Thursday, April 17, 2014

Bain Report-- "A WORLD AWASH IN MONEY: Capital trends through 2020"

I missed this when it was released, Dec. 2012, but subsequent events have shown Bain's macro team to have been right on the money, so to speak.
From Bain & Co:

World awash in nearly one quadrillion of cheap capital by end of decade, according to new Bain & Company report
Global Capital Glut Could Challenge Business and Investment Decision-Making Well into the Future
New York, December 10, 2012—Despite the enormous loss of wealth and leverage resulting from the Global Financial Crisis, the total pool of global capital will expand by 50 percent by the end of the decade, up $300 trillion from roughly $600 trillion today to $900 trillion dollars by 2020; this, according to findings of a new report, “ A World Awash in Money,” published today by global consulting firm Bain & Company.  In addition to the “inertia” or self-sustaining momentum growing the huge stock of capital in the West, new forces of capital expansion from China, India, and other emerging markets will help drive the increase. 

Notably, China will shift from a country that absorbs capital to one that generates capital—Bain projects that China will add $87 trillion to  total global financial assets by 2020, more than four times the amount of growth that will be generated by the Japanese economy and $25 trillion more than the growth in both the U.S. and EU.

According to Bain, the resulting capital pool in 2020 will exceed real global GDP by a factor of ten, as global GDP increases by only $27 trillion over the same period.  The net effect:  Businesses and investors will struggle to find a sufficient supply of attractive, productive assets to absorb the amount of financial capital they have to invest, driving up asset prices and forcing them to lower their expectations for high rates of return on investments.

The Bain report finds that of the $300 trillion in growth, financial assets in the advanced economies will grow by roughly $170 trillion by 2020, while those from emerging markets will account for more than 40 percent of the global increase, or $130 trillion.  Growing at a nine percent compounded annual rate, the proportion of capital sourced from emerging markets will increase from less than one-tenth of the global total, or just $20 trillion, in 1990 to about one-quarter, or nearly $220 trillion, by the end of the decade.  “Holders of this capital will be eager to put it to work by investing in growth opportunities, creating a loop of heavy competition for quality assets, increasing asset prices, and a greater likelihood of deeper and more disruptive asset bubbles,” said Karen Harris, director of Bain’s Macro Trends Group and co-author of the report.  “In fact we have never seen the investment community caught in open, choppy waters to this degree in modern economic history.  The advantage has shifted from having money to fund something to having something worth funding.”

A world steeped in capital superabundance will redraw the map for investment decision-making.  The Bain report identifies the new risks threatening both strategic and financial investors.  Without a sufficient supply of attractive assets to absorb this capital, Bain finds the risk for future asset bubbles extremely high, especially in areas such as basic raw materials and agricultural products, precious metals and rare earths.  Bubbles are also apt to form in illiquid assets like real estate, industrial capital goods or transportation equipment.  Bain concluded that bubbles will remain a fixture of the low-interest-rate global economy through the balance of the decade, as investors move quickly when price signals indicate that an asset is primed to appreciate and pump in capital that causes over appreciation.

In this world of sustained plentiful capital, Bain sees five imperatives for businesses, financial intermediaries and investors:
  1. Rethink hurdle rates—Bain anticipates that the capital glut will be accompanied by persistently low real interest rates, high volatility and thin real rates of return.  Businesses and investors face a tough choice between keeping their capital on the sidelines hoping for higher-return opportunities that will never materialize, or ratcheting down their expectations for interest rates and speed of returns. 
Prepare for bubble risks— The ever-present danger of asset inflation will contribute to an overall steepening of the investment risk curve, which will influence the shape of capital markets through 2020.  To defend themselves, companies will need to strengthen their bubble-detection capabilities by building on insights derived from the long-term fundamentals of their businesses.  Banks, hedge funds and other financial intermediaries that enhance their risk-pricing skills will be better positioned to generate above-market returns over the longer term, earning them a competitive edge.... 


HT: vbounded