“Let me start by pointing out the obvious: the last few years have been exhausting,” said Mina Krishnan, multi-asset portfolio manager at Schroders, during a session on regime shifts at the Canadian Investment Review’s 2023 Global Investment Conference.
“We’ve had the [coronavirus] pandemic, the war in Ukraine, the energy crisis and Brexit.”
As a result of this period of chaos, she noted, global markets are undergoing a regime shift away from a 40-year period of broad global economic stability and low inflation, with the next period defined by higher inflation and more volatility.
While Krishnan acknowledged her perspective isn’t universally accepted by the institutional investment community, she added the evidence is compelling. “Did you know it’s been 11 years since U.S. equities underperformed the rest of the world? It’s been 26 years since Japan had a policy rate above one per cent.”
She said defined benefit pension plan sponsors that are looking to safeguard portfolios and find strong sources of market-beating returns in the new regime must understand three forces driving the underlying change: decarbonization, de-globalization and demographics. “What these three Ds do is create a world where inflationary pressures will be with us for the foreseeable future.”
Krishnan also encouraged investors to expect the shifts brought about by these underlying trends to come slowly and in waves. “It’s so easy to get engulfed in all of these day-to-day headlines and miss the bigger picture. . . . Think about the last time the global economy went through a major change — with the introduction of the internet and smartphones. It’s not like we woke up one morning and all started texting.”
She said demographic changes are affecting the global economy in a way that will play out over the coming decades. The world’s population is growing older and the proportion of working-age adults is shrinking in many countries. “We all know about Europe and Japan, but did you know China is now joining that club? No other nation is aging at the same speed or scale.”
Within developed nations, the traditional response to shrinking workforces has been to accept more immigrants, she added, noting China’s unlikely to be able to adopt a similar approach. Another tool that’s been used by some developed nations — with varying effectiveness — has been to raise retirement ages. “I’m sure we’re all seeing the news about the protests in France right now over [President Emmanuel] Macron raising the retirement age. That does make us question how much the participation rates can be raised.”
With this in mind, Krishnan said institutional investors can expect many economies will find new ways to adapt. “That’s going to create competition, put upward pressure on wages and put a squeeze on company margins.”
De-globalization could also exacerbate the problems faced by institutional investors, she said. In the last 30 years, companies in developed nations scoured the globe for the most efficient sources of capital and labour. “What the pandemic did was wake us up to the fragility that has been built into that process.”
The final D — decarbonization — will likely push inflation even higher, she added, noting its impact on markets has been accelerated by the geopolitical chaos of the past five years. “In Europe, that was prompted by the war in Ukraine and, in the U.S., by the energy crisis that followed the Inflation Reduction Act. . . . On the positive [side, the energy crisis is] going to spur greater investment and greater demand for investments in renewables.”
Krishnan sees three plausible outlooks for growth and inflation in 2023. “I call these the good, the bad and the ugly.”
The good refers to a soft landing with inflation coming back down to the target range without a rise in unemployment. While she said most investors may think this outcome is overly optimistic, she noted rising consumer spending on services may make it somewhat plausible. “What conventional wisdom misses is that a dollar spend at a restaurant employs 6.5-times as many people as one dollar spent on an app.”
The bad refers to a hard landing. With bond yields contracting and equity values falling, Krishnan believes this is the outcome most likely to occur. “What we expect is equity multiples to contract [further] and bond yields to fall [even more].”
And the ugly refers to a scenario where there’s no landing at all. “In the 1970s the [Federal Reserve Bank] had to hike inflation three times, raising rates to successively higher peaks.
“Whether you believe we’re in the good, the bad or the ugly, there are opportunities to be found. We just need to be very nimble about managing that asset allocation through the cycle and to be careful of shifting correlations.”
Read more coverage of the 2023 Global Investment Conference.