The current global political and economic environment offers plenty of opportunities and poses many challenges for investors. Here are four of the big ones.
THE BIG PICTURE: LONG TERM STRUCTURAL CHANGE
Most economic and market commentary focuses on relatively short-term questions — the next rate hike, the latest employment figures or how China will manage its currency over the next 6 months.
As a result, longer-term structural changes are often ignored, despite the fact that they may have important implications for long-term investors. Three areas of structural change that merit greater attention from investors are climate change, demographic trends and technological developments.
Climate change remains an important issue, both as a physical risk to real assets and as a policy risk to a wide range of carbon-sensitive assets.
There is clearly some uncertainty around the future direction of US climate change policy under President Trump but it remains an issue of global importance, and investors should review how their portfolios are exposed to carbon-intensive assets and how they may be affected by policy developments like carbon pricing or a carbon tax.
Demographic trends and technological advances are two of the key drivers of long-term economic growth, affecting the size of the working age population and the rate of productivity growth.
The overriding demographic trend is global aging. Fertility rates have fallen across much of the world and advances in health care have led to increased longevity. As a result, there will be fewer workers to support more people as the ratio of the “dependent population” – children and retirees – to the working age population rises.
Technological disruption meanwhile promises a fundamental change to the way people live and work and is likely to transform labour markets over coming years.
If 2016 reminded us of anything, it’s that forecasting – and especially political forecasting – is challenging. With very few pollsters or commentators having accurately predicted the outcome of either the EU referendum in the UK or the US election, it would be wise to keep an open mind in relation to elections taking place in the Netherlands, France and Germany in 2017.
Growing nationalism, fragmentation and what some have dubbed “the death of liberal politics” are likely to remain prominent influences on the political landscape for some time. Indeed, it may be that large parts of the developed world are undergoing a political regime shift on a similar scale to the one ushered in by Margaret Thatcher and Ronald Reagan in the early 1980s.
While populism and nationalism have been on the rise for some time across Europe, elections in France and Germany in 2017 have the potential to ignite a crisis within the Eurozone, given their size and importance to the European project.
Marine Le Pen, leader of the National Front, has already stated that as President she would seek to take France out of the Euro and hold a referendum on France’s membership of the EU.
In Germany, the AfD (Alternative for Germany) has been extremely critical of the Eurozone bailouts and has suggested that it would hold a referendum on German membership of the single currency.
The potential implications of political fragmentation are far from obvious, not least because there remain many uncertainties around the economic policies that will be pursued by US President Trump.
SHIFTING ECONOMIC POLICIES
We may have witnessed the high point of central bank influence on national economies – essentially by managing interest rates and increasing money supply (known as monetary easing) – with a growing concern over the limitations and unintended consequences of monetary policy.
“Monetary easing” has been the primary policy adopted by central banks and governments around the world to try and stimulate their economies since the 2009 Global Financial Crisis. But with increasing calls for more “fiscal stimulus” – boosting economic activity with increased government spending and tax cuts – central banks may not have as much influence on the value and fluctuations of global stocks, bonds and the currency values.
Japan – the world’s third largest economy – has already taken some tentative steps toward fiscal stimulus, committing to billions of dollars in additional government spending over three years. And US President Trump is widely expected to implement fiscal expansion with a combination of tax cuts and infrastructure spending.
The speed and size of any shift from monetary easing to fiscal stimulus could have important implications for investors in the years ahead.
BE PREPARED FOR LOWER RETURNS
The sustained period of monetary easing by central banks — now entering its ninth year — has created a challenging environment for investors. With real bond yields below zero in much of the developed world and most asset classes looking expensive, generating annual returns as high as 3%-4% will be difficult over the next 3-5 years. The exceptional returns of the past eight years will not be repeated.
Investors with portfolios dominated by equities, credit and government bonds need to prepare for lower returns or consider less familiar asset classes and more flexible strategies in order to deliver on their return objectives in coming years. Investors should place a greater emphasis on diversification.
KNOWLEDGE IS POWER
When several major influences like these create an environment that can pull your investment portfolio in different directions, it becomes more important than ever to be informed and confident about your strategy.
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