Implications of a world of low numbers
A world of low numbers
Each quarter I am invited by several consultants and international clients to hold a conference call discussing the state of the world, current drivers and future trends. The focus recently has been the implications of the world of low numbers - whether low growth, inflation, interest rates or bond yields. The latest example of the decline in trend rates of growth came from the USA, with the Fed admitting that medium term growth in the USA could be under 2% a year! Much of the discussion on the causes has focused on innovation and productivity. Yet, we should also consider the structural break in the relationship between global trade and global GDP growth; the elasticity of global trade to GDP growth reverting to levels last seen in the 1970s to early 1980s.
If trend economic growth is so low, then even mini-cycles become significant. One such cycle we see appearing is an upturn in business profits. This improvement is necessary when equity market valuations are high and the corporate sector overly indebted by historic standards. The world economy has gone through a profits recession for well over a year, as the chart demonstrates. Key sectors have been affected, energy and materials by lower commodity prices, as well as the financial sector restrained by the flattening of yield curves. Many companies are still lowering their outlook for the coming quarter, while analyst estimates for 10-12% growth in 2017 seem optimistic. The good news is that higher commodity prices, the end to the inventory overhang, and some improvement in capital spending and top line sales into 2017 all make sense at this point in the industrial cycle. Conversely, some sectors will suffer from higher wage costs - possibly due to tight labour markets or minimum wage increases. On balance we expect to see moderately positive profits growth in 2017.
Another mini-cycle is slowly appearing - the Federal Reserve decision to tighten monetary policy in the face of that rise in wage pressures in the US. There is still a debate in the Fed, between those who wish to run the economy faster for longer, and those with worries about the deterioration in inflation expectations. The speed with which wages are allowed to rise, and the interaction with productivity growth as more labour is pulled into the workforce, will impact corporate profits growth in the US. Bond markets will also be affected by Fed tightening into 2017, but the Fed's decisions have to be seen in the context of other central banks actions. Most major central banks around the world are maintaining or beginning accommodative monetary policy, examples being recent interest rate cuts in Brazil, India and Indonesia, while central bank statements in Australia, Canada and Sweden hinted at the need for further relaxation. Even if the US bond yield edges higher on the back of expectations of Fed moves, global bond yields will continue to be restrained by the actions of other countries. This explains why we hold onto our sustainable yield theme in portfolios and advisory meetings with clients, emphasising ‘sustainability' when corporate cash flow pressures are only slowly growing.
In the current environment, multiple-asset income still seems good advice for investors: drawing together a series of income streams from equities, corporate bonds and real estate, choosing from different countries around the world. The relative performance will depend on the themes discussed in this article - will the expected improvement in corporate profits to allow the economic cycle to continue or will the imbalances slowly building up in China, emerging markets, Europe and the USA finally prove too much for policy makers.
Andrew Milligan, Head of Global Strategy, Standard Life Investments
First published in Professional Pensions, November 2016.