By Ginger Szala, ThinkAdvisor
In today’s constantly recalibrated world, a five-year investment horizon might seem too long a view. But not to Northern Trust’s Executive Vice President and Chief Investment Strategist Jim McDonald, who delved deeper into the bank’s recently released five-year economic outlook, noting that although these findings will be more targeted this year and next, the big picture provides investing context, especially post-pandemic.
Northern Trust, which holds $15.7 trillion in custody/administration and $1.5 trillion in assets under management, updates its outlook annually. This one covers some ground visited by last year’s report, although it notes that the post-pandemic global economy will take a different shape, largely due to the virus’ lingering effects.
For example, interest rates will remain low, central banks will remain accommodative, inflation will be 2% or less, technology continues to expand its footprint and the climate change impact and sustainable investing appetite will continue to grow.
Investment wise, equities continue to be where to invest, but they won’t see the double-digit returns we’ve seen in last five years, the bank states in its report. However, long-term credit, real estate, natural resources and private equity will be healthy return diversifiers.
But hurdles are on the horizon, such as a global graying workforce, China/West confrontations, especially when it comes to natural resources, and how the slowing growth of global population has impacts on several factors.
Here are 10 areas McDonald highlighted in his conversation with ThinkAdvisor:
1. A return to mediocrity
Don’t expect double-digit investment returns going forward, he says. Although economies are recovering from the pandemic, “we have some significant long-term constraints on growth.”
The bank projects annualized real growth of 2.9%, with the United States at 2.1%, Europe at 2%, Australia at 2.4% and China at 4% growth over the next five years. This slowed growth is due to several constraints, McDonald says.
“First, population growth is slowing worldwide and the change in the working-age population alongside productivity are two big drivers for growth,” he explained. “Secondly, all of the debt that’s been issued in response to the pandemic is going to slow future growth.”
U.S. equities should end 2021 up around 4.7%, but going forward, it will be closer to 4.3% annualized over five years. Global equity markets will be around 4.6% annualized over a five-year period, although the United Kingdom is forecasted at 6.2% “as it finds its post-Brexit bearings,” the report notes.
The bank doesn’t point out the pandemic separately, but as McDonald said, “we debated [that], but decided that it actually impacts many different parts of the forecast. … On the inflation outlook, it is raising prices short-term, but the increased implementation of technology during the pandemic will be disinflationary long term.”
2. A hybrid work approach is a competitive edge
“Companies will end up continuing with hybrid work models because their employees are demanding it, and we’re now in an environment where employees have the upper hand,” he says. Many companies are in a hybrid mode, he adds, because they believe the flexibility “is a competitive advantage.”
3. Reduction of global workforces impacts growth
The global graying of the workforce means it is shrinking. Australia’s healthier growth is largely due to its increasing population, where U.S. population growth projected over the next five years is 0.6% while Europe and China will be at 0.2%.
“And changes in population growth numbers happen extremely slowly,” he says. “So China making changes to its one-child policy is unlikely to measurably change the overall ratios, especially when it takes at least 18 years to get [people] into the workforce.”
In fact, “the only real variable is immigration, and that’s an area that the U.S. has underperformed prior growth because of increased focus on limiting immigration over the last several years,” he said. “In [this] political climate it [isn’t] being embraced, even though it would be a positive to the economy.”
4. Central banks will remain accommodative
No longer the simple lenders of last resort, central banks now “work in unison with fiscal policy, funding the latter’s stimulus and keeping borrowing costs low.”
And though they see the Fed remaining accommodative, “we are in the eye of the storm right now,” McDonald says. “The [recent] inflation numbers are way higher than anybody had expected and it isn’t as much due to easy central bank policy as it is to supply disruptions from the pandemic. But we do expect the rate of inflation to moderate.”
In this “benign” inflationary environment, there will be demand for long-dated fixed income. The 10-year treasury will be around 1.5% and 2% over the next five years, and “in of itself will constrain how far the Federal Reserve can go because they don’t want to invert the yield curve.”
5. Expect central banks to push monetary activism
As Northern Trust states, “central banks have realized that the funding they provide can be leveraged to target systemic risks to growth and inflation such as climate change and income equality.”
“What this means is they’re going to be looking at things beyond just their traditional metrics,” McDonald says. “And we think that will lead to easier policy than they would have otherwise implemented.”
6. Technology is the new oil
Like with crude oil, technology has geopolitical risk. The China/West fight over technology independence, Northern Trust states, is causing supply chain disruptions, such as for the automobile industry, where the West faces semiconductor chip shortages due to China constraining supply. But there is another effect.
“Technology’s clearly a driver of lower inflation because [it] is leading to continued automation,” McDonald said. It is disinflationary allowing the economy to grow through some constraints. For example, one client who owns a group of restaurants used to have 20 staff per restaurant. With the pandemic and labor shortage, they managed to use technology to reduce that number to 12, “and the servers are happier because they’re making more money.”
How does that affect employment long term? He says that the “continued technology impact holding back job growth keeps inflation down and keeps the growth rate in the economy down and extends how long this expansion is going to [continue].”
7. Blockchain, not Bitcoin
How will digital currencies pan out in next five years? “Blockchain is really what is going to make an impact on economy versus the digital economy,” McDonald says. “Blockchain by itself is another disinflationary force, just like automation is because what it allows is financial institutions to automate a significant amount of their paperwork and back office,” which is “bad news” for employees in that their jobs will get automated.
8. Real assets, alternatives and commodities offer diversity
Real estate still holds promise going forward, with a projected five-year annualized outlook of 5.1%. “We find that actually very comparable to what we see for the developed equity markets,” he says. “It’s better than equities and it’s a different asset class. It is really driven by what happens with interest rates and credit spreads, and is an inflationary hedge.”
Natural resources and commodities the bank sees as coming in at an annualized 5%, and McDonald says they believe energy and mining metals are the strongest. However, he says, “we believe strongly that the way to get exposure there is through stocks, the equities of the natural resource producers,” and a basket of this group would be recommended.
Private equity, projected to grow at an annualized 7.6% rate, and private credit, projected at 6.0%, also are good diversifiers, although they may be difficult to access. However, McDonald cautions on hedge funds and even private equity: “you may not want to invest in a fund that will let you in because the really good funds are nearly impossible to get into because demand is so high.”
9. Climate change has reached a tipping point
As the report states, “a consensus is emerging on the importance of climate change — increasingly market-driven.” McDonald says the uncertainty is the magnitude of its impact, “but I can tell you definitively that the amount of client focus on understanding climate change on what they own, and how they invest … is only expanding.”
10. Count on taxes going higher
McDonald says taxes definitely will go up and “we’ve built some margin compression into our equity forecasts because of higher taxes.” Northern Trust is projecting the U.S. corporate tax rate to be anywhere between 25% and 26.5%, “and that’s about a 5% reduction to S&P 500 earnings, so we actually think that’s very manageable.”
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