Despite powerful new initiatives by policymakers and central banks, the world’s economy remains driven by problems and a continuing slow expansion.
If central banks and the world’s leading policymakers are in a state of befuddlement, lost in unfamiliar terrain with an old map and a broken compass, then what are investors, savers, and money managers to conclude? Maybe it’s time to sight in a new compass.
Anyone taking a hike through backcountry—terrain without good sightlines—wouldn’t think of going without a compass and an accurate map. The same would apply to portfolio strategy.
Just why are the old maps obsolete for the current landscape? The topology has changed, as have the magnetic forces. This partly explains the incredible popularity of the recent book by Thomas Piketty (“Capital in the Twenty-first Century”).
In short, imbalanced wealth distribution and the ongoing impact of the historical global financial crisis are playing a role.
There are additional factors:
1. Aging societies and, concurrently, post-familialism. Put simply from an economic perspective, lower population growth as well as an aging demographic means slowing economic growth.
2. China-post phenomenon. The worldwide economic impact and demand shock of China’s high growth over the last three decades is epic. It was a growth-charging development that cannot be repeated. Consider just this one fact: Just what nation in the world today representing one-fifth or more of the world’s population can pull off a home ownership miracle from 0 percent to 65 percent of households in less than a quarter century? This will never happen again. As such, a hangover period can be expected to continue yet for some time.
3. A dearth of productivity growth. A major contributor to rising living standards is productivity growth. It has slowed steadily since the peak levels recorded in the 1960s.
4. Europe. While some may be discussing how Europe has been successfully saved, the reality is that Europe’s problems are far from over. Its woes consist of three separate problems that need to be dealt with: 1) a liquidity crisis; 2) insolvency; 3) internal demand imbalances. The European Central Bank may well have addressed the short-term liquidity issues, but the other problems are deep-rooted and remain unaddressed. We therefore must expect further world-impacting dislocations from Europe.
The serendipitous trends and growth drivers of the post-WWII era are behind us. The defining new characteristics of the current environment will also remain with us for some time.
Looking to a global map, we note an additional mix of uncertainties. There is a maelstrom of potentially challenging developments in the geopolitical arena, when compared with the relatively contained post-war period. How does it all fit together?
Nobody is quite sure, and few developments here have received high profile in the popular media. However, indisputably, recent developments are momentous.
China and Japan are new active players in the geopolitical sphere. China is pushing its influence across the South China Sea. Japan is again ramping up in its military expenditures. The Middle East is as fractious as ever. Catalysts and sudden shifts in this sphere could be sudden, as already shown by the shockingly rapid advance of ISIS (Islamic State of Iraq and Syria). Instabilities in the Ukraine continue.
What next? Will oil prices continue to climb? These are all part of the unknowns that must be factored into portfolio policies.
Reorienting to the New Map
Investment returns to date this year have been surprisingly robust. The actions of central banks around the world have continued to assuage investors. However, we must orient ourselves to the new map and sight in our adjusted compass.
For now, the pendulum is swinging back to austerity policies and a reduction in monetary easing. Nevertheless, due to slow economic growth, interest rates are likely to stay low and could very well fall further in years ahead.
Given a lower “natural real rate” near zero, we expect financial market returns to remain positive, though modest, over the foreseeable future. Volatility could also be expected to stay lower than historically has been the case. Without a doubt, markets will experience fluctuations.
Globally, demand for quality income assets is expected to stay elevated. We continue to favor a balanced approach with an emphasis on income generation.