Low Interest Rates & Stock Market Gains

I’m expecting low interest rates and stock market returns over the next five years.  Ben Bernanke, before he was Federal Reserve chairman, talked about a global savings glut.  Here’s how we get there.

The emerging economies save more than we do.  (We’re graphing an economy-wide savings rate that includes not only personal savings but also corporate and government savings.)  There are some good reasons for higher savings rates in emerging economies:

• Weaker social safety net, so people save
• Weaker consumer and mortgage credit institutions, making debt harder to come by
• Uncertainty about how long the strong growth will last

Now take the higher savings rate in the emerging countries and look at how fast they are growing:

The faster growth of the emerging countries means that their share of world GDP is rising.  So a higher portion of world economic activity is happening in countries with high savings rates.  So the total
world savings rate is rising.

That’s supply; now let’s talk demand.  I think It takes less capital to produce a dollar’s worth of GDP these days.  I don’t have world data, and U.S. data run contrary to my hypothesis, but that’s not stopping me. We get more value from the knowledge, engineering, and marketing information embedded in goods and services, relative to the bricks and mortar required to make steel or glass or fabric.  And the intellectual inputs to GDP don’t require much capital.

If I’m right, demand for capital is falling while supply is rising.  That’s a formula for interest rates staying low, and returns on equity being low.  What’s on the horizon to change this?  Rising spending in the emerging countries, to lower their savings rate.  Consumer spending will increase, as will construction of infrastructure.  In addition, environmental improvement will push up the ratio of capital per dollar of GDP in the emerging countries.  These trends, however, will take some time.  So look for at least five years of fairly low returns on capital.