In The Age of Turbulence, Alan Greenspan outlines his vision for the world, and particularly the United States, between now and 2030. He chose 2030 because that’s when the last of the baby boomers reach age 65 – retirement. And the impact the baby boomers have on the world’s economy as they shift from being producers to consumers of capital is a major theme of his book. (If you don’t want to read it all, chapter 25 summarizes his arguments and predictions.)
In 2030, Mr. Greenspan forecasts the real U.S. GDP will be 75% greater than today. That may sound like a big number but it’s only 2.5% annual compound growth – well within historical norms. That’s the good news. The bad news is forecasted increases in inflation and, correspondingly, long term interest rates. Inflation could rise to the 4-5% level and long term U.S. Treasuries to 8-9% yields due to stresses caused, in part, by rising social security, Medicare and other federally mandated health care payments. Mr. Greenspan also points out that if Treasury yields rise (today, 30 year Treasuries are yielding less than 5%), risk premiums on other investments, such as stocks and real estate, will increase. If such adjustments were to occur rapidly, it would result in deceasing prices for those assets. Occurring over a longer period of time, the investments would grow in value but not as quickly as if the risk premium remained unchanged.
What do Mr. Greenspan’s predictions mean for investors? Stocks, real estate, and short-term bonds. Assume the risk premium for stocks increases, and using Mr. Greenspan’s parameters, the forward P/E on the stock market could fall from its present 15 to 12. However, the real growth in GDP will more than offset this decrease. In 2030, the stock market would still be 60% higher than today in real terms. In normal dollars the market would be even higher because it reflects moderate rates of inflation. Sounds like a good place for long term investors.
Real estate also does well in periods of real growth and moderate inflation. The value of residential (notwithstanding the current downward adjustment in that market) and commercial real tend to track real growth. Hard assets, such as real estate, also increase in value due to inflation. You can lose money if you own a home or building in a declining area (Detroit comes to mind) but overall real estate investors will fare well under Mr. Greenspan’s scenario. I suggest you invest in commercial real estate through real estate funds which focus on real estate investments trusts (see Yielding to REITs).
Long term bonds should be avoided. They go down in value when interest rates rise. Of course, you can hold a bond until maturity and get your principal back but its real value will be reduced by the amount of inflation that occurred over your holding period. And, if the coupon/interest payment doesn’t provide an after-tax return in excess of inflation, that’s a double whammy. The current yield curve is essentially flat. Treasury yields are approximately: One moth, 3.40%; 5 year, 4.00% and 30 year, 4.80%. We will see a much steeper curve if inflation and interest rates are expected to, or do, rise. With the current flat yield curve, and Mr. Greenspan’s expectations, the only safe fixed income investments are those with short maturities, TIPs (Treasury inflation-protected bonds) and, for the higher risk investor, collateralized loan and adjustable-rate mortgage pools.
