Wall Street's Best Minds
Byron Wien on "New Industrial Revolution"
The Wall St. pro shares the latest views of a mentor who sees a new breed of innovators emerging.
By Byron Wien
Updated July 2, 2014 12:00 p.m. ET
People often ask me if I have a mentor, someone who has influenced my thinking over my career. I have had many, but over the past thirty years I have learned a great deal about investing from the person I have come to refer to as The Smartest Man in Europe. The most important lessons he taught me were (1) that the primary force behind good performance is recognizing important changes before or just as they are starting to happen, and (2) when something significant is happening, put a lot of money behind it. Concentrate on the big ideas; don't over-diversify.
"There is a new industrial revolution taking place around the world based on innovation. It is centered in California but there are pockets of it elsewhere in the United States and in a few places abroad. There are creative new companies being formed every day.
"Overall I see the United States growing at about 2% in real terms. To grow at 3% you would need another building boom and I don't see that happening anytime soon. The use of robotics will improve the productivity of industrial companies and profit margins will stay high, but it will be hard to bring down the unemployment rate.
"There is a further problem in that the broader use of technology has made the skills necessary to get and hold a good job more demanding. You will need a fine education and even then it will be tough to find a satisfying job. Many young people are not working in the areas they were trained for. Those who are employed in their desired field will find their wages going up very slowly.
"The broad market will probably not have a major move over the intermediate term, but the innovators will do well. From time to time there will be surges in certain sectors. The homebuilders had their day, now energy and oil service stocks are doing better, but the secular move higher will be accomplished by the innovators.
"Germany is a curse. Europe needs more money to stimulate its growth. Europe is out of the deflationary recession that was caused by the austerity programs that Germany supported, but it is only growing at 1% now. It needs a dose of quantitative easing to grow faster, but Mario Draghi, the head of the European Central Bank (ECB), refuses to provide it. He has been encouraged by his German advisers to be wary of inflation, but more people in Europe are worried about deflation than inflation. The inflation rate in Europe is less than 2%. Monetary easing would be good for the economies across the continent. A few weeks ago the ECB announced some minor accommodative steps, but they were insufficient to have any profound impact. There is one circumstance that could cause the ECB to ease monetary policy in a major way and that would be if the economy of Germany starts to slow down. I think that is likely to happen in the next year, and then you could see Angela Merkel prevailing on Mario Draghi to liberalize monetary policy.
"As for the other countries in Europe: I think François Hollande will be re-elected in France. I do see Europe shifting somewhat to the right politically, but I don't think France will elect a far right candidate. It is basically a socialist country and probably will remain so. I have some renewed hope for Italy. They have a new reform-minded prime minister there and he is determined to restore growth to the economy. He hopes to do this by reducing regulation and removing the barriers that prevent workers from entering certain trades, thereby increasing labor mobility. I hope his program will work. Spain is clearly coming out of its housing collapse–induced recession. The industrial economy is doing well, foreign capital is coming back and sun-seekers are returning to the resort areas. Tourists are also going to Greece; hotel bookings there are up 45%. Portugal is benefiting from the economic recovery in Spain. Of them all France is the most unpredictable.
"One of the problems of Europe beyond its economic woes is that it has limited power politically. It fears Russia and would like to have imposed tougher sanctions on the country, but its economic interests would have suffered a negative impact if they did that.
"The United States is an example of that. It is weary of the wars it has been waging in the Middle East for a decade or more with little to show for it in terms of establishing democracies there. The U.S. was naïve to think it could establish democracies in areas that are so strongly tribal in nature. The probable solution for Iraq is that it will be broken into three parts – Kurdish, Shiite and Sunni. The country could only be run as a single entity by a strongman, as Saddam Hussein was and Malaki is not. We see that in Egypt where el-Sisi has virtually destroyed the Muslim Brotherhood that previously was in power. Afghanistan is a lost country. Al-Qaeda is setting up cells there and I don't think the U.S. can stop it.
"I also am not hopeful the Israelis and the Palestinians can achieve a peace accord anytime soon. The hawks are in control on both sides. The Palestinians want all of their territory back, the closing of the settlements and the right of return in order to recognize Israel and the Israelis are not likely to agree to that, so the stalemate is probably going to continue. Israel is one of those places where technology innovation is vibrant. Much of the creative work is coming from people whose basic education took place in Russia. With all of its problems Russia still has the best public education system in the world. You hear a lot about the oligarchs, but the society there is based on status – your education, your job – more than money. The Russian economy is suffering because Putin spent so much on defense and didn't diversify the economy beyond energy.
"I am optimistic that there will be some agreement which will result in Iran pulling back from its nuclear weapons development program. There are too many young people in that country who know what is happening elsewhere in the world and they want to be part of it. The clerics cannot hold them back indefinitely. The sanctions are hurting and everyone but the very top leadership wants them removed. The real story in Iran and throughout the Arab world is that 70% of the population is under 30 and these younger people want change and the prospect of a better life. If the sanctions were lifted there would be enormous foreign direct investment in Iran and a huge boom. I don't have much hope for Syria. Al-Assad and his oppressive regime are there to stay. The northeast could be broken off and become a part of Iraq, however.
"Eventually I see oil production in the Middle East returning to pre-conflict levels and even moving higher. I agree with you, however, that increased production will not be enough to meet the demands of the developing world – especially India and China – and I see oil prices heading somewhat higher. As for gold, it has now been established as an asset class although it is not one embraced in Europe and the United States. It is a part of almost all institutional platforms in India and many other places in Asia. I think it has formed a base here at current levels, but I don't know when it will move substantially higher. I think at least a small amount of gold should be in all portfolios.
"I think the election of Modi in India without a run-off is a very positive development. He appears to be a real reformer, which is what the country needs, but he has to deliver. The market may have already discounted a good part of what he is likely to achieve. I visited China this year and my conclusion is that the size and the diversity of the country present a challenge to how central government rules the country.
As a result, the regional authorities have a lot of power and it is hard for Beijing to know if they are always performing in accordance with the intentions of the central government. It is true that China has ascended to the position of second largest economy in the world but that is because of the size of the population, not its per capita income. I don't expect a hard landing, however, because they have enough control over the economy to avoid that.
"As for the rest of the world, I am pretty bored. I think Indonesia is basically a commodities rather than industrial market and if commodities do well, so will the country's equities, but I can't predict commodity prices. In Latin America I am bullish on Argentina; Brazil will recover, but it is too early to invest now.
"Everyone seems to be disturbed by the lack of volatility in the market, but volatility is the product of excesses and there are few excesses now. The U.S. stock market is fairly valued, the economy is healing and the U.S. bond market has settled down to a new low-yield level. The Middle East is not likely to blow up. Despite all of this, a lot of people are afraid and because of that the market should go higher.
Europeans are under-invested. Saving the European Union and the euro preoccupied investors over the past two years. As the economy strengthens, there will be more structural change – a banking union and more fiscal convergence in Europe.
• The art market is reflective of the inequality problem. It is the most unregulated market in the world. Prices may be topping soon because of wealth taxes.
• After 2012 and 2013, it is proving much harder to make money in equities.
• There is a big boom coming in Myanmar even though the military is still in power.
• Hillary Clinton will win the 2016 election."
We had a lively discussion on almost every point but we were more in agreement than in past years. That, however, may be a worrisome sign. Half-way through his ninth decade The Smartest Man in Europe is still as informed and opinionated as ever. He should be an inspiration to all of us.
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