Since the early 1980’s the financial sector has ridden an extraordinary wave of prosperity. The combination of increasing debt levels and rising share markets turbo-charged the growth in the banking and investment industries.
To highlight the strong correlation between the fortunes of the financial sector and credit booms, let’s look at two images. The first from Hoisington Investment Management is titled ‘US Total Debt since 1870’.
The second graph was obtained from Thomas Philippon’s, November 2008 research paper titled ‘The Evolution of the US Financial Industry from 1860 to 2007: Theory and Evidence’.
The evidence in both credit bubbles is clear. Rising debt levels were the wind beneath the wings of the financial industry. There is, however, one significant difference between now and the 1930’s peak in the US financial industry. This time around the investment industry is far larger and more sophisticated than it was in the ‘Roaring 20’s’.
In today’s investment industry we have institutional and boutique fund managers; hedge funds; investment administration services; industry superannuation funds; self-managed superannuation funds; online broking services; options trading programmes; financial planners; share brokers and the list goes on.
The credit bubble combined with technology spawned a multi, multi-billion dollar industry. A lot of people have their livelihoods and capital tied up in this industry. Call it survival or self-interest, but there is no way they will go down without a fight.
If we look to the past to possibly divine the future, we see the US financial industry went from being 6% of GDP in 1930 to less than 2% of GDP in 1950. Over a twenty-year period the industry contracted more than 65%.
As revenues stagnate, businesses aligned to the financial sector will look to maintain profitability by reducing costs. This is evident in job losses in retail banks, investment banks and share broking firms.
If the global share markets follow in the steps of the past two major credit contractions — The Great Depression and Japan post-1990 — revenues will fall substantially and the recent job losses will be the tip of the iceberg.
2007 All Over Again
Let’s take one step back and look at the period leading up to the market top in 2007; the investment industry had an easy story to tell. Share markets had returned on average 15% per annum (growth plus dividends) for nearly 25 years. Interest rates had fallen from over 16% to around 4%. Little persuasion was needed to encourage investors to swap their cash for shares.
It was like ‘stealing candy from a baby’. There were the occasional hiccups in the growth story — the 1987 crash and the 2000 ‘tech wreck’ — but the recovery after these periods were used as evidence to convince doubters of the market’s resilience — ‘in the long term shares always go up’.
Revenue streams were based on a percentage of funds invested. All industry participants clipped the ticket and enjoyed rising levels of income and profitability.
It is more than five years since the market topped out in late 2007. The massive amounts of central bank intervention underwrote the market recovery — until cracks started appearing recently. An uneasy calm has descended over markets, and industry revenues have been ‘treading water’.
Investors are in two minds as to whether they sell now, realise their gains or losses and go to the safety of cash OR stay with their allocation to shares (and possibly buy more) and hope for the market to deliver on its much-hyped promise of delivering in the long term. The conditioning from 25-years of rising markets still holds enough sway to make the latter a viable proposition.
In this period of ‘stability’ the investment industry’s marketing efforts have moved into overdrive.
There have been countless articles headlined with common themes like: ‘shares under-valued’; ‘high dividend yield stocks to buy’; ‘maintain a long term share market view’; ‘invest in value stocks’; ‘protect your portfolio with defensive stocks’; ‘is there a better time to invest in the market?’ and they go on and on ‘ad nauseum’.
The main thrust of the industry’s marketing message is best summarised as: ‘shares are under-valued or fairly valued and it is either a bad time to sell or a good time to buy’.
No stone is being left unturned in the efforts to convince investors to stay the investment course.
As stated earlier, the industry players are fighting for their survival. They know a mass exodus (stampede) from market related investments will deliver the industry the same fate as the Thanksgiving turkey.
There are two points worth considering with the current predicament the industry finds itself in:
- It is obvious the fortune of the share market plays an integral role in the investment industry’s prospects. The severe and longer than expected downturn (sparked by the GFC) has exposed the industry as being basically a one-trick pony. If the share market goes lame, then the circus is largely over.
- Do you ever recall hearing the analysts, industry commentators and economists who are now telling us the market is reasonably valued, making any pronouncements in 2007 about the market being over-valued? Ah, the sounds of silence.
The next serious market downturn will truly test the belief systems, of both investors and the industry players, that were forged during the 1982–2007 secular bull market.
Does the industry dare tell the truth about the share market’s long term (secular) cycles to enable investors to make an informed choices or will it continue to bury its head in the sand and use selective data to support its own interests ahead of yours?
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