Taking a deep look into capital market movements and the currents that shift and shape them is something Northern Trust Chief Investment Officer Bob Browne does yearly, and his 2019 projections center around “stuckflation,” the “fractious” U.S.-China trade war and consequences of the mess he says the Federal Reserve and other central banks have created. Here are the bank’s six assumptions for this year going to the next five:
1. Global Growth Restructuring
Globalization is taking a step backward from what is optimal, according to Northern Trust. A big change has been that President Donald Trump has a “mercantilist policy that’s really focused on the strength of the export sector, strength of the domestic economy versus really thinking about the leadership role the U.S. has played historically,” Browne says. “Ultimately, there’s going to be less growth to go around — we’re not forecasting a recession as a result of this, but it will slow things down as additional frictions get created as part of this adjustment process.”
This also means new supply chains opening — that is, companies moving from China to Malaysia or Vietnam, which already is happening. Browne says “we’re still in the early days” and that this change is “a step backward from our view of what is optimal, but … that doesn’t mean it’s bad.” The key point is that a slowdown of global economic growth is in progress.
Technology may help with growth, but even that is being threatened with potential new regulations. “Some of these global [tech] companies are getting so big and massive that they’re challenging government [and fair competition] … which leads to a reaction that will probably slow things down if you believe that these companies were a source of important growth,” he says, adding that “we still absolutely believe that technology is going to be a political issue in 2020,” that is, pro-business versus privacy issues.
2. Irreconcilable Differences Between China and the United States
This issue isn’t going away, says Browne, adding it’s like “a marriage that really was working for one partner more than another.” He says the status quo was “unacceptable” across the board in Washington. “That means there is an ongoing risk of a trade war periodically, and hopefully we’ll get an armistice,” but he sees this as a “multi-year reality. This is not going to disappear anytime soon.”
This means market volatility will continue, although “both sides do have an incentive to make sure it doesn’t get too ugly.” However, “if there is an agreement, how sustainable is it? Just given the volatility of policy coming out of the U.S., the very nature of the president himself, the Chinese as much as anybody should be skeptical of the sustainability of a so-called deal.” He adds that the Chinese can wait out Trump, although if Trump does win the 2020 election, “he’s got nothing to lose.”
3. Stuckflation 4.0
The last-five year average U.S. economic growth was 2.6%, and Northern Trust sees that dropping to 1.7% over the next five years, Browne says, noting, “it’s positive but that’s not an immaterial drop of 90 basis points in the world’s largest economy.” He adds that “stuckflation” has been on the firm’s list for four years running and “we think the structural forces that keep inflation low continue to dominate the cyclical ones that might periodically cause inflationary pressure.”
They are worried that cyclical pressures might grab the market’s attention more than the structural, although that hasn’t been the case thus far. “But we’re wary that low unemployment takes enough capacity out of the labor sector that leads to broad-based inflation,” Browne says.
Yet with global bond rates so low, “markets certainly are not demanding to be compensated for inflation risk.”
That said, “central banks have to remain accommodative,” he says, adding that “the Fed’s stubbornness will have to be addressed. We think they’ll cut again in September, and should continue to cut thereafter.” He says at least it needs to “unwind its mistakes from last year,” which is the last two hikes.
This also means investors will have to “think a little bit outside the box.” Northern Trust is overweight in global REITs, which are up about 17% for the year, and global listed infrastructure, which is up 18%.
4. Executive Power Play
President Donald Trump and other populist politicians aren’t necessarily bad, he says; they “are just going to stir the pot. The reality is ultimately they’re judged by policy.”
For example, originally Trump was looked upon as a pro-business, pro-growth president, but now is seen as pro-protectionist and the markets are responding accordingly. An another example is President Recep Tayyip Erdogan of Turkey, who was looked upon favorably early on as being pro-business, but once corruption and the strong hand of the government started to cripple private investment, the currency weakened and foreign investors exited Turkey.
“Our advice to investors is you don’t have to necessarily give populist politicians the benefit of the doubt, but don’t assume they’re bad for the markets. Look at the integrity and success of a policy.”
5. Monetary Makeover
He saves his greatest criticism for the U.S. Federal Reserve, pointing out that global central banks haven’t gotten to their 2% inflation target and should “have a green light to emphasize economic expansion over the risk of inflation … But the Fed we’re flummoxed by,” he says. He says long-term forecasts of a federal funds rate over its current 2.5% are “ridiculous.”
“The idea that [the Fed] can pre-emptively tighten interest rates in the wake of a fiscal stimulus that’s going to be a plus, well, they’re going to find out how short their leash is,” he says, pointing out the interest rate hikes after the tax cuts basically canceled out the positive stimulus.
“How [can] a central bank without evidence of inflation act pre-emptively? [That] basically undermines fiscal policy of elected officials!” he says. “People at the Fed are missing how much the political world has changed.” He adds that this behavior will become “politically unacceptable.”
6. Staking Out Climate Risk
The topic of climate change becomes more important and is affecting investors already, Browne says. They call it “transition risk” — that is, investors have to think about physical impact on the global environment and the potential for property damage, such as in agriculture, he says. Carbon-intensive industries will be more highly regulated, “and even if they’re not regulated, we’ll see consumer behavior affected,” he says. Browne adds that the anticipation of the change in the environment “may actually lead to changes in behavior either at the policy level or at the consumer level, and that’s what investors need to be thinking about.”
Investment-wise, Northern Trust likes high-yield bonds, U.S. equities, global real estate and global-listed infrastructure.
Northern Trust began trading its forecasts in 1993 when it launched the Global Tactical Asset Allocation Fund (BBALX). The four-star Morningstar-rated fund is just over 11% for the year and has just under $90 million in assets.
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