The U.S. economy has grown about 3.5% annually from the 17th century until the late 20th century. Most of American industry and wealth can be attributed to significant technological advancements starting in the Industrial Revolution. Over recent decades, productivity has significantly dropped off with some estimates of the economy growing at 1.8% annually. Returns from innovation appear to be entering a period of stagnation. Although the causes and implications of such events remain in question, it has become increasingly vital for investors to analyze performance across similar environments in history to successfully navigate uncertain markets.

1.
SUCCESSFUL
INVESTING
IN
A
LOW
GROWTH
ECONOMY:
A
HISTORICAL
PERSPECTIVE
Aaron
Careaga
Research
Analyst
http://www.wealthmarkllc.com/research
WEALTHMARK
LLC.
1329
North
State
Street,
Suite
206
Bellingham,
WA
98225
February
2013

2. ABSTRACT
The
U.S.
economy
has
grown
about
3.5%
annually
from
the
17th
century
until
the
late
20th
century.
Most
of
American
industry
and
wealth
can
be
attributed
to
significant
technological
advancements
starting
in
the
Industrial
Revolution.
Over
recent
decades,
productivity
has
significantly
dropped
off
with
some
estimates
of
the
economy
growing
at
1.8%
annually.
Returns
from
innovation
appear
to
be
entering
a
period
of
stagnation.
Although
the
causes
and
implications
of
such
events
remain
in
question,
it
has
become
increasingly
vital
for
investors
to
analyze
performance
across
similar
environments
in
history
to
successfully
navigate
uncertain
markets.
Aaron
Careaga
WealthMark
LLC.
1329
North
State
Street,
Suite
206
Bellingham,
WA
98225
aaron@wealthmarkllc.com
2

3. 1. Introduction
Most
academic
and
professional
theories
on
productivity
are
based
on
the
Solow
Growth
Model,
which
is
predicated
off
the
fact
that
economic
growth
is
continuous
along
an
infinite
horizon.
There
has
recently
been
significant
discussion
of
economic
papers
forecasting
dismal
growth
with
the
possibility
of
little-­‐to-­‐no
return
on
investment.
Economist
Robert
Gordon
argues
that
prior
to
1750,
the
growth
that
we’ve
become
accustomed
to
today
was
nonexistent
and
recent
productivity
is
likely
an
outlier
in
the
larger
economic
history
of
the
world.
Source:
Gordon
2012
Technological
advancements
from
the
Industrial
Revolution
significantly
progressed
economies,
but
innovation’s
ability
to
further
growth
appears
to
becoming
less
effective.
Basic
inventions,
such
as
indoor
plumbing
and
controlled
energy
(light
bulb),
heightened
the
standard
of
living
far
more
than
social
networks.
Society
might
not
be
as
well
connected
without
recent
innovations,
but
at
least
the
standard
of
living
would
remain
higher
than
that
of
agrarian
ancestors.
Gordon
explains
that:
Attention
in
the
past
decade
has
focused
not
on
laborsaving
innovation,
but
rather
on
a
succession
of
entertainment
and
communication
devices
that
do
the
same
things
as
we
could
do
before,
but
now
in
smaller
and
more
convenient
packages.
The
iPod
replaced
the
CD
Walkman;
the
smartphone
replaced
the
garden-­‐variety
“dumb”
cellphone
with
functions
that
in
part
replaced
desktop
and
laptop
computers;
and
the
iPad
provided
further
competition
with
traditional
personal
computers.
These
innovations
were
enthusiastically
adopted,
but
they
provided
new
opportunities
for
consumption
on
the
job
and
in
leisure
hours
rather
than
a
continuation
of
the
historical
tradition
of
replacing
human
labor
with
machines
(Gordon
2012).
Jeremy
Grantham,
cofounder
and
chief
investment
strategist
at
GMO,
recently
wrote
an
influential
newsletter
on
the
subject
called
On
the
Road
to
Zero
Growth.
The
paper
examines
Gordon’s
research
and
the
fact
that
U.S.
GDP
growth
has
remained
above
3
percent
in
recent
history.
3

4. Grantham
contends
that
growth
rates
near
3
percent
are
unsustainable
and
exhibit
only
a
small
blip
in
history,
fueled
by
population
growth
and
industrialization.
As
resources
dwindle
and
populations
peak,
he
forecasts
U.S.
real
growth
of
0.9
percent
through
2030
and
dropping
to
0.4
percent
from
2030
to
2050.
Most
valuation
models
use
annual
growth
rates
around
5
percent.
How
do
you
value
investments
necessary
for
retirement
in
a
0.9
percent
real-­‐growth
economy?
Pricewaterhouse
Coopers
also
updated
its
long-­‐term
economic
outlook
in
January
2013,
titled
The
World
in
2050.
The
report
includes
an
analysis
of
key
growth
drivers
and
implications
of
global
shifts
with
a
forecast
of
total
GDP,
average
real
GDP
growth,
and
income
per
capita
for
developed
and
emerging
countries.
PwC
projects
China
to
overtake
the
U.S.
in
terms
of
total
GDP
between
2017
(PPP
estimate)
and
2027
(MER
estimate)
depending
upon
underlying
assumptions.
The
U.S.
is
expected
to
be
the
second
largest
economy
behind
China
by
2050
with
annual
growth
slowing
relative
to
younger
economies.
China
is
forecasted
to
produce
3-­‐4%
real
growth
with
the
U.S.
and
E.U.
countries
growing
at
a
significantly
lower
pace.
As
the
following
chart
displays,
Nigeria,
Vietnam,
and
India
exhibit
the
greatest
potential
for
real
annual
growth
through
this
period.
Source:
Hawksworth
and
Chan
2013
PwC
states
that
recent
claims
on
a
slowing
technological
frontier
and
real
U.S.
growth
projections
around
1%
seem
“rather
at
odds
with
the
accelerating
pace
of
change
in
ICT
and
the
potential
for
further
rapid
progress
in
areas
like
nanotechnology
and
biotechnology
over
the
coming
decades”
but
they
believe
that,
“it
is
possible
that
measured
GDP
growth
could
slow
down
due
to
difficulties
in
measuring
technology-­‐related
improvements
in
the
quality
of
some
services”
(Hawksworth
and
Chan
2013).
Multiplier
effects
of
technological
innovation
are
rarely
obvious,
especially
in
traditional
measures
of
productivity,
and
often
lag
business
sentiment
for
such
advancements
relative
to
classic
examples
of
innovation
in
living
standards.
As
an
alternative
perspective
on
the
above
pessimistic
outlook
of
technological
innovation,
the
Economist
argues
that,
“the
main
risk
to
advanced
economies
may
not
be
that
the
pace
of
innovation
is
too
slow,
but
that
institutions
have
become
too
rigid
to
accommodate
truly
revolutionary
changes”
(Economist
1,
2013).
This
is
probably
another
major
factor
contributing
to
4

5. slowing
economy
productivity,
but
data
backing
these
claims
will
likely
not
be
apparent
for
many
years
to
come.
Projecting
recent
behavior
onto
future
expectations
is
extremely
capricious.
Forecasts
can
give
investors
comfort
in
seeing
the
future,
but
events
almost
never
unfold
as
initially
expected.
James
Montier,
a
member
of
GMO’s
Asset
Allocation
team,
believes
that,
“attempting
to
invest
on
the
back
of
economic
forecasts
is
an
exercise
in
extreme
folly,
even
in
normal
times.
Economists
are
probably
the
one
group
who
make
astrologers
look
like
professionals
when
it
comes
to
telling
the
future…
They
have
missed
every
recession
in
the
last
four
decades!
And
it
isn’t
just
growth
that
economists
can’t
forecast:
it’s
also
inflation,
bond
yields,
and
pretty
much
everything
else”
(Montier
2011).
With
these
thoughts
in
mind,
it
has
never
been
as
imperative
to
learn
from
past
experiences
given
recent
levels
of
volatility
and
potential
conjunction
of
multiple
forces.
Technological
pessimism
is
not
a
new
phenomenon
and
historic
performance
is
never
a
definitive
indicator
of
future
returns,
but,
regardless
of
the
outcome,
it
is
necessary
to
analyze
market
trends
and
investor
reactions
throughout
similar
periods
in
attempt
to
better
prepare
for
an
uncertain
future.
5

6. 2. Deciphering
the
Past
Prior
to
the
1800s,
societies
across
the
globe
were
primarily
agrarian
driven.
Wealth
was
mostly
derived
from
farming
and
the
exploitation
of
labor,
resulting
in
mild
income
inequality
and
distinct
levels
of
society.
Four
features
characterized
pre-­‐industrial
societies
across
history:
high
fertility
rates,
little
education,
the
dominance
of
physical
over
human
capital,
and
low
rates
of
productivity
growth
(Clark
2004).
Technological
innovation
led
to
a
major
change
in
economic
structures,
resulting
in
significant
supply
and
demand
shifts
across
labor
and
resource
markets.
On
financial
evolution,
it
is
important
to
recognize
that
bankers
and
other
facilitators
of
trade
have
existed
since
Roman
time
and
ultimately
laid
groundwork
for
the
current
financial
structure.
European
banking
institutions
started
to
facilitate
trade
and
the
transfer
of
funds
in
the
1600s.
The
New
York
Stock
Exchange
was
created
in
1792
and
most
of
the
bellwether
U.S.
financial
institutions
were
founded
around
the
mid
1800s.
The
Civil
War
was
a
catalyst
for
debt
securities
around
this
same
time
as
bonds
were
issued
to
finance
wartime
expenditures.
But,
nothing
on
today’s
scale
of
financial
markets
ever
existed
prior
to
industrialization
and
advancements
in
communication.
Investing
before
the
industrial
revolution
was
drastically
different
from
today
and
somewhat
limited
from
the
common
man.
Markets
were
inefficient,
assets
hard
to
transfer,
time
was
a
luxury,
and
most
did
not
have
discretionary
capital
to
invest.
The
transition
in
standards
of
living
and
societal
structure
can
be
seen
in
the
significant
real
wage
growth
spurred
from
industrialization.
Source:
Clark
2004
History
has
been
plagued
with
slow
economic
productivity
until
the
19th
century.
Common
investment
vehicles
utilized
pre-­‐industrialization
were
in
hard
assets
(land,
gold,
silver)
constrained
by
supply,
leading
to
a
more
dependable
store
of
value.
Capital
became
increasingly
necessary
to
build
the
factories
and
railroads,
leading
to
the
issuance
of
corporate
bonds
and
stocks.
One
of
the
leading
academics
on
financial
history
is
Niall
Ferguson,
who
authored
the
book
“The
Ascent
of
Money”.
In
summary
of
financial
evolution,
Ferguson
explains
that:
6

7. From
the
thirteenth
century
onwards,
government
bonds
introduced
the
securitization
of
streams
of
interest
payments;
while
bond
markets
revealed
the
benefits
of
regulated
public
markets
for
trading
and
pricing
securities.
From
the
seventeenth
century,
equity
in
corporations
could
be
bought
and
sold
in
similar
ways.
From
the
eighteenth
century,
insurance
funds
and
then
pension
funds
exploited
economies
of
scale
and
the
laws
of
averages
to
provide
financial
protection
against
calculable
risk.
From
the
nineteenth,
futures
and
options
offered
more
specialized
and
sophisticated
instruments:
the
first
derivatives.
And,
from
the
twentieth,
households
were
encouraged,
for
political
reasons,
to
increase
leverage
and
skew
their
portfolios
in
favour
of
real
estate.
(Ferguson
2008,
341)
Reiterated
in
the
chart
below,
the
Economist
mapped
significant
innovations
across
the
timelines
originally
constructed
in
Gordon’s
research.
Major
improvements
in
transportation
lagged
GDP
growth,
but
it
seems
that
advancement
in
communications
were
adopted
at
a
quicker
pace
and
jumpstarted
the
largest
period
of
economic
growth
(GDP
terms)
in
history.
Source:
Economist
1,
2013
Technological
innovation
has
also
greatly
impacted
employment
demand
over
the
past
couple
of
centuries.
Manufacturing
advancements
streamlined
production
and
allowed
workers
who
were
previously
employed
in
labor-­‐intensive
roles
to
reevaluate
career
opportunities
and,
in
some
cases,
to
seek
higher
education.
The
reallocation
of
labor
from
agriculture,
low
skill
jobs
towards
white
collar
and
high
skill
occupations
becomes
evident
in
a
decade-­‐by-­‐decade
analysis
of
U.S.
civilian
employment
distributions.
7

8.
Source:
Katz
and
Margo
2013
As
GDP
is
derived
from
the
productivity
of
a
nations
workforce,
effects
from
technological
innovation
on
employment
demand
shifts
are
indicative
of
long-­‐term
economic
trends.
From
the
1980s
through
2010,
research
has
displayed
a
hollowing
of
middle
skill
occupations
likely
due
to
the
computerization
of
related
duties
(Katz
and
Margo
2013).
The
polarization
of
workers
is
also
likely
to
impact
economic
growth
as
many
significant
drivers,
from
consumer
spending
to
income
taxes,
are
derived
from
this
middle
class.
To
further
understand
financial
market
relationships
through
more
recent
periods
and
to
help
investors
prepare
for
future
volatility,
an
analysis
of
four
cases
of
economic
uncertainty
are
presented
below.
Germany’s
Weimar
Republic
has
become
a
prime
example
of
monetary
policy
and
it’s
affects
on
investors
through
currency
debasement
and
uncontrolled
hyperinflation.
The
Great
Depression
gives
insight
into
the
political
monetary
relationship,
investing
through
high
unemployment,
economic
stagnation
and
unstable
price
environments.
Analysis
of
the
U.S.
economy
through
the
1970s
provides
investors
with
possibly
the
best
indicator
of
future
environments,
if
long-­‐term
forecasts
discussed
above
play
out,
because
it
was
the
birth
of
Staglfation
–
little
to
no
economic
growth
and
high
levels
of
inflation.
Finally,
a
look
at
the
top
performing
investments
through
Japan’s
lost
decade
and
beyond,
allows
insight
into
market
reactions
to
economic
stagnation,
an
aging
workforce,
high
debt
levels,
and
long-­‐term
price
instability.
8

9. GERMANY’S
WEIMAR
REPUBLIC
Days
of
mass
stimulus
have
been
tried
before
and
held
devastating
consequences.
The
current
economic
and
monetary
environment
displays
traits
similar
to
that
of
past
crisis.
Learning
from
historic
market
events
and
how
to
manage
risks
associated
with
similar
policies,
mitigating
volatility
with
the
goal
of
earning
return
is
critical
to
today’s
investor
success.
The
Weimar
Republic
is
a
classic
period
of
hyperinflation,
where
unemployment
ran
wild,
economic
growth
stalled,
and
the
value
of
the
Reichsmark
dropped
like
a
hot
rock
until
it
ultimately
collapsed.
Germans
struggled
to
survive
during
this
period
due
to
the
devaluation
of
currency
resulting
in
the
erosion
of
most
life
savings.
Citizens
were
forced
into
a
pure
survival
mindset
that
challenged
many
societal
values.
Wartime
activities,
supply
shocks,
and
the
removal
from
the
gold
standard
allowed
the
German
government
to
exploit
its
currency
until
the
point
of
failure,
as
shown
in
the
chart
below.
Those
who
benefited
during
this
time
were
debtors
as
the
value
at
which
agreements
were
entered
vaguely
represented
the
present
value
of
underlying
currency.
Loans
were
written
off
at
relative
cents
on
the
dollar.
Source:
Gresham’s
Law
2011
Ronald
H.
Marcks,
who
wrote
Dying
of
Money
under
the
pen
name
Jens
Parsson,
described
equity
performance
throughout
this
period
as:
“At
the
height
of
the
boom,
stock
prices
had
been
bid
up
to
astronomical
price-­‐earnings
ratios
while
dividends
went
out
of
style.
Stock
prices
increased
more
than
fourfold
during
the
great
boom
from
February
1920
to
November
1921.
Then,
however,
shortly
after
the
first
upturn
of
price
inflation
and
long
before
the
inflationary
engine
faltered
and
business
began
to
weaken,
a
stock
market
crash
occurred.
This
was
the
Black
Thursday
of
December
9

10. 21,
1921.
Stock
prices
fell
by
about
25
percent
in
a
short
time
and
hovered
for
six
months
while
all
other
prices
were
soaring.
Stocks
in
general
were
no
very
effective
hedge
against
inflation
at
any
given
moment
while
inflation
continued;
but
when
it
was
all
over,
stocks
of
sound
businesses
turned
out
to
have
kept
all
but
their
peak
boom
values
notably
well.
Stocks
of
inflation-­‐born
businesses,
of
course,
were
as
worthless
as
bonds
were.”
(Parsson
1974)
Investing
through
this
period
of
hyperinflation
was
obviously
more
volatile
than
anything
experienced
in
recent
years,
but
profitable
traits
still
remain
true
to
today’s
environment
and
managing
such
risk.
The
last
place
you
want
to
be
invested
in
times
of
extreme
inflation
is
cash
or
other
forms
of
debt
denominated
in
the
underlying
currency.
A
leading
journalist
and
author
on
Germany’s
Weimar
Republic
experience
explains
that,
“Speculators,
wealthy
industrialists
who
can
borrow
cheap,
debtors
like
the
government,
farmers,
and
those
with
mortgages
have
benefitted
the
most
from
hyperinflations”
(Fergusson
1974).
Investors
turn
to
hard
assets
(precious
metals,
real
estate)
and
commodities
as
a
store
of
value,
where
supply
is
constrained
by
relative
availability
or
production.
As
demand
for
necessities
increases
so
does
the
possible
return
from
transferring
such
assets.
A
necessary
consideration
of
investing
in
real
estate
is
the
opportunity
cost
of
renting
versus
owning
a
home.
As
inflation
rises,
the
purchasing
power
of
an
individual’s
income
shrinks
relative
to
an
increasing
rental
price.
Much
like
the
Weimer
Republic
days
of
hyperinflation,
investors
who
came
out
better
were
those
who
held
debt
financing.
Vehicles
such
as
TIPs
and
other
inflation-­‐
indexed
hedges
are
now
available
to
protect
portfolios
should
a
similar
scenario
arise
today.
Stocks
generally
do
not
perform
great
during
periods
of
high
inflation,
but
past
experience
has
shown
they
are
on
average
better
investments
compared
to
holding
cash
or
government
bonds.
Equity
focus
should
be
constrained
to
inflationary
protected
businesses
that
operate
with,
or
own,
a
decent
amount
of
hard
assets.
Consumer
retail
and
financial
related
stocks
will
be
hit
the
hardest
when
individuals
lose
purchasing
power,
demand
plummets
and
creditors
are
left
holding
the
bag.
Takeaways:
• Debtors
benefit
during
periods
of
hyperinflation
• Avoid
cash
and
similarly
sensitive
investments
affected
by
the
debased
currency
• Hard
assets
and
commodities
typically
offer
protection
from
inflation’s
effects
and
offer
a
decent
return
opportunity
• Inflation
indexed
investments
can
by
utilized
to
hedge
volatility
• Seek
equity
investments
in
inflation
protected
businesses,
avoid
consumer
cyclical
and
finance
sectors
10

11. THE
GREAT
DEPRESSION
The
fall
of
the
Weimer
Republic
to
Hitler’s
Germany
gave
way
to
the
Great
Depression
in
1930
and
eventually
WWII.
This
period
was
seen
with
high
unemployment
levels,
currency
swings
between
deflation
and
inflation,
and
stagnant
economic
growth
across
the
globe.
In
periods
of
deflation,
cash,
bonds,
and
other
debts
denominated
in
the
underlying
currency
increase
in
value.
Cash
becomes
a
scarce
resource,
increasing
its
relative
value,
as
the
real
value
of
hard
assets
drop.
It
pays
to
maintain
a
high
level
of
liquidity
as
financing
terms
tighten
and
debt
payments
become
costlier.
Fixed
income
assets
become
more
attractive
than
most
non-­‐dividend
paying
equities
to
preserve
capital.
As
the
real
value
of
hard
assets
drop,
the
purchasing
power
reserved
in
deflated
currencies
increases,
allowing
investments
at
more
equitable
entry
points.
Financially
stimulating
policies
implemented
through
the
middle
of
the
Great
Depression
swung
deflationary
pressures
to
inflationary
and
resulted
in
spurring
growth.
Equities
became
attractive
as
inflation
eroded
the
value
of
holding
cash
and
similarly
denominated
assets.
Top
performing
industries
through
the
Great
Depression
include
aerospace,
defense,
energy,
technology,
and
materials.
The
best
returning
stocks
if
purchased
during
the
depression
were:
Source:
Moscovitz
2009
Defense
spending
and
aviation
innovation
fueled
the
growth
of
companies
like
Electric
Boat
and
Honeywell
due
to
the
unique
demands
of
the
era.
If
the
U.S.
and
other
major
countries
were
to
enter
another
globally
conflicted
phase,
either
fueled
by
government
or
business
demand,
similar
companies
are
expected
to
return
a
comparable
market
performance.
The
key
is
trying
to
forecast
which
companies
will
be
driven
by
long-­‐term
demand
and
not
affected
by
intermediate
fluctuations.
Another
consideration
is
that
deflation
increases
an
individual’s
purchasing
power
and,
in
times
of
stagnant
economies
and
low
wage
growth,
people
are
more
willing
to
spend
their
discretionary
11

12. income
on
cheap
fixes
that
provide
temporary
happiness
or
escape.
Sin
stocks
in
tobacco,
alcohol,
and
candy
companies
saw
more
growth
than
say
luxury
auto
manufacturers
through
the
Great
Depression.
When
compared
to
the
Great
Recession,
fast
food,
alcohol,
and
electronic
producers
have
seen
increased
sales
over
private
jet
or
high-­‐end
jewelry
firms
in
recent
periods
of
stagnation.
Source:
Zweig
1,
2009
WWII
boosted
the
global
economy,
giving
people
a
source
of
jobs
and
stimulus
through
government
wartime
spending.
The
period
following
this
era
also
exhibited
the
highest
real
incomes
in
U.S.
economic
history.
From
1963
to
2010,
the
top
performing
sectors
of
U.S.
equities
during
the
recessionary
phase
of
market
cycles
were
less
economically
sensitive
and
included
12

13. consumer
staples
(100%),
health
care
(71%),
utilities
(71%),
and
telecom
(57%)
(Fidelity
Management
and
Research
2010).
Takeaways:
• Deflation
typically
increases
the
value
of
cash,
fixed
income
assets,
and
other
debts
sensitive
to
the
underlying
currency
• Inflation
erodes
the
value
of
holding
cash
and
similarly
sensitive
assets,
equities
offer
greater
return
opportunity
• Sin
stocks
and
cheap
luxuries
(ex.
personal
electronics)
typically
outperform
consumer
cyclical
and
luxury
sectors
through
periods
of
stagnation
• Consumer
staples,
health
care,
utilities,
and
telecom
sectors
of
U.S.
equities
have
performed
the
best
through
recessionary
phases
of
market
cycles
13

14. DANCING
WITH
ANIMAL
SPIRITS
The
seventies
were
an
astronomical
decade
in
U.S.
monetary
policy,
a
turning
point
that
forever
changed
the
economic
political
relationship.
The
Federal
Reserve
vigorously
grasped
its
newly
acquired
tools
unshackled
from
the
gold
standard,
attempting
to
satisfy
mandates
by
directing
markets
through
fluctuating
interest
rates
and
the
money
supply
while
using
inflation
and
employment
as
indicators.
As
a
brief
history
of
central
bank
policy
modifications
and
market
reaction
through
this
period,
Steven
Cunningham
and
Polino
Vlasenko
explain:
On
August
15,
1971,
the
U.S.
abandoned
the
gold
exchange
standard
by
jettisoning
the
Bretton
Woods
Agreement.
The
dollar
depreciated,
and
oil
was
priced
internationally
in
dollars.
The
result
was
that
the
real
incomes
of
oil
producing
nations
crashed.
In
1973,
the
Shah
of
Iran
claimed
that
Middle-­‐Eastern
oil
producers
were
paying
300
percent
more
for
U.S.
wheat,
but
had
not
adjusted
oil
prices
accordingly.
On
October
16
of
that
year,
OPEC
raised
the
price
of
oil
by
70
percent
to
$5.11
a
barrel.
By
1981,
it
was
nearly
$40
a
barrel.
With
billions
of
dollars
redirected
to
oil-­‐related
purchases
in
the
U.S.
economy,
the
prices
of
other
goods
in
the
economy
would
have
fallen
as
demand
for
them
decreased.
According
to
the
Phillips
curve,
the
lower
prices
would
have
meant
higher
unemployment.
The
logic
left
the
Fed
with
little
choice.
If
the
Fed
did
not
increase
the
money
supply
to
stabilize
the
prices
of
non-­‐oil
products,
the
U.S.
would
have
faced
economy-­‐wide
deflation.
Unemployment
would
soar
as
profit
margins
collapsed.
Trying
desperately
to
manage
the
situation,
the
Fed
pumped
money
into
the
economy.
Once
the
oil
prices
stabilized,
the
Fed
could
not
remove
the
additional
money
from
the
economy
fast
enough.
The
result
was
higher
overall
inflation.
With
the
expectations
of
high
inflation
built
into
the
economy,
this
higher
inflation
no
longer
produced
lower
unemployment.
Instead,
the
economy
stagnated.
Stagflation
was
born.
(Cunningham
and
Vlasenko
2012)
Stagflation
is
characterized
as
an
economic
cycle
that
displays
slow
business
growth,
high
unemployment,
and
rising
inflation.
Graphed
below
is
the
annual
change
of
the
consumer
price
index
in
the
United
States
through
the
1970s.
With
normal
CPI
growth
in
the
range
of
2-­‐3%,
the
worst
years
of
this
decade
reached
12-­‐15%
annual
growth.
Upward
price
pressure
and
downward
business
and
wage
growth
created
a
difficult
environment
for
consumers
and
investors
alike.
Source:
Trading
Economics,
Bureau
of
Labor
Statistics
2013
14

15. Analyzed
on
a
longer
time
frame,
it
becomes
apparent
that
consumer
prices
remained
consistently
stable
from
1775
until
1970.
Since
the
removal
from
the
gold
standard,
prices
have
jumped
ten
times
relative
to
purchasing
power
in
the
early
twentieth
century.
Although
major
economic
advancements
have
come
through
a
looser
monetary
policy,
the
frequency
of
market
volatility
and
downside
risk
associated
with
rebalances
has
increased.
Source:
Liberty
Blitzkrieg
2013
U.S.
Consumers
will
likely
be
hit
the
hardest
due
to
their
inability
to
evade
inflated
prices
of
necessary
goods
and
erosion
of
cash
sensitive
accounts.
The
yield
on
most
money
market
or
savings
type
accounts
will
net
a
negative
return
with
high
inflation,
increasing
the
need
to
venture
into
higher
risk
assets.
Investors
looking
for
a
diversified
portfolio
including
fixed
income
should
seek
short
duration
terms
and
inflation
protected
vehicles
to
minimize
negative
effects.
So,
what
asset
classes
performed
the
best
through
recent
periods
of
inflation?
It
all
depends
on
the
relative
economic
stage.
Equities
outperform
all
other
classes
as
inflation
rises
from
a
low
below
3.3
percent,
as
displayed
in
the
chart
below.
After
this
median
is
reached
and
inflation
continues
rising,
commodities
become
the
top
performing
sector
and
equities
returns
significantly
fall.
Rebalancing
a
portfolio
to
adapt
to
these
changes
is
increasingly
difficult
due
to
the
lag
in
data
available
relative
to
real
time
market
decisions.
15

16.
Source:
JP
Morgan
Asset
Management
2012
Investing
in
businesses
that
hold
competitive
advantages
and
are
focused
on
commodities
or
other
hard
assets,
operating
in
international
and
emerging
markets,
can
insulate
portfolios
from
rising
domestic
inflation
risk.
Certain
producers
are
also
positioned
better
to
maintain
profit
margins
as
demand
of
necessary
goods
(food,
clothing,
shelter,
transportation)
varies
less
then
discretionary
sectors
through
high
inflation
and
slow
growth.
The
rapidly
evolving
U.S.
energy
market
will
become
even
more
important
to
investors
as
energy
and
the
development
of
domestic
natural
resources
increases
as
an
economic
growth
driver.
Balancing
responsible
economic
and
environmental
policies
to
control
resource
extraction
and
development
will
increase
sector
volatility
in
the
short-­‐term,
but
investing
in
well
diversified
and
alternative
energy
companies
to
return
alpha
is
a
necessary
consideration
for
today’s
investors.
The
1970’s
in
the
United
States
were
a
period
of
high
unemployment,
rising
prices
(inflation),
and
stagnant
business
growth
spurred
from
policy
changes
and
supply
spikes.
Based
on
research
referenced
throughout
this
report,
it’s
plausible
the
U.S.
economy
is
reentering
a
similar
phase,
which
some
predict
to
last
much
longer
then
what
was
experienced
in
the
seventies.
Takeaways:
• Equities
outperform
all
other
classes
as
inflation
rises
from
a
low
below
3.3
percent,
above
this
median
commodities
become
the
top
performers
• Businesses
that
hold
competitive
advantages
and
focused
around
commodities,
operating
in
international
and
emerging
markets,
can
insulate
portfolios
from
domestic
inflation
risk
• Necessary
goods
producers
remain
more
consistent
than
discretionary
sectors
through
high
inflation
and
stagnant
growth
• Diversified
energy
companies
and
related
alternative
tech
innovators,
aimed
at
improving
energy
productivity,
hold
significant
growth
opportunity
16

17. THE
LOST
DECADE
During
the
1980s,
Japan
was
a
model
economy
that
most
developed
country’s
strived
to
emulate.
After
twenty
plus
years
of
stagnation,
Japan
has
become
the
prime
case
in
analyzing
how
to
profit
through
similar
environments.
The
collapse
of
a
housing
and
stock
market
bubble
has
left
Japan’s
economy
in
a
rut
that
government
policy
makers
cannot
seem
to
resolve.
The
chart
below
is
of
the
NIKKEI
225,
an
average
price-­‐weighted
stock
index
that
tracks
the
top
225
companies
on
the
Tokyo
Stock
Exchange.
Japan’s
market
peaked
in
December
1989
at
38,916
and
has
fallen
81.9
percent
to
its
lowest
level
of
7,054
in
March
2009.
The
NIKKEI
has
slightly
recovered
from
its
low
and
currently
trades
around
11,000;
about
70
percent
below
it’s
1989
peak.
Source:
Yahoo
Finance
2013
The
Japanese
people
have
dealt
with
a
great
deal
of
economic
volatility
since
the
bubble
collapsed,
mainly
high
unemployment
with
swings
of
deflationary
pressure.
The
country’s
central
banking
authority,
the
Bank
of
Japan
(BoJ),
recently
adapted
its
monetary
strategy
to
follow
similar
expansionary
policies
as
the
Federal
Reserve
in
hope
of
stimulating
economic
growth.
BoJ
plans
to
inject
13
trillion
yen
($145B)
per
month
in
an
attempt
to
achieve
2%
inflation
target,
possibly
starting
in
January
2014.
This
could
initiate
a
similar
environment
in
Japanese
equities
that
the
U.S.
markets
experienced
in
mid
2009,
rallying
from
historic
lows.
Stephen
King
of
HSBC
recently
told
Reuters
that:
Japan
has
failed
to
deliver
lasting
recovery
for
two
decades
now
so
the
political
case
for
doing
something
more
radical
is
now
quite
high
and
I
think
the
BoJ
understands
that,
but
if
this
is
pushed
too
far,
the
BoJ
simply
becomes
an
agent
of
MoF
and
then
the
risk
is
that
either
foreign
investors
or
domestic
residents
lose
their
faith
in
money,
raising
the
risk
of
inflation
overshoot
and
yen
collapse…
Weak
financial
systems
can
be
more
easily
managed
when
structural
growth,
led
by
productivity
gains,
is
so
high.
Japan's
problem
was
that
it
reached
the
global
technology
frontier
in
the
late
1980s,
exposing
its
banking
weakness.
(Reuters
GMF,
pers.
comm.)
Capital
injections
will
translate
into
a
cheaper
Yen
relative
to
international
currencies,
where
the
BoJ
hopes
to
inflate
away
some
government
debt
and
stimulate
increased
exports
as
prices
of
17

18. goods
manufactured
domestically
become
relatively
cheaper.
Neighboring
Asian
manufacturers,
such
as
South
Korea,
will
likely
feel
negative
economic
impacts
from
Japan’s
accommodative
monetary
policies
as
their
pricing
becomes
less
competitive.
Markets
are
already
pricing
in
stimulus
expectations
as
exhibited
through
the
recent
rally
in
Japanese
equities.
But
until
the
effects
from
stimulus
take
hold
it
remains
necessary
to
avoid
currency
denominated
or
driven
investments
in
a
deflationary
environment.
Financial
companies
lose
on
liabilities
as
consumers
profit
from
holding
currency
in
periods
of
deflation.
The
top
performing
stocks
through
Japan’s
20
year
stagnation
have
been
focused
in
stable
operating
environments
fueled
by
strong
consumer
demand,
usually
diversified
amongst
export
markets
(Weeratunga
2010).
The
composition
of
sectors
included
in
major
Japanese
indices
changed
significantly
over
this
period,
but
all
major
indicators
of
the
local
equity
market
display
similar
trends.
The
best
sectors
in
the
TOPIX,
which
tracks
the
first
section
of
Tokyo
Stock
Exchange,
from
1990
to
2010,
were
health
care,
utilities,
consumer
discretionary,
and
information
technology.
Source:
Weeratunga
2010
Bellwether
firms
that
hold
proprietary
research,
brand
name,
or
any
other
form
of
competitive
advantage
differentiate
true
winners
amongst
the
crowd.
These
companies
exhibit
long-­‐term
growth
prospects
not
likely
to
be
undercut
through
competition
or
damaged
by
intermediate
economic
fluctuations.
When
analyzing
not
only
long-­‐term
sector
trends,
but
also
individual
company
returns,
it
becomes
apparent
that
successful
firms
globally
diversify
revenue
streams
(Weeratunga
2010).
The
following
table
displays
top-­‐performing
companies
in
the
TOPIX
from
1993
to
2010.
18

19.
Source:
Weeratunga
2010
In
times
of
uncertainty
non-­‐cyclical
economically
defensive
stocks
offer
refuge
from
volatility
through
consistent
revenue
and
common
dividend
payments,
resulting
in
performance
comparable
to
the
Great
Depression
period
in
the
U.S.
The
portion
of
internationally
diversified
earnings
relative
to
long-­‐term
market
performance
is
also
clearly
visible.
This
trait
will
likely
become
harder
to
achieve
in
U.S.
equities
due
to
significant
increases
in
market
correlations.
Japan
also
holds
a
significant
aging
population
that
drives
profitability
of
health
care
related
companies,
another
trend
likely
to
develop
further
in
U.S.
markets
as
similar
demographic
shifts
unfold.
Takeaways:
• Financial
companies
lose
on
liabilities
as
consumers
profit
from
holding
currency
and
debt
in
periods
of
deflation
• Best
performing
Japanese
equities
have
been
focused
in
stable
operating
environments
fueled
by
strong
consumer
demand
with
internationally
diversified
earnings.
Top
sectors
include
health
care,
utilities,
consumer
discretionary,
and
information
technology
• Seek
bellwether
firms
that
hold
proprietary
research,
brand
name,
or
other
forms
of
competitive
advantage
to
protect
against
volatility
• Non-­cyclical
economically
defensive
stocks
offer
refuge
from
volatility
through
consistent
revenue
streams,
and
many
offer
dividend
payments
19

20. 3. Adding
it
Up
Market
performance
across
history
has
taught
invaluable
lessons
that
must
not
be
ignored
given
the
similarity
in
recent
developments.
With
that
in
mind,
developed
economies
seem
to
be
entering
a
period
unique
to
only
future
environments
that
are
certain
to
differ
from
past
market
reactions.
The
globalization
of
economies
and
significant
improvements
in
financial
efficiency
has
led
to
highly
interconnected
markets
that
shift
on
a
multitude
of
factors.
Germany’s
Weimar
Republic
displayed
the
damaging
effects
of
uncontrolled
currency
debasement,
supply
shocks,
and
resulting
hyperinflation.
Relative
to
today,
investors
must
take
away
the
importance
of
avoiding
cash
and
equally
affected
investments
and
seek
diversification
amongst
equities
more
protected
from
inflation’s
eroding
power.
The
Great
Depression,
1970s
U.S.
experience,
and
Japan’s
Lost
Decade
exhibit
many
differences
unique
to
each
period,
but
also
similarly
profitable
investing
traits.
In
times
of
high
unemployment,
stagnant
economic
growth,
and
price
instability,
investors
are
best
served
by
seeking
refuge
in
economically
defensive
assets
that
hold
competitive
advantages
unlikely
to
be
stolen.
Examples
of
these
include
vehicles
driven
by
necessity,
like
healthcare
and
sin
stocks.
The
value
of
short
duration
debt
holds
when
interest
rates
rise
and
chance
of
default
increases,
commonly
seen
in
periods
of
inflation.
U.S.
real
asset
returns
across
investment
classes
throughout
recent
history
exhibit
the
importance
of
such
considerations.
Source:
Barro
and
Misra
2013
The
most
recent
decade
of
monetary
intervention
is
unprecedented
as
the
majority
of
central
banking
authorities
the
world
over
hold
to
seemingly
unending
quantitative
easing
and
zero
interest
rate
policies.
The
infusion
of
cheap
credit
is
not
driven
by
actual
demand,
rather
asset
purchase
programs
attempting
to
stimulate
real
economic
growth.
As
an
investor,
it’s
necessary
to
question
if
recent
market
gains
are
inorganic
and
try
to
anticipate
what
will
happen
when
the
music
stops.
Hopefully
these
monetary
authorities
can
successfully
balance
policy
objectives
while
smoothly
deleveraging
without
collapse.
Central
banks
are
left
with
little
room
for
downward
rate
movements
given
the
zero
bound.
Because
of
this,
it
is
likely
the
yield
on
cash
and
rate
sensitive
investments
have
only
one
direction
to
move.
This
is
bad
for
fixed
income
assets
because
relative
values
are
inversely
related
to
interest
rates,
meaning
as
rates
adjust
upward
the
prices
at
which
bonds
trade
will
fall.
20

21. Given
the
current
environment,
the
Economist
recently
projected
future
returns
over
the
next
decade
and
found
that,
“Government
bonds
look
like
the
least
attractive
asset
to
hold”,
and
achieving
superior
equity
returns
will
be
difficult
because,
“the
cyclically
adjusted
price-­‐earnings
ratio
is
well
above
the
historical
average”
(Economist
2,
2013).
They
believe
the
highest
opportunity
for
return
will
be
found
in
U.S.,
European,
and
British
equity
and
housing
markets.
Source:
Economist
2,
2013
When
looking
at
the
relative
equity
market
value
as
a
whole,
in
price
to
earnings
terms,
over
the
long
run
it
becomes
apparent
it’s
currently
slightly
overvalued
but
nowhere
near
the
heights
of
the
dot
com
bubble.
If
investors
lose
hope
on
U.S.
stock
returns,
the
retreat
to
safer
assets
and
more
auspicious
markets
will
lower
domestic
valuations
and
create
opportunity
for
higher
returns.
This
concept
was
exhibited
through
the
market
rally
from
U.S.
equity
lows
of
2009.
Investors
holding
U.S.
stocks
over
the
long
run
will
likely
outperform
those
flipping
between
investments
in
more
short-­‐term
rosy
markets.
A
country’s
economic
growth
relationship
with
stock
market
returns
can
be
deceptive.
For
example,
“the
Chinese
economy
has
expanded
far
faster
than
those
of
Latin
America.
Meanwhile,
Latin
stocks
earned
an
average
of
8.2
percent
annually,
while
Chinese
stocks
averaged
less
than
a
1
percent
annual
return”
(Zweig
2,
2012).
As
demonstrated
in
the
chart
below,
the
most
consistent
highest
returning
investments
include
emerging
and
international
equity
market
indexes.
Analyzing
total
returns
across
asset
classes
over
the
past
decade
reaffirms
the
importance
of
diversification
and
rebalancing
to
minimize
volatility.
This
concept
will
be
discussed
in
greater
detail
in
the
following
portfolio
strategy
section.
21

22.
Source:
JP
Morgan
Asset
Management
2012
As
mentioned
above,
the
relationship
between
economic
growth
and
stock
market
returns
can
be
deceptive.
GMO
research
displayed
in
Jeremy
Grantham’s
latest
newsletter
proves
a
negative
correlation
between
the
two
factors
over
the
past
thirty
years.
Even
though
this
concept
seems
counterintuitive,
historical
data
on
developed
economies
supports
the
claim.
If
innovation
stalls,
and
U.S.
productivity
continues
to
decline,
the
stock
market
might
actually
perform
better.
Even
though
this
might
be
true
over
historic
periods,
because
of
monetary
intervention
and
a
multitude
of
macroeconomic
factors
unique
to
the
current
environment
investors
must
proceed
with
caution.
Source:
Grantham
2,
2013
If
volatility
increases
and
earnings
growth
stagnates
consumers
will
be
forced
to
adapt,
shifting
purchasing
behavior
accordingly.
Expenditures
are
likely
to
trend
towards
maximizing
well-­‐being
22

23. and
minimizing
excess.
Necessities
such
as
food
and
water,
shelter,
clothes,
alternative
transportation,
energy,
and
defense
become
vitally
important
as
capital
available
for
service
and
luxury
related
purchases
shrink.
Debt
and
equity
markets
rebalance
to
the
new
economic
conditions,
valuing
low
cost
manufacturers
of
necessities
higher
than
more
economically
sensitive
luxury
manufacturers
or
service
providers.
Resource
supply
will
greatly
influence
the
pricing
of
necessities
due
to
significant
population
growth
across
the
globe.
Securing
rights
to
critical
inputs
will
become
a
major
challenge
for
developed
governments
and
leading
manufacturers.
Companies
and
governments
with
the
capital
and
network
resources
to
secure
such
reserves
will
greatly
determine
the
long-­‐term
growth
ability
of
underlying
markets.
A
cannibalization
of
wasteful
processes
and
technologies
is
probable,
increasing
the
likelihood
of
achieving
higher
investment
returns
from
firms
that
hold
secure
competitive
advantages.
Necessity
demand
and
resource
supply
are
factors
that
must
be
considered
when
constructing
a
selectively
diversified
portfolio
in
attempt
to
increase
alpha
while
minimizing
beta.
23

24. 4. Creating
a
Selectively
Diversified
Strategy
For
the
average
investor,
holding
a
portfolio
of
individual
companies
is
extremely
risky
and
will
most
likely
underperform
market
benchmarks.
It
has
never
been
more
important
to
focus
on
each
underlying
asset’s
resilience
when
constructing
a
strategy.
By
utilizing
the
many
financial
tools
and
vehicles
that
are
widely
available,
a
selectively
diversified
portfolio
that
arbitrages
economic
trends
has
the
greatest
opportunity
for
success
through
market
cycles
over
the
long
run.
Simple
strategies
that
are
robust
in
nature
prove
more
reliable
for
investors
to
maintain.
A
portfolio
retains
significant
capital
appreciation
through
compounding
value
gained
over
many
years
by
minimizing
transaction
costs
and
maintaining
low
turnover.
Proper
diversification
and
rebalancing
guided
by
individual
tolerances
is
also
necessary
to
achieve
these
standards.
Return
opportunities
diminish
as
more
capital
flows
into
passive
vehicles,
like
ETFs
and
index
funds.
To
optimize
this
risk
and
return
relationship,
the
following
strategy
suggestions
are
given
as
possible
opportunities.
EQUITIES
Investing
in
companies
who
hold
competitive
advantages
like
R&D,
proprietary
technology,
or
brand
image
will
prove
more
resilient
than
younger
firms
without
such
resources.
The
few
that
hold
multiple
competitive
advantages,
proven
management,
and
consistent
financial
resource
create
a
defensive
moat
further
protecting
against
volatility
and
increasing
the
probability
of
long-­‐
term
growth.
Targeting
sectors
that
include
major
holdings
of
companies
that
exhibit
these
traits
should
be
given
major
consideration
when
constructing
a
balanced
portfolio.
History
has
shown
that
consumer
defensive,
health
care,
technology,
and
related
industries
that
hold
similar
traits
perform
the
greatest
through
moderate
growth,
high
unemployment,
and
politically
unstable
environments.
As
global
population
growth
continues
and
major
demographic
shifts
evolve
in
emerging
markets,
investments
in
energy
productivity
and
disruptive
innovators
will
follow.
Capturing
sectors
that
profit
from
such
demand,
securing
resources,
or
investing
in
renewable
energy
technology
in
portfolio
strategy
is
increasingly
critical.
Firms
that
position
themselves
to
harness
the
changes
already
occurring,
by
improving
or
transforming
consumption
efficiency,
should
greatly
aid
in
supporting
a
nation’s
long-­‐term
growth.
Possible
catalysts
to
innovation
include
employment
supply
and
demand
relationships,
which
have
significantly
changed
over
the
past
thirty
years.
Immigration
and
the
proportion
of
females
in
the
work
force
have
greatly
influenced
real
wage
growth
and
competition
across
almost
every
sector
of
the
American
economy.
Companies
have
a
larger
base
of
candidates
to
choose
from,
increasing
competition
and
restraining
growth
in
real
wages.
This
is
a
positive
force
for
the
country’s
overall
productivity
as
more
workers
are
generating
value,
but
could
also
be
attributed
to
the
polarization
of
income
equality.
With
relatively
cheaper
labor,
firms
become
more
selective
when
hiring
and
have
incentive
to
reinvest
capital
in
improving
operating
efficiencies.
This
drives
down
the
demand
for
low
skill
workers
and
rewards
innovation
in
improving
processes.
Optimization
is
a
supporting
factor
to
improving
short-­‐term
efficiencies,
and
ultimately
profitability,
but
can
significantly
inhibit
the
long-­‐term
disruptive
growth
opportunities
of
an
industry.
Research
on
the
various
types
of
business
innovation
and
resulting
effects
have
been
greatly
explored
by
Harvard
Business
Professor
Clayton
Christensen.
24

25. As
an
investor,
the
highest
prospect
for
future
growth
lies
with
companies
that
balance
capital
reinvestments
not
only
in
improving
efficiencies
but
also
in
disruptive
innovation.
Characteristics
of
this
trend
are
commonly
exhibited
through
private
equity
investment
risks
and
returns.
This
is
not
practical
for
the
average
person
due
to
the
capital
requirement
necessary
to
analyze
and
track
every
aspect
of
multiple
companies
while
looking
for
profitable
innovators,
but
the
main
idea
can
be
attributed
to
larger
industries
in
general.
It
is
highly
unlikely
that
technological
evolution
will
continue
along
a
linear
path.
Yet,
over
the
long
run
the
greatest
opportunity
for
return
has
been
created
by
firms
willing
to
invest
in
disruptive
innovation.
Individual
investors,
unable
to
meet
secondary
market
requirements,
should
invest
in
technology
as
a
whole.
The
reason
being
that
the
cream
(disruptive
innovators)
is
likely
to
rise
to
the
top
and
support
widespread
growth.
Whether
through
proprietary
research
and
development
or
acquisitions
and
mergers,
companies
able
to
disrupt
such
spaces
are
often
the
proven
leaders
that
hold
management
and
financial
capabilities.
Granted,
financing
such
ventures
in
an
early
stage
creates
higher
opportunity
for
return,
but
also
significantly
increases
the
risk
of
losing
capital.
This
is
often
not
feasible
to
the
average
investor
with
a
long-­‐term
strategy.
Investing
in
technology
as
a
whole
also
provides
some
diversification
against
tech
value
traps.
If
a
moderate
economic
growth
climate
persists,
the
compounding
effects
earned
from
investing
in
equities
that
pay
dividends
becomes
even
more
important.
Stocks
that
pay
dividends
offer
a
consistent
level
of
income,
above
earnings
growth,
that
significantly
increases
return.
In
fact,
research
has
proven
that
dividend
payers
outperform
non-­‐dividend
payers
through
bull
and
bear
markets
(BlackRock
2013).
Earning
a
consistent
cash
flow
over
long
periods
of
time
supports
investors
through
slowing
growth
and
economic
volatility.
For
a
historical
perspective
of
such
differences,
the
chart
below
exhibits
the
S&P
500
average
annualized
returns
broken
into
capital
appreciation
and
dividends
from
1926
through
2012.
Source:
JP
Morgan
Asset
Management
2012
Takeaways:
• Seek
robust
and
economically
defensive
equities
that
hold
multiple
competitive
advantages
• Companies
focused
on
advancing
the
energy
productivity
and
resource
acquisition
and
processing
space
offer
significant
return
potential
• Disruptive
innovators
will
drive
economic
and
portfolio
growth
• Dividends
provide
consistent
return,
protect
against
swings
in
capital
appreciation
25

26. FIXED
INCOME
Major
emphasis
is
given
to
equity
investments
because
they
conceivably
provide
superior
protection
against
inflationary
pressures
that
are
likely
to
fluctuate
in
coming
years.
The
results
of
such
an
outcome
could
be
devastating
to
those
holding
currency
denominated
or
fixed
income
vehicles
tied
to
the
effects
of
monetary
intervention.
Given
the
time
horizon
of
many
investors,
diversification
amongst
fixed
income
vehicles
is
necessary
to
preserve
capital.
Because
the
current
environment
for
such
investments
is
likely
to
increase
in
volatility,
portfolio
allocations
should
incorporate
today’s
unprecedented
risks
before
trends
reverse.
Hedging
positions
with
short-­‐term
government
securities
or
TIPs
might
offer
a
decent
refuge
from
such
uncertainty.
Utilizing
a
globally
diversified
bond
index
or
other
form
of
high-­‐grade
credit
offers
the
greatest
opportunity
for
return
in
this
space.
Individual
fixed
income
investments
should
remain
short
in
duration
until
the
economic
outcome,
as
affected
by
central
banks,
stabilizes.
Fixed
income
assets
could
preserve
value
and
possibly
offer
decent
return,
dependent
upon
global
economic
volatility,
if
interest
rates
maintain
at
a
permanent
low
level.
If
risks
driven
by
growing
populations
and
aging
demographics
seriously
conflict
the
global
economy
it’s
likely
that
fixed
income
vehicles
would
outperform
other
investment
classes.
But,
such
a
case
is
doubtful
unless
developed
economies
crumble
or
some
catastrophic
event
occurs.
Takeaways:
• Limit
exposure
to
interest
rate
sensitive
vehicles
• Seek
short
duration
fixed
income
assets
• Indexed
fixed
income
assets
(ex.
TIPs)
provide
hedge
against
inflation,
but
also
hold
interest
rate
risk
• Globally
diversified
indexes
that
hold
high
grade
credit
offer
some
protection
against
default
and
rate
fluctuations
ALTERNATIVE
Real
estate
investments
look
appealing
given
current
valuations
relative
to
pre-­‐crisis
heights
and
low
financing
rates,
but
when
cap
rates
adjust
after
monetary
easing
ceases,
property
values
will
fluctuate
wildly.
Overly
optimistic
valuations
and
projections
of
this
industry’s
recovery
paired
with
reversing
rates
could
form
another
bubble.
Given
these
circumstances,
it
is
advisable
for
the
average
investor
to
limit
allocations
in
this
space
to
relative
need
based
on
immediate
utility
received.
One
of
the
most
plausible
methods
of
government
shedding
debt
is
by
deflating
its
currency
and
is
witnessed
throughout
many
recent
crises.
Alternative
investments,
driven
by
supply
and
demand
characteristics
or
other
unique
traits,
should
rise
in
value
over
the
long
run.
This
is
a
broad
statement
that
carries
macroeconomic
risks
unique
to
each
underlying
assets.
The
market
has
already
priced
in
current
volatility
and
as
interest
rates
normalize,
it
is
very
likely
to
see
a
reversion
in
gold
prices
maintained
at
a
higher
support
level.
Also,
it
is
important
to
note
that
today’s
financial
markets
offer
vehicles
that
more
effectively
hedge
various
risks
without
removing
as
much
alpha.
26

27.
Source:
Kendall
and
Deverell
2013
Investors
are
likely
to
see
increased
inflation
throughout
international
markets
as
monetary
authorities
continue
their
attempts
to
stimulate
growth,
most
recent
driver
being
Japan’s
expected
2%
inflation
target.
But
these
forecasts
shouldn’t
drive
gold
price
expectations.
Research
shows
little
correlation
exists
between
changes
in
one-­‐year
inflation
expectations
and
gold
price
adjustments
over
the
past
twenty-­‐five
years
(Kendall
and
Deverell
2013).
In
terms
of
general
commodity
prices,
inflation
has
shown
to
be
more
closely
related.
Source:
JP
Morgan
Asset
Management
2012
With
resource
scarcity
in
certain
precious
metals,
shifting
weather
patterns
affecting
commodity
pricing,
and
exponentially
growing
population
demands,
commodities
and
related
investments
are
likely
to
increase
in
value
as
these
trends
evolve.
Portfolio
strategy
should
include
exposure
to
natural
resource
assets,
with
the
most
advisable
vehicle
being
an
ETF
or
similar
fund
that
contains
globally
diversified
holdings.
Capturing
such
growth
will
become
increasingly
important
to
insure
significant
return
opportunity
and
to
hedge
against
the
risk
of
rising
manufacturer
input
prices.
With
economic
growth
in
emerging
markets
projected
to
continue
at
a
decent
rate
over
the
near
future,
commodity
demand
growth
should
remain
fairly
consistent.
Further
price
support
will
be
gained
if
developed
economies
recover
better
than
expected.
27

28. Takeaways:
• Property
valuations
are
sensitive
to
changes
in
interest
rates,
control
real
estate
exposure
and
expect
volatility
• Gold
is
likely
to
revert
to
a
new
average
price
as
volatility
decreases,
remains
the
only
true
store
of
value
across
history
• Inflation
expectations
do
not
reflect
gold
price
expectations,
more
correlated
with
commodity
price
expectations
• Natural
resources
will
grow
in
value
as
demographic
trends
develop,
offer
possible
hedge
against
rising
input
prices
FINAL
NOTE
Market
history
has
consistently
proven
more
variable
in
nature
than
economist
forecast.
Predicting
the
future
today
is
just
as
uncertain
as
predicting
returns
at
the
start
of
the
Industrial
Revolution.
Many
factors
influence
the
outcome
of
investment
performance,
and
due
to
the
high
degree
of
globalization
and
financial
interconnectivity
that
has
occurred
throughout
the
past
couple
of
decades,
forecasting
opportunities
of
such
growth
and
innovation
will
never
be
uniform.
Significant
advancements
over
the
past
three
centuries
have
propelled
many
industries
into
a
new
space,
reallocating
capital
towards
furthering
different
degrees
of
innovation.
The
current
technological
plateau,
as
it
may
seem
to
some,
doesn’t
have
to
be
the
final
landing
of
U.S.
productivity
growth
demise.
Government
subsidized
innovation
hubs
and
other
forms
of
business
guidance
should
help
refocus
efforts
along
a
more
meaningful
growth
path.
The
brief
historic
analysis,
portfolio
strategy
implications,
and
research
referenced
throughout
this
report,
should
act
as
guidance
to
investors
preparing
for
market
transformations.
Many
of
the
ideas
discussed
above
are
unorthodox
and
are
likely
to
conflict
with
some
traditional
portfolio
strategies
or
investing
beliefs.
Further
research
on
the
opportunities
considered
above
is
welcomed
to
better
aid
investors
in
profiting
through
volatile
market
evolutions.
28

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29