Wednesday, October 16, 2019

Investment Insights

Six themes to guide investors the next five years

Trade conflicts, slow growth and politics among the most likely to rattle markets

By Jim McDonald/
Northern Trust 

Recent strong risk asset returns, paired with sharply lower global interest rates, represent an atypical investing environment. Investors have been working through a mash-up of slowing growth, muted inflation and easier monetary/regulatory policy — all wrapped in rising political uncertainty and on-again/off-again trade tensions. Against this backdrop, six key themes have emerged for our five-year outlook

#1 Global Growth Restructuring

The global economy must evolve as political and technological developments spur the world to step back from a more optimal framework for global trade.

What this means for investors: Slow economic growth and the risk of recession will accompany this restructuring, although eventually the global economy will emerge stronger and better suited to this new world. Growth is likely to be slower over the next five years than the past five years (Exhibit 1). Market volatility is likely to increase in response to negative economic data. Investors should prepare for equity returns below long-term historical averages.

Click image to enlarge chart.

#2 Irreconcilable Differences

Conflict between the U.S. and China — a focal point of Global Growth Restructuring — will produce a cascade of political, economic and market changes.

What this means for investors: As the two countries zigzag between economic armistice and war, never achieving peace, market volatility is likely to spike. Investors need to be aware of whether other countries align with the U.S. or with China.

For more on investment themes, download the full paper.

#3 Stuckflation 4.0

Muted growth in global demand and timid policy responses suggest Stuckflation — now a theme for four consecutive years — is here to stay. Most major central banks continue to miss their 2% inflation targets (Exhibit 2).

What this means for investors: Low interest rates and flat yield curves will continue to make it difficult to find investments with attractive yields. We anticipate that disappointment with inflation rates will eventually lead to a coordinated policy response.

Click image to enlarge chart.

#4 Executive Power Play

Populist leaders are grabbing political power in exchange for pro-growth policies that have supported the long-running equity bull market. Looking ahead, leaders are at risk of overplaying their hands.

What this means for investors: Voter enthusiasm for these leaders may decline once economic growth slows, and investors should be ready for market volatility. Truly strong leaders will balance the populist movement with sensible economic policy. The risk is that they don’t devote enough energy to good economic policy.

#5 Monetary Makeover

The persistently low inflation that accompanies Stuckflation has stripped central bankers of their purpose.

What this means for investors: Central banks will reluctantly take unprecedented moves. Still, investors can’t look to central banks to boost inflation and global economic demand. This task is the responsibility of fiscal and broader economic policy — controlled by politicians. As a result, economies and investors may be more vulnerable to political developments.

#6 Staking Out Climate Risk

The impact of climate risk regulation will build slowly and sporadically as the world tries to reconcile growing carbon emissions with Paris Agreement commitments.

What this means for investors: Investment categories with direct exposure to transition risk — created by higher fuel standards, updated building codes, and clean energy and other requirements — require special attention. However, these risks will vary greatly by country, and transition risk can be reversed when confronted by political backlash. In some cases, this already has happened. Investors should consider industry risk on a country-specific basis.

Sound Like Fun?

So low growth, low yields and political volatility. It might not sound like fun to be an investor over the next five years. But we always confront uncertainty even in the best of times. As we see it now, positive breakthrough prospects are evenly matched with dire scenarios. Our outlook falls in between, which should result in decent risk asset performance and subdued fixed income returns during the next five years.

Learn More from Jim McDonald

Watch the replay of the webinar The Next 5 Years: What Investors Can Expect, featuring Jim and Chief Investment Officer Bob Browne, CFA.

The views expressed herein do not constitute research, investment advice or trade recommendations, do not necessarily represent the views of Northern Trust or TEXPERS, and are subject to revision over time. 

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