Market Perspectives: Five-Year Outlook

Power to the people (20% probability)

5-year-outlook-power-to-people-header

Global Investment Forum: Five-Year Outlook

Power to the People is our downside scenario, in which we consider the negative outcome when monetary and fiscal policies’ failures fan the burning embers of an already disaffected and alienated population across global markets.

We are giving this scenario a probability of 20% as several of the events on which it is predicated are scheduled to occur. What we are unable to predict is which event will be the catalyst.

In this scenario, there is a sense of our vulnerability to the increasingly unpredictable outcome of human sentiment, with polls becoming less reliable, the significant global penetration of social media and shifting patterns of demographics.

Given the shock waves following the result of the UK’s referendum on EU membership and Trump’s victory in the race for the White House, there is a heightened awareness of the need to give serious consideration to the risk of seemingly unexpected outcomes.

Growth stalls

5-year-outlook-growth-in-non-farm-labor5-year-outlook-growth-in-working-age-populationOne of the events that would lead to a populist backlash is the possibility that current low levels of U.S. growth falters, with productivity maintaining the current downward trend, aggravated
by the falling levels of the working-age population. We anticipate that this stall in productivity would trigger a U.S. recession.

Probabilities of recession from multivariate regression model (%)

Similarly, in Europe, as we’ve mentioned previously, the reality of not being a single country or federation is creating a politically fragmented and volatile environment that is not conducive for growth. We can see that higher policy uncertainty harms consumer spending and leads firms to scale back their investment plans.

Eurozone: Policy uncertainty, consumer spending and investment


Dropping the baton

Elsewhere, we’ve looked at the prospective shift between existing monetary policies, implemented by central banks with varying degrees of success, and the move towards governments’ increasing fiscal stimulus.

In this scenario, in response to the global stalling of growth we anticipate that there will be several knee-jerk reactions, including the continued application of the negative interest rate policy. This will eventually create a populist backlash against the lack of economic growth, persistent un- and under-employment of the labor force aggravated by increasing cost-saving automation, and impoverishment of savers. In response, where governments do move to implement fiscal stimulus, what they do is too little, too late.

Current swap rates, %


Populism x Population stagnation x Protectionism = a globally explosive chain reaction

Populist politics are widespread in their impact. In Europe, this scenario predicts a Brexit-contagion effect as other countries push for votes to leave and begin to pull out of the European Union.

In the U.S., the disruption and volatility caused by the vitriolic Trump versus Clinton election campaign has long-term implications for the implementation of new policies and an increased requirement of politicians (of both parties) to accommodate the demands and views of marginal voters. Although it remains to be seen how Trump’s campaign rhetoric translates into actual policy.

The continued problems in the Middle East are a source of concern to governments. As political and economic refugees continue to flood into the European Union, the migrant crisis is also causing further pressure on the EU’s open borders policy, making it a bone of contention between increasingly protectionist voting factions. Also, there is the threat of deteriorating national relationships given the large number of countries with vested interests in the area including Russia and the U.S. Elsewhere, in Asia, warfare also remains a tension as relationships between China and the U.S. flare-up in the South China Sea.

In manufacturing economies and emerging markets, growing protectionism delays global trade agreements and increases tariffs, just as some emerging markets are coming out of long periods of recession.

Seeking opportunities

In these deflating conditions, we would anticipate that equities would go into a tail spin although the outlook would be more positive for bonds.

Rates will not have had sufficient time to rise from current low levels before the potential downturn anticipated in this scenario. Therefore, central banks will be constrained to drop rates further unless they move to the negative interest rate policy. It is likely that investors would chase gold in this scenario, moving to a physical asset in preference to receiving no or negative interest. Other yield generating assets, such as income equities and property, have the potential to outperform the market on a relative basis.

The upshot of this extreme reaction is uncertainty. This, in turn, leads to investors saving more and investing less, which stalls economies further.

 

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Slow and steady wins the race (70% probability)
‘Slow and steady wins the race,” which focuses on the prospect of continued marginal incremental improvements in global economic growth.

 

All pulling together (10% probability)
‘All pulling together,’ in which human nature triumphs and centralized policies are successful, stimulating global growth.

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