A Round Trip And Now What?

I’ve spent a lot of time reading about what went wrong in the financial markets in the past year. A lot of the best stuff has come in the form of letters and presentations from hedge fund managers who have been at the front lines in this crisis. Most of that stuff is highly confidential and not bloggable. But there is one chart that I keep thinking about that I wanted to share with you.

I saw this chart in a presentation by a leading hedge fund manager. This is a Bloomberg chart that anyone with access to a Bloomberg terminal can recreate and I apologize for the grainy quality and somewhat out of date nature of this.


This is a chart that goes back to January 1994 and charts the S&P vs the rest of the world (minus Japan). Apparently taking out Japan doesn’t change this chart much but it’s cleaner without it.

This shows that for seven years from 1994 to 9/11, the US outperformed the rest of the world by a lot. And from 9/11 to the end of last year, the rest of the world outperformed the US by the exact same amount. It was one big round trip. And that round trip ended in a mess.

I am not going to try to explain why this round trip ended in a global financial meltdown, but it mostly has to do with massive leverage and liquidity and we finally hit the breaking point.

You’ll notice that in the past several months, the US has started to outperform again. This is probably due to positions around the world being unwound and dollars coming home (or something like that). I don’t know if you can make too much of the recent time period.

But the big question is where do we go from here? As we start think about how to position ourselves collectively for the next move up (whenever that comes and it could be a long while), I think this chart is worth paying attention to.

And if you haven’t read it yet, I suggest everyone read Fareed Zakaria’s The Post-American World. It gives an interesting context to this whole issue. Here’s my blog post that I wrote this summer after I finished it.

#stocks#VC & Technology

Comments (Archived):

  1. andyswan

    Who knows. If we can somehow avoid the mistakes of Europe, I think we outperform in a big way. If we go down the road of “equality of results”, we’ll continue to fall behind those with sharper elbows in the Asian markets.

    1. fredwilson

      andy – what do you make of the return of Paul Volcker?

      1. andyswan

        too early to say IMO

  2. Soren Macbeth

    Clearly, the model for global growth that had been in operation for a long time, that being US consumer leveraging themselves and buying up enough stuff to lift up the rest of the global economy is not going to work, at least for long, long time. I’ve heard it said that Chinese and India consumers will step into to fill the void. Personally, i have my doubts.In terms of how to position capital – I think patience is the key. There are going to be many, many “buys of a lifetime” on the other side of this downturn. Deleveraging by banks and hedge funds have devastated a wide range of asset classes. If you have the stomach to buy these forced sales and ride out the volatility for a few years it will be well worth it.

    1. wood83

      Fred,I think it’s all but impossible to bet on any cycle right now because this is uncharted territory. As we all try to wrap our minds around this, I’m struck by just how many comparisons I’m being shown by various and sundry colleagues, research providers, clients. Yesterday a leading technician showed me two charts that were supposed to debunk the “Myth of Buy and Hold.” His charts looked at simple stock returns from the top in 87 through October 2008, and in it he showed the your returns were dwarfed by intermediate term government bonds over that span. Even if you bought at the lows of 87, the returns for stocks weren’t high enough to offset the risk of owning equities versus government bonds.And yet, he failed to include dividends in his model. Dividends vastly change that picture and, of course, tell us what we intuitively know already. Stocks when held for periods beyond 10 years ARE conducive to above average returns [which you would expect given the added risk].As to the notion of emerging markets consumption picking up the slack. That can and should happen. But it’s no foregone conclusion and, as Soren said, it will take a LONG time if it happens. Less than 40% of China’s GDP has been for personal internal consumption. They certainly have it within their system to become a major engine for global growth by ramping consumption, but that’s a societal change that has to come slowly. Just think how long it took our nation [despite being the political and economic hegemon for decades] to get there.

  3. lebousquet

    Empires regress to the mean, just like stock markets. In world affairs, that suggests a multi-polar world rather than the latest period of U.S. hegemony. A crude analogy, perhaps, but if the same principle applies to the financial world, I’m betting much of the upside lies abroad.

    1. fredwilson

      That’s my gut too.And in US companies that can sell to rest of world

  4. ppearlman

    soros’ book precedes zakaria’s by 4 years and while it is highly political does communicate critical views wrt the waning of u.s. dominance… he deserves proper respects in this discussion nailed it much earlier..http://bit.ly/WKEp

    1. fredwilson

      Ok. I’ll start citing sorosBut that means I have to read his bookCan he write like Fareed?

      1. ppearlman

        eh… kinda thick writing and v political.. if u must.. start w classic alchemy of finance which has a recent edition w a foreward by none other than paulvolcker… its also thick but presents brilliant model of reflexivity essential way of thinking about cause and consequence…or jump to his most recent work directly about the credit crisis 2008 which is an application of reflexivity to the current predicament..

  5. lebousquet

    Fred–As for Volcker, I don’t think he’s the fed regulator par excellence that he’s sometimes made out to be, but I will give him this: he opposed killing Glass-Steagall, which in retrospect seems like a very useful Act.

  6. jrh

    During the 20th century many pundits predicted that the US would be overtaken by the Soviet Union, and later by Japan. Those predictions didn’t turn out so well.Especially in the 1930s, many commentators saw the advantages of the Soviet command economy, and predicted that this model would swamp free enterprise. In fact, the Soviets rapidly exceeded US production in raw materials such as steel. The pundits had further evidence that they were right as the USSR led the US in some technological areas (Sputnik). But we all know the rest of the story. I often though of this when I was in Russia at the tail end of communism, and it seemed like everywhere you turned there was a big pile of rusting steel…Similarly, the Japanese way of business has some advantages over that of the US. Especially in the 1980s, there was a wave of pundits predicting that the US was falling behind due to our poor education system, our lack of teamwork in the workplace, etc., etc., etc.But the Soviet and Japanese models hit some kind of natural wall that they can’t get past. I think the barrier for China will come even sooner. The country is too hard-wired to do one particular thing. The lack of accountability on their accumulating assets will come back to haunt them.The genius of the US is its ability to constantly adapt to new models — not just to imitate, but to create new models from scratch at an astounding pace. This requires BOTH creation of the new and destruction of the old. It’s the creative destruction part that other societies can’t seem to master…and that even the US is often uncomfortable with…

    1. fredwilson

      AgreedAnd Fareed makes all of those points in his bookWhat do you make of India? I think India is really interesting in this context

      1. jrh

        I’m a huge fan of India, but they are not in our league, not for many decades. India is a long, long way from making use of its own talent, much less attracting outside talent the way the US does.Obviously they have a lot of tech talent. Bollywood is a good sign–the economics of film production are pretty similar to venture-backed tech, especially in the web era.Sometimes you hear people say the US can’t remain competitive because our educational system is so bad. Then a few minutes later you’ll hear them talk about how India is overtaking the US. These two things do not go together!

  7. Druce

    This says when the US sneezes, the rest of the world catches cold. (Or when the US gets the flu, the rest of the world gets pneumonia)US is down ~40% year to date, a lot of markets are down more. And the dollar has gone up so US is outperforming (I believe this chart doesn’t include change in in FX and the latest spike would be bigger if it did) .The US blows up, riskier markets go down more, flight to quality like Treasuries -> dollar goes up, US outperforms. Counterintuitive is an understatement.I would say the latest spike is a blip in a long-term trend. But certainly a Rorschach test.

  8. kidmercury

    those of us who were super bearish before it became trendy and all the cool kids started doing it know that the game hasn’t even started yet. this is just the pre-game. batting practice, so to speak. but you youngsters are all starting to get bearish, which is good. because the path to the next wave of riches involves going through this bear market.the real game is when the US dollar starts to get devalued and when oil goes back to 150 and beyond. when does it start? who knows. i thought it would’ve started by now already, but apparently people are still wiling to delude themselves via US treasury bonds and (gulp) US dollars. within four years, though, we’ll see the dollar wreak its havoc. then you’ll see the government come in and make things worse, as they always do, with stuff like wage and price controls and forex controls and gold controls and more control. unless the people wake up, though given all you youngsters are still in the mode of reciting “yes we can” and “change” and “hope” and other mindless chants, it’s clear we still have a lot of waking up to do.now if you’ll excuse me, i have to go polish my gold and silver coins.

  9. jasonkolb

    I think while we are screwed, the rest of the world is screwed worse. A chart of us vs. the rest of the world should trend up and to the right for the foreseeable future.

  10. JeremiahKane

    While I believe, as Zakaria argues, the rise of the rest of the world is truly one of the “great stories of our time” my concern is how the rest of the world will react to this crisis. At the start of the great depression the US along with the rest of the world compounded the problem with monetary errors, in part driven by an ill-fated dedication to the gold standard, along with policy errors. The US could close off the immigration that has been so crucial to our growth and swing to a protectionist agenda that would harm our economy with respect to the rest of the world.A far bigger risk is watching emerging countries that don’t have the same robust institutions and history react to these upheavals. China could close itself off to the rest of the world as it has done throughout its history, europe could feel a backlash against immigration that slows its growth.I would not be surprised if the US far outperforms the rest of the world, although the world as a whole will be poorer for it.

  11. howard lindzon

    I still believe in the USA Other than some global etfs in the last bull run, you could have made fortunes right here at home while the world beat us to a pulp.We have all the intellectual property and high margin businesses.If we boot GM, F and all the other legacy manufacturing businesses faster and get people retrain and enthused about global commerce and markets, our margins will improve that much more.

  12. AndyFinkle

    When the US sneezes the world gets a cold. The converse is also true. The world’s economies (and hence markets) will go now where without the mighty US consumer. US will lead us out of this mess over the next decade – rest of the world (markets) will follow.NOTE if you want to see a REALLY cool chart, look at my laste blog post http://www.afpr.com there is a chart comparing the DJI from 1929 – with 21st century NASDAQ overlayed …think history doesn’t repeat itself? Think again!www.twitter.com/A_F

  13. dsheise

    I´d go along the line that we shouldn´t compare the US versus Europe, Japan, or Brics. We should compare companies that can be more efficient on this global scale versus the ones that get outpaced by them. There will be a lot of american winners but there definitely will be chinese, indian and brazilian (for sure) ones too.There are great balance sheets backed by great talent everywhere, each of these countries has it´s own.The world needs a good mix of leaders in high tech from the US, services from India, manufacturing from China and commodities from Brazil. Won´t these be the out performers? Now we have to find out who will the leading banks, cause it seems that they all screwed up so far.For this to be true we still need governments to let it happen. Less trade barriers (today the US still imposes barriers to Brazilian commodities while Brazil places high taxes on American tech products- it wont work this way). Doha needs to be revisited and they need to find a way out.

  14. maximo

    I don’t know how useful this will be to a trader, but here is my view because the question you ask is an excellent question not just for investors but everyone who cares about this country.Long before I got into into business school I was a Ph.D student in economic history. So naturally I pay close attention to geopolitical/Macro issues and I make this an integral part of my investment strategy now that I’m on my own trying to make my mark in this world. From 9/11 to the recent economic meltdown the U.S. lagged in growth because it got caught in a stupid militant crusade where business interests and national interests where not aligned to work for the same common goal (and let’s not forget the insane amount of money flowing into real estate which does not add to productivity and job creation like technology does). The interests of the nation state and the national economic interests were on opposite sides. Just as money follows the greatest return on investment so should the flag of empire. The war worked well for a few—Halliburton and Northrop Grumman come to mind but those are hardly the industries of the future or the most efficient since they depend on government favoritism. During the past 8 years the U.S. focused on one part of the world and that took a toll. Just take a look at the disproportionate flow of money to Latin America from China during the past 8 years. Of course conservative ideologues will deny this by saying war is a profitable enterprise. That was true in a different era as most of you fine gentlemen and ladies already know. Today we don’t fight over land (unless you’re Palestinian in the West Bank) but for access to cheap labor, knowledge, skill, and innovation. The global financial system is about relationships and that’s how money flows. In the past the IMF and the World Bank pretty much decided who would get what and under what conditions because that’s how the big players decided things at Bretton Woods.So, why is the U.S. outperforming again? For the same reasons it did before. The U.S. dollar is reclaiming its place as the “reserve currency” for the nation-states which can’t have a constitution for longer than two years. Just look at the extreme opposite of what we represent: Chavez and Mugabe.As a person who has traveled extensively to Eastern Europe, Asia, and Africa I can tell you that the so called emerging economic growth story is half-true and half lies. I knew Brazil would flop because you can’t sustain growth when you have more than 20% unemployment and a Jim Crow culture in place and very little industry to complement the commodity sector. Remember the 1970s Brazilian miracle? Some miracle that was! Same shit today. Bloated commodity prices (and demand from China) camouflaged the social warts for a while, but not for long. The last time my sister was in India she almost died! I’m tired of this BRIC bullshit. Yeah, you can make money, lot’s of money, but when people tell me these countries pose a threat to the U.S. I just have to contain my laughter. Maybe so, in 100 years.The way I see it Zakaria and Freedman—brilliant that they are they are just journalists and they are not free from intellectual bias. I still vividly recall scholars at the University California calling the fall of the Soviet Union the End of History. It was one of those grandiose declarations by historians that don’t necessarily mean anything but it reflects how disjointed we are from reality. What does the rise of everyone else mean anyway? India has educated workers but no infrastructure. Jesus, 90% of the population does not have access to clean water (which tells you that might be an investment idea). Now let’s go to China where they have been building like crazy, but they have a workforce that is unskilled and aging. Russia? They have a mean oil oligarchy, nukes, and good Vodka and they want to be a player again. This brings me back to the End of History theme.The end of history as Marx defined was supposed to bring workers to the apex of power. Instead, with the collapse of communism the end of history meant that capitalism had won—it was after the 1987 crash and the start of a huge bull market. Reagan was in Power and Thatcher ruled England. Western capitalism and the U.S. reign supreme. But the free market and the conservative manifesto of lower taxes had no opposition. Moreover, in the geopolitical arena the U.S. had no opposition either and I think that was a problem because it created a huge policy void. The thesis-anti-thesis model that makes reality more efficient was absent. We became complacent. Surely due to technology the world got better at making things and exchanging goods and services outside the U.S. sphere of influence. But there is no consumer nation that rivals the American market. And Adam Smith said it best: “Consumption is the sole end and purpose of production.” I would like to see how these economic miracles fair when you take out the American consumer.I think those here with a sense of history will go back to the 1979 crisis which Volcker fought with monetary restraint. But let’s focus on the market reactions to the Fed policies because the situations are different—back then Volcker raised interest rates and restricted banks from lending to fight inflation. But like today we had a weak dollar and a huge federal deficit as well. The markets did not react badly at all.This is my thesis: The dollar will gain strength. And I know many people are betting that the dollar will take a dive again but a strong dollar is needed now. I think the weak cycle might be over for now. I hear China suggested diversifying away from the dollar. My questions is into what? The Euro? I’m shorting the Euro right now because I saw what it’s doing to people in Europe. In economic and historical terms the Euro is an experiment and I doubt China will drop the dollar. Just because Gisele Bündchen wants Euros doesn’t mean the rest of the world is going to hate the dollar forever. The dollar means stability—and I mean political stability because our financial system certainly is not stable. But the U.S. is not going anywhere. This country is an economic Titan! We just had bad leaders for 8 years.

    1. howardlindzon

      really goood stuff maximo

  15. tweetip

    Now what? Bad stuff.

  16. gregorylent

    coming to china, after 12 years in india, i realize those two countries should not be spoken of in the same breath … china is developed, india, willfully and arrogantly undeveloped …i can walk down the sidewalk without looking at the ground anywhere in china, impossible in india, you need to watch every step. the electricity goes out every day in every city in india, never in china … i could go on .. and on, internet penetration, quality, and speed … water, waste, roads, cleanliness … on and on

  17. Joel Spolsky

    This chart doesn’t exactly show what you think it shows — it’s highly deceptive, because it’s in dollars. If you look closely you’ll see that this chart is just a chart of the dollar’s performance relative to world currencies. It doesn’t really reflect a bubble in the US, per se… other countries had bigger bubbles than we did.

  18. Will Johnston

    I started a new venture in August, which is an online ecommerce store. I did this after spending the summer researching what I saw as an emerging market opportunity. Since we launched we have seen double our projections for revenue and traffic each month. This is definitely an interesting time and one where there are great risks as well as opportunities.

  19. skiracer

    it is very hard to compete against cheap labor but the USA should not be looking to manufacture the mundane items that cheap labor produces best. when it comes to creating innovative products and tooling up for a production effort no one beats the USA. we have our economic and social problems and im sure we will find an equitable way to deal with and solve those issues that are most pressing for our country. the entire international community is becoming more tightly bound together as emerging countries and markets come into the worldwide economic equation. when our backs are pushed tight to the wall is when the USA is at its best. if anyone is naive or foolish enough to believe the USA is headed to becoming less or a leader or player in these markets i say put you money up on that side and see how far it gets you.