ROGER HIRST: Welcome to the workshop on market drivers. Now, hopefully, you've already reviewed the previous parts of this module, and you have an idea of some of the key concepts. But as a quick reminder, here we're referring to the main factors that underpin the performance of the whole market ecosystem rather than just the individual assets. That's in a later module.
We'll be looking at the key trends across three distinctive time horizons of secular, cyclical, and tactical. You see, a single trade idea is all well and good. But what's relevant to me might be totally inappropriate to you. It might not be in the right asset class or the right time frame for your particular requirements.
But all trades play out within an evolving economic environment. And that can have a huge impact on all your investments. And that's whether you're a day trader or a long-term investor. So we all need to understand the economic environment and what it means for our own investing framework and portfolio.
And that's exactly what we're going to explore in this workshop. We want to show ways that you can identify these economic environments and trends so that you can build your own investment framework, one that suits your style and your objectives and which you can constantly test to evolve and improve your trades and your investments.
So let's kick this off with a very high-level view of some of those big trends. And there's going to be some pretty basic stuff in here. But it's an absolutely essential starting point. When we talked in the pub about secular trends, we were basically talking about very long-term trends. And when I say "long term," I mean very, very long term. These are often decades or multi-decades in length.
But of course, even within long-term secular trends, there are often these shorter cyclical trends, which are usually a few months to a few years in the making. And then, finally, just to make things more complex, within those cyclical trends, there are even shorter-dated tactical trends, which can take place intraday or over a few days to a few weeks.
So there is short-term tactical trends within slightly longer-term cyclical trends within very long-term secular trends. Now, don't panic about having to learn all the trends. All you need to do is be equipped to identify them.
So let's look at a simple example that was discussed earlier. And we use Raoul's chart of truth again, showing interest rates on 10-year US government bonds. Now, as a quick sidebar, you've probably heard people banging on about long-term interest rates. And you might be thinking, why do I care?
Well, in simple terms, long-term interest rates on government bonds are the benchmark used to establish rates for mortgages, corporate credit, and other important economic variables that we face in our daily lives. The difference we'll spread between rates of these different types of debt is an essential economic variable that we will learn more about later in this workshop.
But back to that 10-year interest rate on US government bonds. So normally, people look at the chart from the early 1980s. But we're going to pull out even further and look at this chart going back 60 years because then we can see two secular trends and multiple cyclical and tactical trends within those.
Now, hopefully, you can see that there is an extended period where yields are generally upward sloping from around 1960 to 1980. And then there's a period where they're downward sloping from 1980 to 2022. These two big trends can be classified as generational or secular trends in yields.
And you could argue that the period from 1945 to 1980 was a secular period of interventionist government policy, with fiscal policy via spending and taxes as that key driver. It was also a period of positive demographics, with the baby boomer generation being born and entering the workforce in the second half of that period.
Then we had the period from 1980 onwards, which is one of free market policies. And a far more hands-off approach was undertaken, driven by the likes of Ronald Reagan and Margaret Thatcher. Monetary policy, which is things like interest rates, dominated this period, whilst fiscal policy started to take a backseat.
And by the way, if you're getting impatient and thinking, this is all great with hindsight, but how do I actually know if I'm in a trend or if that trend is changing, well, don't worry. We'll get to that. But for now, we need to look at the past to learn what to look for in the future.
So let's go back to that early 1980s and look at that disinflationary secular trend. And just for fun, we'll make this a log scale to equalize the magnitude of the moves because then the top of the trend becomes even clearer. And we'll touch on log charts in the next module.
So this represents the big secular downtrend in yields. But you can also see that the trend is not a straight line. There are numerous sharp upturns and even sharper downturns that average out over the long term. These are the cyclical trends within that secular trend. But the bottom line here is that the overall direction of travel is pretty much consistently in one direction. Now, that won't always be the case with secular trends. But in this case, it is.
Now let's zoom in again to the decade of the 1990s. And you can see that over the shorter time frame, these gyrations would have felt like some monstrous moves in yields both up and down. For many bond traders at the time, the sell-off in bonds, which means high yields that took place in 1993 and 1994, was one of the toughest experiences of their lives. But many people did make fortunes.
And it was because the US Federal Reserve surprised the market with its hawkish turn towards tightening. And bonds experienced a very sharp sell-off. And just imagine if you were a secular bond bull back then but kicked off your long bets at the beginning of that cyclical bear market. Over the longer term, you may have been right. But you might not have survived that initial foray into the market.
And that's why we should be very clear with our preferred time horizon and how the other two cycles influence it. You should be constantly testing your investment thesis and evolving your framework. And this is because we don't have the benefit of hindsight when we're inside that unfolding trend.
But back to our chart, and let's zoom in one more time because there are many smaller swings even within these cyclical trends. Let's head into the 1990 to 1993 period. And once again, you can see within the overall cyclical downtrend in yields, there are many shorter up and down cycles. In fact, we can keep zooming into these trends until we have an intraday chart in which we will see trends within trends within trends. And when you ever hear markets being called "fractal," this is exactly what's meant by that.
So the point we're making here is that there are various trends that underpin markets. Sometimes these trends can work together and provide outsized opportunities. But sometimes they can work against you and make life very difficult. But now that you are aware that they exist, you can try to identify them in almost any environment. So let's talk a little bit more about different types of secular, cyclical, and tactical trends and some of the instruments that we can use to identify them.
We'll start all the way at the top of the longer-term secular level and then keep drilling down. Secular trends are usually created through the interaction of long-term variables, like demographics, debt, technology, and the longer-term government policies of the given country or region.
Some of these trends are extremely hard to pinpoint whilst you're actually living through them. Others are easier to notice as they're actually happening but still difficult to invest in because of the long time horizon. Usually, the best way to take advantage of long-term secular trends is by building a business or positioning your life and career around them or investing in your pension, which is focused on decades into the future, or maybe even just buying a house. These are long-term decisions that position you to ride out the secular wave without having to think or worry about short-term movements.
In any case, we have to be on watch for changes to a secular trend. We could be living through one today. Let's take the chart of truth once again. The secular trend is easy to see. But each time yields were testing the top of that channel, questions at that moment in time were being asked about whether the secular trend was about to break. We have to constantly test our own ideas and our framework.
For instance, inflation in early 2022 has been doing something completely different compared to its long-term trend. So will this mean the end of the secular trend in bond yields? Well, that's something we'll be watching over the next few months, if not years.
And what else can be considered a secular trend? Well, demographics are one of the obvious ones, both at a global and a regional level. The rate of change of population growth probably peaked in the 1970s. This was the decade that saw inflation make new highs. Other factors were at play, such as the OPEC energy shock and wage price spirals driven by unionized workers. But these may all have been influenced by those demographics.
Japan's population dynamics have been in a secular decline for some time, impacting inflation and investment trends. If the working population is in decline, GDP should fall unless workers are replaced with technology. And we are seeing this first hand with the working-age population between 18 and 64 declining around 15% since the mid 1990s, whilst GDP per capita remained unchanged.
India is expected to have healthy population growth, which should improve the country's output as long as it can secure sufficient resources to support the increasing population. To go deeper into the favorable demographics and debt story of India and other countries in the region, as well as parts of Africa, make sure you watch the Monsoon secular theme presented by Raoul Pal and Grant Williams. You can find it in the additional resources of this module.
And speaking of debt, the buildup of debt could also be considered a secular trend, though this may be a subset of demographics once again and the policies that we use to manage economies. The total debt-- that's household, corporate, and government combined-- to GDP ratios of many Western countries have been on the rise for decades.
Technology is another big catalyst for secular shifts. Going back through history, some of the largest changes in the economy have been driven by innovation, things like the rise of steam power, the internal combustion engine, the electric grid, automobiles, air travel, the rise of the computer era, and, more recently, the development of the internet, big data, and crypto. And secular themes like these can, of course, run concurrently.
And as we mentioned earlier, we have had a secular trend in economic policy with the level of government involvement after 1980 being far less than it was from 1945. The years from 1945 to 1980 were dominated by fiscal policies of government spending and taxation, whilst the period from 1980 to 2022 generally saw a decline in taxation and a switch towards the monetary policy of central banks in order to manage economies.
Globalization is one secular trend that some investors, including Lyn Alden, who we've heard from in the previous segment, think may have run its course. Within this was the rise of China. After joining the WTO in 2001. The scale of China's integration into the world economy was like a sudden surge of population growth. Commodity prices soared, but the combined effects of globalization and technology meant that higher input prices didn't always translate into higher consumer prices.
Perhaps the trend of globalization has now peaked, and we may be embarking on a trend towards reduced globalization. Add this to the secular trend towards renewable energy, and we could be seeing new trends towards both high commodities and higher inflation relative to the last 30 years. So we could be entering a secular phase of commodities outperforming stocks. Now, that's not a prediction but more of an observation applying some of the framework we've learnt so far in this module.
Debt, demographics, technology, and policy are some of the things that you need to be using to determine secular trends and longer-term investment themes. These typically play out over many years and even decades. But they can provide the grounding for the investment environment on which we can anchor our own investing framework.