New analysis of the global economic environment suggests that returns on key asset classes will be modest in the near term, following more than three decades of high performance. Investors may need to consider their strategy in line with the changes to the new environment, which appears set to stay in the mid-term.
The latest edition of Willis Towers Watson’s ‘Long-term statistics’ report tries to make sense of the current and coming performance of the global economy in line with historic trends. The study aims to provide investors with a snapshot of current conditions as a means to better inform their respective decision making.
The authors note that the current economic environment, with its global growth, interest rates and asset returns, may well remain relatively stable in the years to come. Uncertainties exist, however, particularly in China and the Eurozone, where there is said to be overcapacity – leading to possible headwinds around global wage growth, returns on capital and inflation.
For China, in particular, one of the biggest issues highlighted by the report is the growing burden of corporate/non-financial debt, which has increased to around 170% of GDP. While it is not immediately troubling, as cited by a recent McKinsey & Company report, the debt does create an impetus for the country to enter into reform mode. The transformation, and the quality of its execution, comes with risks, as well as lower growth rates of around 6%.
Globally, there are a number of uncertainties that compound current systematic risks inherent in the system, some are latent while others more directly visible – such as the slowdown in China, geopolitical risks and lower commodity prices for emerging markets. According to the firm’s analysis, it comes from a broad range of global events and rivalries, including global terrorist threat, fallout from the Syrian war, hostility between Shia Iran and Sunni Saudi Arabia, tensions in the South and East China Seas, European migration issues, Grexit and Brexit concerns, and the US presidential election, to name just a few.
The current uncertain economic times, coupled with low interest rates and geopolitical tensions mean that the outlook from the firm’s analysis shows relatively weak performance, across key asset classes relative to previous decades, for the coming five years. Developed equities in particular, with an outlook of 3.2% per annum over the coming five years, are down on recent trends of around 8% per annum, while emerging market equities perform slightly worse at 2.9%. US investment grade fix income stands at between 1% returns, while US high yield returns around 2.6%. US and UK 10-year bonds provide relatively low returns at 1.8% and 1.6% respectively.
The study suggests that the current asset market environment remains relatively uncertain and that moderate rates of return remain the most likely scenario. In some instances, the firm suggests that a ‘more radical reassessment of institutional or industry missions’ may be required to survive in the new normal. For pension plan investors this could mean reducing returns by shifting asset classes, as low wage growth allows the fund to still meet savers’ objectives even with reductions in its returns.
The firm adds, “The cautious outlook we have held for the past year or two is retained. Downside risks remain unusually elevated, not so much in number but in severity due to the inability of policy to mitigate their impact. We continue to encourage all investors to adopt a cautious approach to risk as a consequence.”