A cautious outlook for growth

Financial market returns over the next five years are expected to be “modestly below long-term historical averages”, according to the predictions set out in a five-year outlook Capital Market Assumptions (CMA) report published by Northern Trust Asset Management (NTAM) in August 2022 for 2023.

Growth, inflation, and monetary policy are the core themes for the CMA’s forward-looking, historically aware approach to understanding the historical relationships between asset classes and the drivers of those asset class returns. In an exclusive interview with Asia Asset Management NTAM’s Chief Investment Strategist APAC & EMEA Wouter Sturkenboom explains why he remains cautious on growth and considers how relationships between asset classes may evolve over the long-term and shorter term. 

“We think it’s important to differentiate between average and terminal economic growth. Average growth rates are expected to decline, but have nonetheless been flattered by the tail end of Covid-related fiscal stimulus. Our expectations for terminal, or equilibrium, growth rates have also been lowered due to a combination of structural headwinds from demographics and debt levels, as well as the cyclical headwind from an increased focus on various forms of security (physical, energy, technological),” he observes.

Slow growth transitions

Expanding on the security issue he points to the energy security argument, which has gained power since Russia’s invasion of Ukraine. And while he predicts significant investment in renewables, particularly in Europe and Asia, and to some extent in the US following completion of the Manchin deal, it is likely to be a slow growth transition given the cost of giving up on relatively cheap and efficient fossil fuels and the process of creating a new energy system. 

Within the context of growth, Sturkenboom also highlights an increased need for supply chain resiliency, escalated by the Covid-19 pandemic. He sees companies exercising the need for diversification and redundancy strategies “around maintaining larger inventory levels and ensuring they have multiple sources of supply they can tap into when needed”, within an investment environment that is moving from globalisation to regionalisation.

Closely related and high on the agenda are technological security – focused on how certain regions are unwilling to depend on other regions, most notably the US and Asia for “crucial technological inputs into the future engines of economic growth” – and physical security. 

Sturkenboom also admits caution in relation to the China market, citing the hampering of the country’s structural growth engines caused most notably by zero-Covid regulations, creating a challenging demographic environment for debt dynamics and the property sector. 

Inflation recalibration

“The triangle between growth, inflation and monetary policy is very important, but on the inflation front we are a bit more optimistic,” notes Sturkenboom, on the assumption that central banks in the US, the UK and Europe will be largely successful in bringing inflation down over the next five years.

“With the focus on inflation and cash rates being so much higher, we are seeing a lot less negative yielding debt. The impact of monetary policy on risk taking is shifting, with support resulting in higher discount rates, and lower profitability outlook, especially in long-duration equities, such as tech companies. From a risk appetite perspective this is creating a headwind, and we are recognising this in our equity market forecast. The challenge that we all face is how to assess incoming information on the inflation front and tally that back to central bank policy forecasts at a time when the markets are so sensitive,” Sturkenboom observes. 

Year ahead

With the long-term trends clear, Sturkenboom’s investment strategy for EMEA and APAC for the year ahead remains cautious, particularly across the APAC region. He notes that tactical allocation is roughly in alignment with NTAM’s 2023 view, with China’s zero-Covid policy and property sector woes defining strategy.

“There is a rising long-term concern that what the Congress in China revealed around a more statist government’s policy is going to be another headwind for structural economic growth,” he explains.

That said, he also notes the need to take note of policymakers in China, and the continuous incremental steps being made to support sectors and parts of the economy to prevent an uncontrolled economic slowdown. And whilst Sturkenboom and his colleagues have judged those steps to be insufficient in terms of changing the overall trajectory, they may result in a less severe slowdown.

“We need to be respectful of this dynamic, as well as the structural rather than tactical headwind. However, the strong dollar environment of the past year, and the fact that it’s now starting to reverse a little bit because of an improving inflation outlook, translates to a slightly more cautious path for the Fed, and more importantly to a lower risk of over-tightening by the Fed, and therefore to a lower risk of global recession. We’re looking at both these trends quite carefully now to assess our underweight position. We are still underweight, but if we change our view, and we believe that the Chinese government is in fact acting more forcefully, and/or the dollar environment has really shifted on a 12-month horizon, then we will also reassess our underweight position and we will close at least some of that.”