Why the decade’s second half may look much different from the first for investors — and workers


For all the pain and suffering brought on by the 2008 financial crash, the years that followed turned out to be pretty decent for the U.S. economy — at least compared with the dire forecasts that were commonplace in 2009 and 2010.

Instead of spiraling into a new Depression, the economy has continued to expand, albeit slowly — underpinned by the Federal Reserve’s easy money. The official unemployment rate is back to 5%. Corporate earnings reached record highs. And a venture capital boom has funded thousands of promising start-up companies.

But as the second half of the decade gets underway, the economy and markets face challenges that could make the next five years very different from the last five for investors and workers. Here is a look at four of the most widely held views on what’s to come, and their implications for your nest egg and livelihood:


Annualized investment returns on U.S. stocks and bonds will be lousy — at best, in low-single-digit percentages.

This may be the most widespread belief on Wall Street at the moment. In part it’s rooted in expectations that economic growth overall will continue to be subpar for the next few years, limiting corporate earnings growth — which ultimately underpins stocks.

Because U.S. stocks have performed so well since 2009, many investment pros believe that prices already reflect near-term profit growth, and then some. The typical mutual fund that owns blue-chip stocks has gained 9.4% a year over the last five years, according to Morningstar Inc.

Even after last week’s steep plunge, the average blue-chip stock is priced at about 18 times estimated 2015 operating earnings, which excludes write-offs and other expenses deemed one-time in nature. Deduct those expenses and the price-to-earnings ratio is a much higher 20.2, or 19% above the average since 1935, according to analyst estimates compiled by S&P Dow Jones Indices.

That’s too much for Doug Ramsey, chief investment officer at Leuthold Weeden Capital Management in Minneapolis. With U.S. stocks at these levels, he said, history suggests annualized returns of just 4% to 4.5%, at best, through the end of the decade — and plenty of volatility along the way. As for bonds, with yields so low it’s mathematically impossible for fixed-income securities to earn high returns unless market yields drop much lower. Here’s how it works: Five years ago a 10-year U.S. Treasury note was paying 3.5% in annual interest. Now, new notes pay 2.11%. The drop in yields means older, higher-yielding bonds have risen in value, boosting their “total return” — interest plus principal change.


But with the Federal Reserve’s decision in December to begin raising short-term interest rates from near zero, it becomes more difficult to imagine longer-term rates declining significantly, barring a new recession or global shock. If longer-term rates stay where they are, all you earn is the interest. And if market rates rise, older bonds will fall in value, offsetting some or all of your interest earnings.

“This is a time to adjust your expectations about what’s a realistic return,” said Darell Krasnoff, a partner at Bel Air Investment Advisors, which manages $7.5 billion for clients.

Still, investors who are tempted to abandon U.S. stocks and bonds entirely because of low-return expectations should keep two things in mind. First, returns are relative: If stocks earn 4% a year, but cash in the bank earns just 1%, stocks still win by a long shot.

Second, if you’re investing regularly via a 401(k) or similar plan and your time horizon is 20 years or longer, don’t fret about the next five years. If fact, root for falling stocks, because you’ll be getting more shares for your money if prices drop.

Investments that have lagged behind over the last five years will beat U.S. returns over the next five years.

The simple idea here is that by buying what’s out of favor you’re buying low, to eventually sell high. But psychologically, it’s hard to buy losers.


Foreign stocks and bonds have far underperformed U.S. markets over the last five years. The average European stock mutual fund has gained 4.1% a year, less than half what U.S. blue-chip funds have returned. Emerging-market stock funds have been a disaster, losing 5.8% a year. Weak economic growth is at the heart of foreign markets’ woes.

Yet many investment pros say the values in emerging markets, in particular, are becoming too tempting to ignore.

“We’re expecting to raise our positions there in the back half of 2016,” Krasnoff said. But in the short term, he said, “there are still a lot of head winds.”

One risk is the continuing weakness of many world currencies against the dollar. Foreign governments have been allowing their currencies to decline in value as a way to make their exports cheaper. But another effect of falling currencies has been to depress returns for American investors in foreign markets.

China, facing a deepening economic slowdown, moved last week to further devalue its currency. That helped trigger a fresh rout in Shanghai stocks — which dove 10% for the week — and fed another global sell-off. The iShares MSCI emerging-markets stock fund fell 8.3% last week. Still, investors who are bullish on foreign markets say it’s time to start nibbling, because it will never be obvious when the markets, or their currencies, have hit bottom.


Wells Fargo Asset Management points to the long-term growth potential of emerging-market economies besides China.

In its 2016 markets outlook report, Wells estimated that China accounted for 56% of world economic growth from 2010 through 2015, while other emerging-market economies accounted for 21%. But over the next five years Wells expects China’s share of global growth to fall to 21% while other emerging economies’ share rises to 34%.

Meanwhile, the potential advantage that European and Japanese stocks have is that their central banks are keeping interest rates at rock bottom to support growth, even as the Federal Reserve begins to raise rates.

The world will face a financial crisis rooted in mammoth debt levels.

Sound familiar? The driving force behind the 2008 U.S. financial system meltdown was a mountain of mortgage debt that giddy borrowers couldn’t repay.

Since then, governments and corporations have been the spendthrifts, piling up a tower of IOUs as central banks have kept borrowing costs at record lows.


Worldwide, total consumer debt grew a modest 21% from 2007 to 2014, to $40 trillion, according to McKinsey Global Institute. But government debt surged 76% in that period, to $58 trillion, and corporate debt jumped 47%, to $56 trillion.

The debt boom has fueled a new round of warnings of financial Armageddon. Albert Edwards, investment strategist at French banking giant Societe Generale, predicts that an “even bigger version” of 2008 lies ahead.

Of course, much of the government borrowing was aimed at escaping the Great Recession by supporting economies until business and consumer demand returned. That borrowing was abetted by central banks, including the Fed, which created money from thin air to buy up government debt. If they choose, they can buy far more.

Corporations benefited by borrowing cheaply to refinance older, high-cost debt. But many companies also have borrowed simply to buy back their own stock, to bolster share prices.

There already have been casualties from the post-2008 borrowing binge. Yields have jumped on corporate junk bonds since mid-2014 as more borrowers have struggled to make payments, particularly in the energy sector. And at the government level, the debt struggles of Argentina, Puerto Rico and Illinois, among others, have become well-known.

But is another massive debt crisis inevitable? Mohamed El-Erian, chief economic adviser at financial services titan Allianz, said that outcome is avoidable with the right government policies, including significant infrastructure spending, and corporate tax reform to remove big uncertainties that hold up business spending. “These things would turbocharge the economy” by stoking demand, he said.


Politically, however, it could take a new crisis to force action.

Howard Marks, co-chairman of Oaktree Capital Management in L.A., one of the world’s biggest debt investors, cautions against overusing the word “crisis.” While much of real life amounts to just muddling through, “In the investing world people go from thinking only about the positives to thinking only about the negatives,” Marks said.

For average investors, the best protection against a new debt crisis may be to avoid higher risk bonds. But if a debt bomb goes off and yields soar, riskier bonds’ investment appeal will rise as well.

More rank-and-file workers in the U.S. will finally see decent pay increases — but potentially at the expense of corporate profit margins.

For workers who are also investors, this presents something of a quandary.

Economists such as David Rosenberg, at investment firm Gluskin Sheff in Toronto, believe that the U.S. economy has reached the point where many workers have the power to press for, and get, higher pay. He notes that the proportion of workers voluntarily quitting their jobs, presumably for better ones, is the highest since early in the Great Recession.

Wages have been rising, but slowly. The sluggish pace isn’t surprising, Rosenberg said. “It takes a long time for people to realize they’re in a better bargaining position.”

But with the U.S. unemployment rate at a seven-year low of 5%, the advantage is swinging from employer to employee as the number of qualified applicants for jobs shrinks. What’s more, for the lowest skilled workers pay is rising because of higher state minimum wage requirements. On Jan. 1, a total of 14 states, including California, raised their minimum wages.


Although it’s true that the decline of labor unions means few workers can bargain together, the Internet and social media give people a powerful means to discover “which companies are good ones to work for and which to avoid,” said Thomas Kochan, a professor of management at MIT.

Those tools become more important as workers who feel underappreciated decide “I’m outta here,” Kochan said.

But if a tightening job market forces wages up, the question for investors is how big a hit companies will take to their earnings — at a time when profits already are under pressure from weak global economic growth.

In a perfect world, rising wages would spark a “virtuous circle” where workers would boost spending, driving up demand for goods and services. That would lift business sales and earnings, in turn allowing companies to continue raising wages.

Reality is likely to be a lot more uneven, posing yet another challenge for stock investors in the next few years. The long-term winners, Kochan said, will be those companies whose higher-paid workers come up with better ideas and boost productivity.

Rosenberg takes a more basic view: “You want to buy stocks of the companies where that extra income is going to be spent.” That could make technology, for one, a big beneficiary, as well as healthcare and entertainment.


Dan Wiener, editor of the Independent Adviser for Vanguard Investors newsletter, said the search for earnings growth could reignite investor interest in “active” fund managers who have proven themselves as good stock pickers.

By contrast, “if you’re a ‘index’ fund investor, you might have a pretty lousy time for the next five years,” Wiener said.


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