite the negative interest rates and the most accommodative measures from their local Central Banks.

The main problem today is that the global population growth has shifted to less developed parts of the world such as Africa and areas that are lacking infrastructure and investments. The population growth in these areas would be difficult to translate into a meaningful push to the global economy.

The way investors think & invest could meaningfully change

These new trends could have a long lasting impact on how central banks would act in the future, and how investors around the world would allocate their funds in the stock markets or elsewhere. The largest world economies are more interlinked than ever and no single major economy lives by itself on an economic island. They are all dependent on each others in a sense that a deceleration in one economy such as Europe or Japan can affect the growth in the other economies such as the U.S.

Divergent central bank policies, such as the U.S. tightening the economy while the rest of the world is loosening it, would be very difficult to implement. For example the U.S. Fed is unlikely to be able to increase interest rates in any meaningful way while the rest of the world is still combating deflation. That would throw the U.S. economy at a great disadvantage and could trigger a recession.

The slow growth we are faced with today, which is partially the result of a slowing population growth and aging one, could last for decades. This could lead to some fundamental changes in the way investors put their money at work now and in the future.

Impact on interest rates: Interest rates in the U.S. and globally are likely to remain at their record low levels for several years as central banks attempt to support a fragile world economy and avoid recessions. This is what Mrs. Yellen was referring to in her speech on Friday. In such an environment, the risks of asset bubbles are minimized and will reduce future needs to hike rates to contain such risks.

Demand for high yield investment products: In a world where growth and inflation expectations are low and interest rates near zero, demand for high-yield stocks and products is bound to continue and even increase.

Corporate growth outlook: As a result of slowing global growth, corporate earnings will continue to stagnate and companies will have to allocate less money to growth projects and more money to preserving cash flows. With demand for yield increasing, companies will be under pressure to increase their dividends to make their companies more attractive for yield seekers. A similar trend has already started a long time ago in Europe. When it comes to dividends, Europe has long had a "dividend culture". Distribution rates in Europe are higher than in most other regions, especially the US where companies have been more concerned with either building up cash on the balance sheet or growing the business. European stocks (excluding the UK) account for 37% of the global dividend basket while US stocks account for 30%. UK and Japan stocks account for 10% and 6%, respectively.

Re-allocation of investors' funds: With a view of slow economic growth, investors are likely to slowly shift their funds allocation to stocks with stable cash-flows and a sustainable dividend rather than to high-growth stocks. Growth investing will be much less a pronounced theme in the future as it is today.
Mrs. Yellen's concerns about a fragile economic growth and difficulties by central banks to kick-start the economy are valid ones and are likely to remain with us for several years to come.

Conclusion

In an environment of continued slow growth and low interest rates, allocating one's portfolio to high-dividend stocks with moderate growth and sustainable cash flows will pay off. Companies with high cash payouts, strong dividend coverage and dividend sustainability will remain the investments of choice. Such investments would include Property REITs, Telecoms, oil & gas pipelines, utilities and certain other defensive high yield stocks such as pharmaceuticals and gas stations.