Joachim Klement wrote this interesting short piece a couple of months ago, posted on the CFA Institute's blog:
Finance, Bubbles, Negative Rates: The What Ifs . . . ?
https://blogs.cfainstitute.org/investor ... -what-ifs/
It references and contains musings on the following paper published late last/early this year by Paul Schmelzing:
"Eight Centuries of Global Real Interest Rates, R-G, and the ‘Suprasecular’ Decline, 1311–2018"
https://www.bankofengland.co.uk/-/media ... 1-2018.pdf
...which sets out the case for there being a 700-year-and-counting ongoing decline in real interest rates., with no end in sight:
With regards to policy, very low real rates can be expected to become a permanent and protracted monetary policy problem – but my evidence still does not support those that see an eventual return to “normalized” levels however defined: the long-term historical data suggests that, whatever the ultimate driver, or combination of drivers, the forces responsible have been indifferent to monetary or political regimes; they have kept exercising their pull on interest rate levels irrespective of the existence of central banks, (de jure) usury laws, or permanently higher public expenditures. They persisted in what amounted to early modern patrician plutocracies, as well as in modern democratic environments, in periods of low-level feudal Condottieri battles, and in those of professional, mechanized mass warfare.
I love a good long term trend...
In Klement's blog article (first link above), the meat begins in the section titled "What if Negative Is the New Reality?", where he considers the implications should Schmelzing's hypotheses be correct:
This is of immense importance because it hints at several critical trends:
- Sustaining high volumes of sovereign debt without defaulting grows easier over time. So Japan’s debt-to-GDP ratio might not be an outlier but a harbinger of what is to come in Europe and the United States.
- Inequality between labor and owners of capital, which is driven by R-G, might not increase forever but eventually level out and decline. It can only grow indefinitely if savings rates rise at least as fast as R-G falls — something we have yet to observe.
- Risk premia for risky assets like equities are largely determined by R-G as well. If R-G remains low for the foreseeable future, these risk premia should remain low too — barring the usual spikes in risk premia during recessions, etc. This means that equity returns and excess returns over bonds and bills will remain low and continue to decline in the coming decades.
- Declining risk premia imply a sustained increase in valuations so such long-term valuation metrics as the cyclically adjusted PE (CAPE) ratio may never fully revert to their historical means.
I can imagine quite a lot of things happening, but I can certainly imagine the above occurring, particularly the latter two bullets regarding an ongoing secular fall in the equity risk premium giving rise to expansion of equity valuation multiples - very handy for existing holders able to benefit from a one-off ongoing revaluation, should that occur.
Prior to the the Covid crisis, my base case was already to "give the benefit of the doubt" to the prospect for equity multiple expansion over the coming 12-15 years largely as a result of Millennial generation demographics (ie. the opposite to the mainstream narrative re the bearish implications of boomers cashing in their portfolios...).
Add Covid to the mix, with its implications for pushing back down - and keeping down - long term gov bond yields, and that's a further opportunity for multiple expansion to occur.
An additional gentle tailwind to multiple expansion - or just an absence of a much-anticipated headwind - over the coming decades arising from an ongoing 700-year supra-secular decline in real rates would just be further grist for the mill...
None of the above is a reason to suddenly become wildly bullish; but possible food for thought for those like me with investment horizons measured in the decades (and plenty of patience).