Back to the roaring 20s

Inflation is the biggest threat to global financial prosperity. If it fails to return to central bank targets, interest rates will remain elevated, economies will stall, and financial markets will stumble.

Inflation has come down sharply across the world since peaking in 2022. In the US consumer price inflation (CPI) has dropped from 9% down to 3.1%, but the inflation hawks believe it will be sticky at these levels, that the last mile to 2% central bank targets will be the hardest to conquer. They cite tight labour markets and the effect of high wage demands. In the US, wage growth is still high due to full employment conditions. The Employment Cost Index measured 3.5% year-on-year at the end of 2023. However, after adjusting for labour productivity growth of 2.7%, the so-called inflation residual is only 0.8%, consistent with CPI returning to central bank targets.

The inflation hawks say that 2.7% productivity growth is unsustainable, that it merely reflects a once-off recovery from the supply chain disruptions that occurred during the Covid pandemic and will return to the sub 1% levels that characterised the decade following the 2008/09 Global Financial Crisis. However, these were unusually low levels, due to private sector deleveraging as households and businesses repaired their balance sheets. The long-term average is 1.5%. The more optimistic view is that the US economy is going through a more permanent trend of rising productivity growth, led by Artificial Intelligence (AI). In this case, inflation should come down irrespective of whether the economy enters recession or not, due to the supply-side nature of the expansion.

AI is widely recognised as a General-Purpose Technology (GPT) with the potential to transform the global economy. Previous GPTs include the adoption of steam power during the 19^th century and electricity in the early 20^th century. These transformative technologies delivered surges in productivity and economic growth. Goldman Sachs research asserts that generative AI could raise US productivity by a substantial 1.5% per annum. When AI progresses along the spectrum from Generative AI to General AI, capable of replicating human intelligence, productivity growth could grow at an even faster pace. According to Bank Credit Analyst research “The global economy has experienced two phase transitions in the past: The Agricultural Revolution and the Industrial Revolution. Both revolutions saw GDP growth rise 30-to-100-fold relative to the previous epoch. A comparable increase in growth, this time driven by super-intelligent AI, would allow global GDP to double every year or faster.”

The widespread adoption of transformative technologies takes time, but the adoption time becomes quicker as technologies advance. The internet revolution of the 1990s accelerated productivity growth from 1% to 3.5% in the early 2000s. The productivity benefits of the AI revolution should permeate even more quickly. A PricewaterhouseCoopers survey conducted ahead of this year’s World Economic Forum meeting in Davos asked global chief executives what they believed would be the effect of generative AI on their businesses over the next 12 months. Among the surveyed CEOs 46% said that AI will boost their firm’s profits over the time frame, and one quarter that it will lead to a headcount reduction of at least 5%.

The productivity cycle goes through long-term waves, led by technological innovation, societal changes, fiscal stimulus and credit cycles. Wars or major crises often create inflection points for a change in trend. There are striking similarities between the current outlook and the early 1920s. Independent research firm AlpineMacro says “We believe that the surprise will be on the side of how well the US economy will continue to re-emerge from the Covid-19 pandemic crisis… The similarities between now and the early 1920s continue to draw our attention. Back then, the world just came out of the First World War (WW1), the 1918 Spanish Flu pandemic and a brief recession in 1920/21. This dark period was followed by booming business activities, soaring stock prices and a spurt of rapid productivity growth.”

The 1920s saw life-altering new technologies including electricity, the automobile, telephone, radio and assembly lines. The 2020s has seen long-lasting economic, social and technological changes, including Work-From-Home, AI, massive fiscal handouts, and onshoring which is creating a manufacturing investment boom in the US.

In the US household debt levels are the lightest in 22 years. The economy is no longer facing deleveraging pressure. Company and bank balance sheets are also at their healthiest in decades, paving the way for another credit boom. AI has reached an important threshold where its application will begin to proliferate at an accelerating pace.

What does this all mean for the financial markets and share prices? According to independent research firm Capital Economics which recently reiterated its bull case for equities, “Gains from AI are likely to flow to capital rather than to labour”, and “… investors have historically sought to capture the perceived economic benefits of new technologies ahead of these technologies actually diffusing through the economy.” Equity market gains may initially be centred on technology shares and particularly the US, due to its greater capacity to innovate, diffuse benefits and adapt to change, but transformation should rapidly spread more broadly. This should result in strong global equity market gains over the next two years, and likely for the remainder of the decade.

Overberg Asset Management specialises in the management of private share portfolios and in providing financial advice, tailored to the investment objectives and needs of each client. Since our establishment in 2001, Overberg has developed a proven track record in global and domestic South African markets. Our collaboration with offshore partners enables access to investment structures with distinctive tax-efficiencies and wealth protection advantages that bridge generations. The company has offices situated in Pretoria, Cape Town, Winelands, Hermanus and Greyton. Contact our experienced and dedicated management team for a free consultation and ensure your financial wellbeing.

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• All writers’ opinions are their own and do not constitute investment recommendations or financial advice. Speaking to a qualified wealth and investment professional is crucial before making financial decisions.
• ‘Overberg Asset Management (Pty) Ltd. is an authorised financial services provider: 783’ established in 2001.

Inflation is the biggest threat to global financial prosperity. If it fails to return to central bank targets, interest rates will remain elevated, economies will stall, and financial markets will stumble.

Inflation has come down sharply across the world since peaking in 2022. In the US consumer price inflation (CPI) has dropped from 9% down to 3.1%, but the inflation hawks believe it will be sticky at these levels, that the last mile to 2% central bank targets will be the hardest to conquer. They cite tight labour markets and the effect of high wage demands. In the US, wage growth is still high due to full employment conditions. The Employment Cost Index measured 3.5% year-on-year at the end of 2023. However, after adjusting for labour productivity growth of 2.7%, the so-called inflation residual is only 0.8%, consistent with CPI returning to central bank targets.

The inflation hawks say that 2.7% productivity growth is unsustainable, that it merely reflects a once-off recovery from the supply chain disruptions that occurred during the Covid pandemic and will return to the sub 1% levels that characterised the decade following the 2008/09 Global Financial Crisis. However, these were unusually low levels, due to private sector deleveraging as households and businesses repaired their balance sheets. The long-term average is 1.5%. The more optimistic view is that the US economy is going through a more permanent trend of rising productivity growth, led by Artificial Intelligence (AI). In this case, inflation should come down irrespective of whether the economy enters recession or not, due to the supply-side nature of the expansion.

AI is widely recognised as a General-Purpose Technology (GPT) with the potential to transform the global economy. Previous GPTs include the adoption of steam power during the 19^th century and electricity in the early 20^th century. These transformative technologies delivered surges in productivity and economic growth. Goldman Sachs research asserts that generative AI could raise US productivity by a substantial 1.5% per annum. When AI progresses along the spectrum from Generative AI to General AI, capable of replicating human intelligence, productivity growth could grow at an even faster pace. According to Bank Credit Analyst research “The global economy has experienced two phase transitions in the past: The Agricultural Revolution and the Industrial Revolution. Both revolutions saw GDP growth rise 30-to-100-fold relative to the previous epoch. A comparable increase in growth, this time driven by super-intelligent AI, would allow global GDP to double every year or faster.”

The widespread adoption of transformative technologies takes time, but the adoption time becomes quicker as technologies advance. The internet revolution of the 1990s accelerated productivity growth from 1% to 3.5% in the early 2000s. The productivity benefits of the AI revolution should permeate even more quickly. A PricewaterhouseCoopers survey conducted ahead of this year’s World Economic Forum meeting in Davos asked global chief executives what they believed would be the effect of generative AI on their businesses over the next 12 months. Among the surveyed CEOs 46% said that AI will boost their firm’s profits over the time frame, and one quarter that it will lead to a headcount reduction of at least 5%.

The productivity cycle goes through long-term waves, led by technological innovation, societal changes, fiscal stimulus and credit cycles. Wars or major crises often create inflection points for a change in trend. There are striking similarities between the current outlook and the early 1920s. Independent research firm AlpineMacro says “We believe that the surprise will be on the side of how well the US economy will continue to re-emerge from the Covid-19 pandemic crisis… The similarities between now and the early 1920s continue to draw our attention. Back then, the world just came out of the First World War (WW1), the 1918 Spanish Flu pandemic and a brief recession in 1920/21. This dark period was followed by booming business activities, soaring stock prices and a spurt of rapid productivity growth.”

The 1920s saw life-altering new technologies including electricity, the automobile, telephone, radio and assembly lines. The 2020s has seen long-lasting economic, social and technological changes, including Work-From-Home, AI, massive fiscal handouts, and onshoring which is creating a manufacturing investment boom in the US.

In the US household debt levels are the lightest in 22 years. The economy is no longer facing deleveraging pressure. Company and bank balance sheets are also at their healthiest in decades, paving the way for another credit boom. AI has reached an important threshold where its application will begin to proliferate at an accelerating pace.

What does this all mean for the financial markets and share prices? According to independent research firm Capital Economics which recently reiterated its bull case for equities, “Gains from AI are likely to flow to capital rather than to labour”, and “… investors have historically sought to capture the perceived economic benefits of new technologies ahead of these technologies actually diffusing through the economy.” Equity market gains may initially be centred on technology shares and particularly the US, due to its greater capacity to innovate, diffuse benefits and adapt to change, but transformation should rapidly spread more broadly. This should result in strong global equity market gains over the next two years, and likely for the remainder of the decade.

Overberg Asset Management specialises in the management of private share portfolios and in providing financial advice, tailored to the investment objectives and needs of each client. Since our establishment in 2001, Overberg has developed a proven track record in global and domestic South African markets. Our collaboration with offshore partners enables access to investment structures with distinctive tax-efficiencies and wealth protection advantages that bridge generations. The company has offices situated in Pretoria, Cape Town, Winelands, Hermanus and Greyton. Contact our experienced and dedicated management team for a free consultation and ensure your financial wellbeing.

Enjoyed this article? Subscribe to our and Bottom Line or join our YouTube community.

• All writers’ opinions are their own and do not constitute investment recommendations or financial advice. Speaking to a qualified wealth and investment professional is crucial before making financial decisions.
• ‘Overberg Asset Management (Pty) Ltd. is an authorised financial services provider: 783’ established in 2001.