Forward-looking private equity investors can reap strong returns from global growth opportunities, despite the powerful headwinds that are buffeting the U.S. economy. That was the assessment of Glenn Hutchins, co-founder and co-chief executive of Silver Lake, a global private equity investment firm, in a keynote address during the 2011 Wharton Private Equity and Venture Capital Conference.
Technology and booming economies in Asia and the developing world offer a wealth of prospective investments, ranging from health care to wireless technology, Hutchins said in a talk titled, “Endgame: The New Economy.” “If you can position yourself in a growing part of the U.S. and the global economy, there is a very bright future ahead of you,” noted Hutchins, whose firm has $14 billion in assets and offices in New York, California, Europe and Asia.
Hutchins called the 2008 global financial collapse the worst he has seen in his business career. The former adviser to President Clinton on health care and economic policy said the crisis is a reminder that even the best investors can be “hurt badly” if they misread economic conditions.
Lingering effects of the crisis still haunt the economy, he noted. For example, the current recovery is far weaker than those that have typically followed a U.S. downturn. “Usually, the deeper down you go the steeper you come back,” said Hutchins, who is chairman of SunGard Corp., a software and technology services provider, and a director of companies including telecommunications provider MCI and TD Ameritrade Holding Corp., a financial services firm. But this time, the “bounce back is anemic by contrast.”
Among the major signs of weakness that he cited:
- Unemployment: Hutchins called joblessness the single most important part of the economic picture. Laid-off workers have currently been unemployed for an average of 34.2 weeks — more than 60% longer than in past economic cycles. “This has long-term consequences for families and kids,” he pointed out, noting that it becomes much harder for people to find work after six months of unemployment since their skills and business networks begin to grow stale.
Meanwhile, more jobs have been permanently lost in the latest decline than in previous cycles. While laid-off workers were frequently hired back by their employers, today’s unemployed must often find new jobs with other companies, Hutchins said. New jobs most often come from small companies that are expanding, he added, but the funds available for such expansions have “declined precipitously” in the wake of the global financial meltdown.
- Excess capacity: Only about 76% of U.S. manufacturing capacity is now in use, Hutchins said, compared with the historic norm of 82%. And the service sector, a source of growth in past recoveries, also lags because these jobs are increasingly outsourced to other countries. The rate of economic growth in the U.S. service sector is now just 0.5%, compared with more than 2% in the previous two recoveries. “The services engine has slowed down,” said Hutchins. “An increasing amount of professional services — architecture, engineering, consulting, legal, accounting — has gradually been able to migrate outside the United States.”
Major corporations are increasingly relocating to other countries as well. “People understand that GDP has moved outside the developed world. They get that jobs have gone with it. But what they really don’t understand is that corporate activity has gone, too,” Hutchins said. Nineteen of the world’s 25 largest companies in market value were based in the United States in 1999, he noted, compared with just 14 today.
- Real estate: Housing remains the heaviest drag on the recovery, said Hutchins. The U.S. housing industry currently has a 24-month supply of unsold homes — including those in foreclosure — or four times what economists consider the optimal level of supply. Weak housing prices reflect this unsold inventory: While prices typically show a 26% gain in the first year of a recovery, in 2010, home prices were down 1% from the previous year.
The impact of the 30-year buildup of debt that preceded the 2008 financial crisis is also impeding the recovery. Debt reached 350% of the U.S. Gross Domestic Product (GDP) that year, according to Hutchins — more than twice the level that preceded the Great Depression. “This was not a product of one decision,” he said of the vast buildup before the recent crisis. “It was not a product of one bubble. This is 30 years of excess in borrowing in almost every sector of our society.”
Such borrowing “sticks with you,” he noted, making it extremely difficult for the economy to grow while government, consumers and businesses shed debt. Consumer borrowing fell for a record nine straight quarters as of the end of 2010, for example, and consumers have lost some $1 trillion in purchasing power as a result of the recession. Debt-burdened consumers are reluctant to borrow, even as credit becomes more readily available.
This increase in saving is taking place at “just the wrong time,” since what the economy needs most is a surge in demand from consumers, whose spending accounts for some 70% of GDP. Investors must thus make a judgment about whether consumers will go back to “aggressive borrowing and shopping,” he said.
The Weight of Budget Deficits
Also weighing on the economy are government budget deficits around the world, which Hutchins called a major threat to the recovery. But “you can’t take the patient off life support until he can sustain himself,” he added. “You have to take the stimulus out of the economy relatively gently,” since a sharp pullback could trigger the kind of double-dip downturn that the United States suffered in 1937.
At the same time, Hutchins applauded the deficit-cutting moves that the co-chairmen of the bipartisan National Commission on Fiscal Responsibility and Reform recommended last December. “There’s a roadmap already out there. The question is, do we have the political will to do it?”
Looking five years ahead, Hutchins predicted the global economy will expand through 2015, with most of the growth coming in Asia and other parts of the developing world. Silver Lake is gearing up for this, he said. Employees are told, “You may not like the food. You may not like the jet lag. You may not like missing your kid’s soccer game, but you’ve got to go” to the emerging markets, particularly Asia. “Not only that, but we’re going to move you there.”
Middle class consumers in emerging markets often look for products that are far different from what U.S. companies produce, Hutchins added. He pointed to the popularity of ultra low-cost Nano cars in developing countries, as opposed to sports utility vehicles from Detroit automakers. India’s Tata Motors is cashing in on the popularity of the Nano, and France’s Renault plans to roll out a model with an Indian partner in 2012.
Meanwhile, what Hutchins called “the global gerontocracy” is providing both challenges for governments and opportunities for investors around the world. Every major country, with the exception of India, is growing older, he said, putting stress on social systems that support the elderly. China faces a particularly difficult challenge, because its one-child policy will require each worker to support two older retirees. Europe and Japan are aging as well, and the United States will have to count on immigration to bolster its younger labor force.
But “as the world gets older it consumes different things,” Hutchins said. He pointed to the growing demand for health care as a target of opportunity for investors in the United States and elsewhere. For example, U.S. health care providers will need to accommodate 30 million new consumers with health insurance as a result of the reform bill that Congress passed last year. Aging populations and an emerging global middle class will strain resources that include energy, food and water, Hutchins added. This will create “massive opportunities in investing in the efficiency and conservation of those resources,” he said.
Technology will remain another staple for investment. Mobile technology “is the largest information technology trend of our lifetimes,” said Hutchins, and the combination of wireless broadband and video will lead to a “vast explosion” in the demand for new products. He pointed to the Apple iPad, which enjoyed the fastest-selling consumer-electronics launch on record.
Hutchins compared the prospects for mobile technology to the rapid growth of personal computers, which arrived some 25 years ago. More than one billion PCs are now in use around the world, he noted. Meanwhile, the worldwide market for mobile phones and other hand-held devices is already five billion-strong and growing. As the makers of hardware and software for all the “gadgets and gizmos” that run on ever-expanding mobile networks innovate further, he added, investment opportunities will naturally follow.