What you need to know about the global econ­omy

Emerg­ing mar­kets tipped to con­tinue in­creas­ing GDP share

Saturday Star - - P E R S O N A L F I N A N C E - MARTIN HESSE | [email protected]

AS AN in­vestor, it pays to fil­ter out the noise, which may lure you into mak­ing hasty de­ci­sions, while keep­ing an eye on the broader in­vest­ment hori­zon, which may help in your fi­nan­cial plan­ning.

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.

ECO­NOMIC DRIVERS

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.

DIS­RUP­TIVE FORCES

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 $15.7 tril­lion 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.

While rapid tech­no­log­i­cal progress and the rise of au­to­ma­tion may boost pro­duc­tiv­ity, it will also cause the loss of jobs. “Are so­ci­eties able

Tech­no­log­i­cal dis­rup­tion.

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.

◆ 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.

◆ 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.

En­vi­ron­men­tal is­sues.

Pol­i­tics. 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 mi­croe­co­nomic 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.

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