Three powerful dynamics in the global economy are poised to potentially lower GDP growth, undermine corporate profits, and keep inflation above 2% over the next five years — all of which should factor into investors’ multi-asset allocations, according to a 132-page report from Rotterdam-based asset manager Robeco.
The first is labor’s likely increased bargaining power, with the outcome of any tussle between businesses and their workers probably being determined by wages, based on the report compiled by strategists Laurens Swinkels and Peter van der Welle on behalf of the multi-asset team at Robeco, which manages $194 billion in assets. The second is the potential for central banks to lock “horns” with governments over the appropriate level of borrowing costs. And the third is a struggle for power between the U.S. and China.
Taken together, this “triple power play” is already starting to unfold, shifting investors into a world of higher risk-free rates and lower expected risk premiums that diminish the appeal of stocks, according to the asset manager. Risk premium is a gauge of relative value for stocks, helping investors determine what their short-term gain might be when taking on the additional risk of buying equities or investing in stock funds.
Robeco provided its forecasts for five-year annualized, projected returns on a range of assets held by euro- and dollar-based investors — including developed- and emerging-market equities, bonds, and cash.
The firm’s base-case scenario, which Robeco’s team refers to as a “stalemate,” calls for a mild recession in 2024, consumer-price inflation in developed economies to remain around 2.5% on average heading toward 2029, and real GDP in the U.S. to average 2.3% or below what the S&P 500 index
SPX
currently implies.
That benign growth outlook is expected to be accompanied by a “tug of war” between central bankers reluctant to lower interest rates and governments in need of low borrowing costs — which “means there is not enough monetary policy tightening” to bring inflation down by enough to meeting central banks’ 2% target. Under such a scenario, developed-market equities are likely to underperform their emerging-market counterparts and domestic bonds should offer a higher return than cash for dollar-based investors, according to Robeco.
“Looking ahead, a key question is: are we eyeing the start of a new bull market that will broaden and pave the way for another streak of above-historical excess equity return?” the Robeco team wrote in the report released on Tuesday. “In our base case, we expect developed markets’ earnings growth to end up below current 5Y forward consensus projections, which are high single-digit or even still low double-digit for the U.S. and eurozone.
“The reason we foresee a decline in profitability is linked to our overarching macro theme, the triple power play. Equities will likely bear the brunt of the power play in geopolitics,” according to the report. Efforts by global corporations to shift production toward geopolitically-friendly powers or closer regions “will prove more costly and lower efficiency.” Plus, “further pressure from margins will come from a lagged response from past policy rate hikes.”
There’s one potential game-changer that could disrupt Robeco’s “stalemate” scenario and create a bull-case outcome instead: The early and rapid adoption of artificial intelligence across sectors and industries, which would likely spawn above-trend growth and push inflation back to central banks’ targets. The result is “an almost Goldilocks scenario in which things are running neither too hot nor too cold,” central banks could take a break from tightening policy, and developed- and emerging-market equities may both be able to come out with double-digit annualized returns from 2024 to 2028.
On the flip side, Robeco offers a bear-case scenario in which mutual trust between the world’s superpowers hits rock bottom, governments are “in the crosshairs” of central banks, and labor loses bargaining power in the services sector. A “stagflationary environment emerges, intensifying the policy dilemma for central bankers” as inflation stays stubbornly high at 3.5% on average and growth comes in at just 0.5% annually for developed economies. In that situation, developed-market equities would eke out an annualized return of 2.25% for dollar-based investors over the four-year period, which would be below the expected return on cash.
On Friday, all three major U.S. stock indexes
DJIA
SPX
COMP
finished lower after almost 13,000 members of the United Auto Workers went on a limited strike. Investors looked ahead to next week’s Federal Reserve meeting, where officials are seen as likely to leave their main policy rate target at a 22-year high of 5.25%-5%.
Treasury yields ended the New York session at their highest levels since August, as traders factored in some possibility that the UAW strike might renew inflation pressures in the auto industry. In a separate development earlier this week, Air Force Secretary Frank Kendall warned that China is preparing for a potential war with the U.S.
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