A ten-year view
Northern Trust recently published its macroeconomic prognosis and expected performance from the various asset classes over the next ten years in the 2024 edition of its Capital Market Assumptions Outlook.
Wouter Sturkenboom, Northern Trust Asset Management’s chief investment strategist for Europe, Middle East and Africa, and Asia Pacific, discusses the predictions and his general insights for the decade ahead with Asia Asset Management.
On growth restraints and geopolitical cleavages
Sturkenboom defines four restraints on growth, two of them which are roughly consensus market views and the other two more intrinsic to Northern Trust’s own analysis.
The first two are “debt dynamics and demographics… really all about the fact that we’re ageing, that we’ve got relatively high debt levels, and those debts need to be financed at higher interest rates”.
The other two are green transition and regionalisation. The green transition is both obvious and, in Northern Trust’s view, necessary, while the regionalisation of global economies and supply chains is a response to current geopolitical tensions as well as an after-effect of the Covid-19 pandemic. These constraints, according to Sturkenboom, have investment costs associated with them in creating newer and greener facilities, or transitioning from a globalised to more regional supply chain.
He likens this investment to “fixing a leaking roof” – performing essential maintenance to prevent deterioration, which also, however, carries costs.
Such upfront costs will continue to hold back growth, particularly where climate change moderation involves replacing a “pretty efficient system that works rather well, had it not been for the externalities associated with that system”, and a similar challenge with deglobalising supply chains.
Furthermore, the different constraints ramify and reinforce each other. For example, regionalisation is being driven by security concerns, but the energy security aspects of these are pushing further support for green transition. All this tends to promote inflation and rein back growth.
On inflation expectations and central bank policies
Factoring into these longer-term trends, Sturkenboom says, are rising inflation as well as central bank rate hikes and the end of cheap money policies. They “are both growth restraints, but also inflationary in their underlying dynamics”, he adds. Moreover, demographics “shrinks the labour force and over time will become an inflationary force”.
On top of this, regionalisation and the green transition are inflationary given the high initial costs. Long term, the green transition may well lower energy costs to near zero, but that prospect is outside Northern Trust’s ten-year forecast horizon.
For now, investors have to decide if they believe “whether or not central banks will push back against those long-term structural inflationary trends that frankly are largely beyond their control”, according to Sturkenboom.
Central banks could decide to push back and create “enormous growth headwinds”. Indeed, he believes that while these “concessions” may not have been explicitly stated, they are de facto in effect as central banks have essentially accepted higher inflation.
In these circumstances, he adds, central banks and monetary policy will be less critical to investment performance and will take a back seat, while other political and socioeconomic factors work themselves out. However, there will be “no more quantitative easing, no more cheap money”. That trend is over, so there will be no more cheap money to drive up debt levels.
For Sturkenboom this means key global policy interest rates are likely to stay in the 2%-3% range. But this forecast could change if further geopolitical events start driving up inflation and central banks intervene more actively.
On asset class performance
Growth constraints and elevated inflation are “not a great environment for equities”, according to Sturkenboom. Northern Trust’s ten-year assumptions are at the core of an equity performance forecast of 6% to 6.5%, which he describes as “healthy but certainly not exciting”. Furthermore, he adds that equity investors in this environment are not being paid substantially well to offset the risk they are taking on.
He believes there are “better risk-adjusted returns elsewhere, high-yield bonds that will benefit from a credit cycle that will be relatively benign on the back of high nominal growth that should allow companies to stay solvent”.
He also looks towards real assets, which can be attractive, both because of inflationary tailwinds and attractive valuations. Real estate, employed selectively, is likely to deliver a better risk/return balance than equities. Private assets are also likely to be able to deliver more returns at less risk.
Sturkenboom characterises this as an unexciting “but not a too pessimistic picture where equities may not push up to the kind of high performance that we’ve seen in the past”. At the same time, “you’ve got to return to that solid base in fixed income return”.
He acknowledges that this reverts to an asset allocation far closer to the traditional 60/40 split, with positive expectations mostly around bonds. With inflation having peaked and interest rates likely to rise no further than they already have as central banks become less aggressive in fighting inflation in order to avoid constraining growth too much, equities would have to deliver at least 8%-9% consistently to justify a higher weighting.
For Sturkenboom, this overall asset performance picture, while not exciting, is neither particularly distressing nor a cause for concern. “Large institutional asset managers should be able to work with those kinds of difficulties without running into problems,” he says. With inflation now back to around historical norms, a similarly traditional asset allocation position is also appropriate.
Despite geopolitical and other pressures, he says it appears that the global economy has to some extent adjusted comfortably to compensate for a lower growth environment and greater tensions, among other things – far from the stagflationary environment of the 1970s.
In particular, he notes that after the shock of Russia’s invasion of Ukraine and other black swan events, energy and food prices now appear to have largely normalised. He suggests that central bank actions may “so far have had a minimal impact on the reduction in inflation”. While they may have influenced inflation expectations, “which is no small thing”, energy, food and even housing prices appear to have adjusted largely through the action of the economy itself.
Sturkenboom notes that technology could influence this picture because it has “the ability to boost growth and has the ability through that productivity growth to lower inflation”. Northern Trust believes that artificial intelligence in particular, may have such an effect over the ensuing decade, with a “modest positive impact on growth and modest inflation impact”.
On private markets
Sturkenboom sees private markets as important “notwithstanding the fact that it is private and therefore information-deficient”, and also the fact that there’s been “hand over fist investment by institutions into certain categories of private assets”.
These caveats aside, he observes that “we’re seeing a growing asset class with already strong historical returns”, as well as a financing landscape that supports its continued growth as banks and other traditional financing sources step back.
He notes that investors are also interested in the private asset illiquidity premium, even though this is largely a matter of delayed information delivery.
Higher interest rates, the large amount of dry powder still to be invested, and less than optimal internal mechanics of the asset class have all helped to lower Northern Trust’s return expectations for private assets. But according to Sturkenboom, they would still have to reduce their actual returns at least a couple more percentage points before they lost their competitiveness as a handy returns booster over and above listed equity performance.
Overall, his prognosis for the next ten years is a slower-growing but more sustainable macroeconomy, where traditional investment approaches are more rewarded.