Franklin Templeton has pinpointed secular stagflation as a key source of concern for investors.
Defined as a prolonged period of chronic underinvestment in productive enterprises relative to the amount of savings in the economy, secular stagnation is said to have taken a backseat to inflation.
But, according to Stephen Dover, chief market strategist at the Franklin Templeton Investment Institute, there are “troublesome signs” that secular stagnation remains a credible description of broad economic trends.
“For example, gross fixed capital formation as a percentage of gross domestic product — a measure of total investment spending in the economy — has been declining in advanced economies since the 1970s and, despite some recovery over the past decade, remains below average investment rates seen in the 1980s, 1990s or early 2000s,” Mr Dover explained.
“Even in China — the world champion of capital expenditures over the past quarter century — rates of investment peaked nearly a decade ago and have been gradually receding ever since. The world cannot be characterised as experiencing a boom in capital expenditures. Rather, large swathes of the global economy are seeing evidence of weak capital formation, a story that may also be unfolding in China,” Mr Dover added.
More timid capital expenditures, Mr Dover explained, may come as a surprise to many given the glitzy inventions of the last few decades; most of these are not enabling the masses to produce more with less — the essence of productive investment.
Moreover, the need to rein in and ultimately reduce mountains of public debt created during the pandemic leads to further drag on total spending in the economy.
The overall impacts of secular stagnation are concerning, Mr Dover said, and flagged the real possibility that “global growth will slow to a weaker trend rate of growth”.
Mr Dover also predicted that secular stagnation could see very low, perhaps even negative, equilibrium real interest rates.
That, he explained, is because to generate full employment, borrowing costs must be “sufficiently low” to induce business investment that might not otherwise take place.
“Although the Federal Reserve and other central banks today are now hiking interest rates to lower current high rates of inflation, they cannot completely ignore the implications of very low long-run equilibrium interest rates,” Mr Dover said.
“Slowing demand and curbing spiking inflation today are necessary, but overdoing things could be very damaging. The interest rate required to slow growth and lower inflation could be much lower than a federal funds’ rate of 3.5 to 4.0 per cent, which is increasingly the consensus view. Hiking rates to those levels could be overkill, in my view,” he continued.
As for the implications for capital markets, Mr Dover warned that weak GDP growth implies that profit growth will also be pedestrian.
“Growth styles which favour the relatively few companies that can sustain high earnings over time appear likely once again to outperform value and cyclical styles that offer fewer profit opportunities in a world of secular stagnation,” Mr Dover said.
Finally, he noted, “low interest rates may again spur unproductive speculation in the customary places, including property markets or cryptocurrencies, or in new ones devised to capture the allure of high returns”.
“This conclusion that secular stagnation may lead to a focus on longer-duration assets may be surprising to some, but highlights the constant push and pull between economic forces and capital markets”.
