Towers Watson says that overall global growth in the next three to five years will be moderate and divergent on a country basis, and risks to global growth are skewed to the downside in its report entitled “Secular Outlook 2014: Investing Under a Cloud.”
The paper indicates that Germany and the U.S. have reasonable medium-term growth drivers, but the U.K. remains heavily indebted and sensitive to interest rate increases. The rest of Europe and Japan are in a difficult economic environment and in danger of remaining in a negative situation of low interest rates, weak growth and low inflation, according to the company.
The goes on to say that a combination of gradual but significant currency appreciation and rapid increases in wages means Chinese labor is now materially less competitive than it was five years ago and will grow at a much slower pace over the next decade compared to the past 10 years.
“This could be implemented gradually by not buying more credit from inflows, rebalancing or de-risking. Or they could change the sectors of the credit market to which they are exposed, with the aim of finding those that offer more value,” the paper says.
“Given the depth of the previous contraction in many economies, the large policy stimulus required to offset it and the subsequent slow recovery, policymakers are likely to remain under pressure to support growth in the next few years. In the absence of a negative event, our base case is for continued but modest recovery and an unusually extended economic cycle,” said Robert Brown, chairman of the Global Investment Committee at Towers Watson.
“However, all will not remain equal, and ongoing indebtedness pressures in much of the developed, and some of the emerging, world exposes the global economy to the continuing prospect of negative shocks. This could be compounded by the inability of many policymakers to respond, given how many policy levers have already been pulled.”
Towers Watson reiterated its rating of “moderately unattractive” on investment-grade credit, which it downgraded prior to recent spread widening. Despite this, it advises investors to revisit credit exposures and decide whether alternative asset mixes are preferred in an environment where economic risks are growing and skewed to the downside.
“If investors want to take advantage of this view, they could replace exposure to investment-grade credit with a blend of equities and gilts that offer a similar level of long-term return,” said Brown. “This could be implemented gradually by not buying more credit from inflows, rebalancing or de-risking. Or they could change the sectors of the credit market to which they are exposed, with the aim of finding those that offer more value.”
In the report, Towers Watson states it is not immediately clear whether investors should be worrying about high or low inflation over the next three to five years. Also, any pent-up upside inflation from extraordinary monetary policy may be unleashed if private sector credit creation increases sharply, whereas the data show a worrying disinflationary inertia.
“As some of the world’s largest central banks begin to emerge from a grand-scale monetary and fiscal experiment after the financial crisis, now is probably the time to worry about more extreme inflation outcomes — something we term ‘tailflation,’” said Brown. “Our view is that inflation risks lie to the downside over the medium term as ongoing deleveraging pressures and significant (although sometimes disguised) economic slack continue to limit the impact of increases to the monetary base.”
The company also urges long-term investors to grapple with unknowables that can affect their investment portfolios through upside and downside risks. It identifies a number of new technologies (such as bio, nano and clean) and big data as having the potential to enhance productivity on a global scale, creating a highly positive scenario for many asset class returns.
“Often, the effects of these technologies will be gradual, but successful technology has the potential to develop into significant regime-shifts at an uncertain point,” added Brown. “Clearly, technological change is not without its downside possibilities. Significant dislocations in industrial structure and labor markets can emerge as new technology is employed, leading to increases in unemployment. However, retooling and re-skilling eventually enables technology-led productivity improvements to dominate.”
“Secular Outlook 2014“ also includes articles on:
- The path for interest rates — The balance of pressure on monetary policy
- Investment outlook and recommendations — Market-by-market expected return implications and investment recommendations
- Credit markets — Beyond the sweet spot of the credit cycle
- The Chinese growth model — Rebalancing and slowing growth in China
- Emerging market equities — Emerging market equities are currently attractively priced
Source: Towers Watson