Market analysts and economists will be the first to tell you that trying to predict the markets is a fool’s game. But what they are able to do is identify economic trends that fund managers should be considering when deciding where to allocate investors’ money.
At a recent media conference in London hosted by global investment house Schroders, Charles Prideaux, the company’s global head of product and solutions, said that the next 10 years would look very different from the past 10 years: a number of economic drivers and disruptive forces would reshape the investment landscape. These are discussed in a recent essay by Prideaux and Keith Wade, chief economist, global economics, at Schroders, titled Inescapable investment ‘truths’ for the decade ahead.
Since the global financial crisis a decade ago, developed markets have seen a slowdown in growth and reduced productivity. China has bucked this trend, but it, too, is expected to slow. While Prideaux and Wade expect global productivity gradually to revert to pre-crisis levels, they expect labour-force growth to slow down over the next decade across all major economies and regions. Emerging markets outside China, however, “may offer greater productivity gains for the foreseeable future than their developed-market counterparts”.
Against this weakening of the supply side of the economic equation, there will be increased demand - from an ageing population. As the proportion of pensioners in a population increases, so does pressure on governments and the workforce to provide for them. “It’s a thumbscrew that isn’t going to go away,” Prideaux says.
“These factors combine to give an outlook of relatively slow GDP growth for the world economy,” Prideaux and Wade say. “Emerging markets will continue to increase their share of global GDP, largely because of the higher productivity growth associated with economies at an earlier stage of development.”
Prideaux and Wade point out that productivity growth is a more beneficial for equity markets than GDP growth. “If productivity growth improves, it should support better corporate earnings and equity returns,” they say.
Inflation over the next decade “will depend on how supply in the world economy grows relative to demand. All things being equal, a weaker supply side should mean more capacity constraints and hence higher inflation”.
However, inflation is likely to be constrained by global debt: in the years since the crisis there has been an explosion in government and corporate debt, with companies taking advantage of the abnormally low interest rates. Prideaux and Wade say other constraints on inflation are the effect of international competition on prices and wages, and the deflationary impact of disruptive new technology.
Interest rates will probably remain low for the foreseeable future, they say. “They will be higher than today’s exceptionally low levels, but are still likely to be relatively low by the standards of pre-crisis levels. Recent comments from policymakers suggest the equilibrium level for the US and UK is around 0.5% in real (after-inflation) terms.”
Prideaux reminded journalists at the conference that over the long term, low rates were the norm. Although it dominated many people’s lives, the period of high interest rates, from the 1980s until 2008, was, in fact, a deviation from the norm.
Prideaux and Wade say some “very powerful crosswinds” are likely to disrupt markets. These include:
* The end of quantitative easing. The “sugar rush” of liquidity provided by central banks in the wake of the global financial crisis is coming to an end. “The $15.7trillion punch bowl on state asset sheets is being withdrawn,” says Prideaux. While the normalisation process is welcome, it will put pressure on financial markets.
* Regulation of the financial sector. Tighter regulation of banks may result in companies beginning to look for alternative sources of funding, which may include private equity.
* Banking-sector market disruption. With more constraints on banks, “non-banks” such as asset managers are taking over banking functions. Banks’ retail functions are being threatened by tech-centred start-ups.
* Technological disruption. While rapid technological progress and the rise of automation may boost productivity, it will also cause the loss of jobs. “Are societies able to upskill people at the required rate to keep up with advances?” Prideaux asked. He cited the three million long-distance truck drivers in the US whose jobs are at risk with the advent of driverless trucks.
* Environmental issues. Doing the right thing to protect the environment is no longer altruistic; it is now an obligation, Prideaux says, and the underlying demand from consumers is going to increase. Sustainability is now an investment risk.
* Politics. Political risk is returning as governments come under financial pressure and societal pressures. There has been little progress in improving global living standards and the inequality gap has widened.
So where does this leave investors?
Prideaux says investors should expect lower returns almost everywhere, except possibly in emerging markets. There is a worry, he says, that investors are still expecting the high returns they have been used to.
Financial market volatility is expected to increase and persist. In this volatile, low-growth environment, active investment management has an important role, Prideaux says, and active managers will score by focusing on the micro-economic picture, picking out companies that will withstand or capitalise on the disruptive forces. Their investment processes will need to be strong to navigate the volatility.
“We can expect greater divergence in performance across asset classes and within markets. While financial markets may offer more subdued returns and become more volatile, the scope for alpha generation (beating the market through investment skill) and diversification should remain significant. Being aware of these trends is important and highlights the advantages which active asset management can provide to investors,” Prideaux and Wade say.
Martin Hesse was a guest of Schroders at its recent International Media Conference 2018 in London.