Global Investment Forum: Five-Year Outlook
For our base case scenario, we believe that, although the global recovery remains subdued, the benefits of a slow and steady strategy will enable the U.S. to avoid a recession and that the rest of the world will remain stable and achieve modest levels of growth.
Alongside achieving slow and low growth in the U.S. and Europe (without stalling), we have hopes for stronger global growth in emerging markets, which have struggled in recent years with the collapse of the oil price and other commodity markets. As countries like China and India become bigger global growth engines, stronger output in these economies will power the global recovery forward. This is anticipated to drive a third of the expected recovery over the coming years, while the end of recessions in emerging markets such as Brazil and Russia should also lift growth.
A full worldwide recovery will, however, be challenged by diminishing volumes of global trade as reflected by the slowing in productivity and an increase in protectionism, although closed markets such as India and those with selective trading partners appear to be faring better than more open markets.
Handing over the policy baton
In our twist to the old story of the Tortoise and the Hare, as the Hare was sleeping, there is a switch of runners as the exhausted Monetary Policy Tortoise hands the baton over to a fresher Tortoise wearing the Fiscal Policy team colors.
As we outlined earlier, we believe that monetary policy has been increasingly running out of ways to ease deflationary pressure and reflate assets. Low or negative interest rates have been described as a dire financial tool, but better than the others available, although, in practice, their effect has been limited. The theory—that interest rates below zero should reduce borrowing costs for companies and households thereby driving demand for loans—has proven somewhat successful in Europe, which has remained resilient in the face of the Brexit shock. However, central banks, in trying to prevent the risk of deflation, can’t seem to kick-start growth. Since the European Central Bank (ECB) and Bank of Japan (BoJ) cut rates into negative territory and drove long end yields much lower through aggressive quantitative easing, monetary policy has started to have adverse impacts on certain parts of the economy – the financial and insurance sectors in particular. More broadly, negative interest rates appear to have caused many consumers to restrain spending and to increase their savings rate, as low or negative interest rates cause their savings for retirement to be lower. This is exactly the opposite effect that central bankers were looking to initiate.
There is a growing sense that more initiatives are needed to stimulate productivity and that fiscal policies will be able to deliver the step-change that is required. Although in Japan, government spending measures have lowered the probability of recession, the possibility of deflation has increased, partly due to the recent appreciation of the yen.
In Canada, with the benchmark interest rate currently at 50 basis points, Senior Deputy Governor Carolyn Wilkins has noted that monetary policy in Canada remains quite stimulative, although less so than it would have been a decade ago when the base rate was higher.1
The evolving role of central banks
In the ‘Slow and Steady’ scenario, we also consider that central banks and governments will become increasingly aligned, and a new paradigm may be emerging as we make the shift from a sole focus on monetary policy to a mix that includes fiscal policy initiatives. With central banks becoming more closely linked to fiscal expansion, some commentators are asking whether central banks have taken on too many responsibilities. Their impact is significant as can be seen when a small shift in base rates results in very marginally effective stimulus. Consequently, there remains scope for slightly more aggressive tightening of rates from the Federal Reserve to stimulate productivity—the equivalent of offering a subsidy to banks.
Low return world
We remain broadly positive on equities, but in line with the generally slow tempo of this scenario, we are predicting a continued period of lower returns as the prospect of increasing fiscal policies creates a business unfriendly environment (with pressure on labor to be paid more at the cost of margins). This is better than the outlook for bonds, which, we believe, will continue to deliver modest total returns due to generationally low interest rates, although equities’ growth may prove better able to deliver dividends as an income substitute.
We are also predicting an increasing bifurcation between manufacturing economies versus consumer economies, altering previous assumptions of emerging versus developed markets, with our scenario favoring the commodity importers over exporters. This, in turn, is also reflected in our belief in the strength of the U.S. dollar over other currencies.
Elsewhere, in this scenario, the benefits of automation versus the disruption effect of new technologies are netted out and not felt to be performance enhancing overall.
In our fable, the influence of the other animals plays an important role as it is their vociferous involvement that helps drive Team Tortoise on to achieve the goal.
We have seen, through the rise of extreme political parties and unexpected voting results, that a sizeable portion of the populations in the U.S. and across Europe are signaling a need for change, almost regardless of a real understanding of the implications. These results are reflecting a disenfranchised and marginalized population—the so-called ‘inequality theme,’ The realities of a sluggish economy are that businesses make less profits, which translates to weaker pay growth and lower living standards. This, in turn, spirals into a growing interest in protectionism and support for the scrapping of trade deals and the imposing of tariffs, ultimately impacting international trade.
However, in our fable, it was the cheering of the wider population that woke the sleeping Hare. Similarly, we believe it will be the increasing influence and passion of the population and individual voters that pushes governments to take the steps to effect changes manifested through fiscal stimulus, while on the flip side contributing to uncertainty and volatility.
We believe that the increasingly aligned actions of governments and central banks would include tax reforms and large-scale investment in economic and social infrastructure projects including transport, utilities and energy.
However, in the ‘Slow and Steady’ scenario (in marked contrast to the ‘Power to the People’ scenario), we believe that the long-term impact of the rise of populism is relatively limited. We believe that the positive response of policy makers (both central banks and governments) will generate appropriate remedial incentives to address the root causes of concern. Importantly though, it remains the most unpredictable and volatile of the various dynamics that we discussed.
1 Source: Bank of Canada, Data and Statistics office. Average base interest rate for 2005: 2.92% and for 2006 4.3% (Jan – Dec).
Power to the people (20% probability)
‘Power to the people,’ reflecting the negative implications of populism and associated ramifications.
All pulling together (10% probability)
‘All pulling together,’ in which human nature triumphs and centralized policies are successful, stimulating global growth.