We believe the populist movement of the past year has not dramatically changed the global economic outlook and that global equity returns are expected to remain below long-term historical averages over the next five years. But we do not think stocks will be overly burdened by elevated valuations and believe they are likely to remain attractive next to low-yielding fixed income asset classes. Meanwhile, we expect interest rates to move only modestly higher, while yield curves should not steepen materially.
Against this backdrop, we believe six key themes have emerged:
1. Entrenched Growth – We believe the global economic expansion will continue at a modest but steady pace throughout the next five-years.
Populist upheavals have failed to shift the economic growth trajectory from its established channel – neither propelling growth higher nor pushing the global economy into disarray. Instead, modest economic growth prevails. High debt levels, aging developed market populations and transitioning emerging economies now serve as a governor on global demand.
2. Stuckflation – The bigger risk to the global economy continues to be too little – not too much – inflation.
Inflation is stuck and is expected to remain subdued as automation-enabled supply easily meets demographic-hobbled demand. Pockets of sustained inflationary pressures (e.g., healthcare, education) will likely be addressed through innovation. Meanwhile, a shrinking labor force may impact demand more than supply.
3. Waiting for Monetary Godot – Patience, gradualism and communication are monetary watchwords going forward.
Much speculation has occurred about the timeline for monetary policy to revert to pre-financial crisis levels. This is not expected over our forecast horizon. After nearly 10 years of unconventional policies, a return to traditional monetary behaviors may never occur. A successful unwinding of huge central bank balance sheets – likely to remain larger than historical levels – will be a focus.
4. Populist Catharsis – Markets prefer policy stability but, when change is required, reward policies that move toward new solutions.
The post-World War II model of democracy, free trade and globalism is transitioning to something new. China’s rise to power and the global economy’s digital transformation are key catalysts upending established political and economic norms. Especially during populist waves, dealing with change is better than avoiding it, no matter how uncomfortable and disorienting it may be. Leaders able to successfully navigate populist environments will come out stronger on the other side
5. Regulation in the Limelight – Amid a new type of political gridlock, regulations are driving the global business and investing environment.
The regulatory policy lever has gained importance and power amid churning political gridlock. U.S. regulatory policies have quickly shifted from headwinds to tailwinds. The European Union has its best shot in decades at real reform. A focus on reducing regulations – combined with synchronized global growth – has ameliorated legislative failures. Local government and corporate entities are also gaining clout, dictating policy changes that draw support from smaller constituencies. These “smart” regulatory adjustments are expected to support ongoing global growth.
6. Valuation Superstructure – Valuations have entered a higher regime supported by fundamental, behavioral and industry drivers.
Steady economic growth and benign inflation provide a solid foundation for elevated valuations versus historical levels. However, current valuations are underpinned by more than just fundamentals. Significant changes to financial markets’ structure, players and investment vehicles advance the case for today’s valuations to endure. Importantly, global equity markets benefit from a healthy degree of investor skepticism. As long as market sentiment remains in check, stock market valuations – paradoxically – will likely find support.
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