What You Need to Know
- The next decade for markets is likely to feature lower returns, higher inflation and greater volatility.
- Changes to global supply chains could lead to a fragmentation of economic markets.
- “Stay the course” may be inappropriate advice for the investing environment of the coming decade.
Many investment discussions focus on the outlook for the next quarter or year. Although the focus on the “here and now” is understandable, most investors should measure their time horizon in years or decades. The distinction between short- and long-term is particularly important today, with near-term “noise” obscuring material changes in long-term economic trends.
Given what is likely to be a different long-term investment environment, balanced portfolios comprising 60% stocks and 40% bonds may provide returns that fall short of the lofty levels reached over the past decade.
Stock and bond returns have benefited from globalization, the “peace dividend,” and abundant energy supply. Each of these “tailwinds” for investment returns is likely turning into a “headwind” at a time when the U.S., China and much of Europe will be struggling with an aging population:
1. Globalization, Regionalization and Fragmentation
Declining globalization and regionalization of supply chains could lead to a fragmentation of economic markets. The loss of U.S. manufacturing jobs, rising income inequality, the COVID-19 pandemic and U.S.-China tensions are among the factors contributing to the backlash against globalization.
One lasting consequence of the pandemic will be a focus on supply chain resiliency. Although the “just-in-time” approach to inventories might have been the optimal financial strategy during placid times, the pandemic exposed the need to consider more of a “just-in-case” approach for key elements within the supply chain.
Changes in approach to managing supply chains and stalling of other aspects of globalization are likely to raise costs and create pressure on corporate profit margins. In addition, fragmentation within the global economy is likely to reduce the total addressable market for many companies with global aspirations. But while global brands may find themselves with a shrinking opportunity set, national or regional champions may benefit from a more “localized” market.
2. The Diminishing ‘Peace Dividend’
Russia’s invasion of Ukraine marks the end of a long period in which capital market valuations and government balance sheets were boosted by relative peace between superpowers. Government spending on defense will likely rise in much of the world as a global arms race looks inevitable. Increased government spending to address energy and food insecurity also will create more of a tax on economic growth while sustaining inflationary pressures.
A less stable world with higher risk of superpower conflict may cause pressure for equity valuations, particularly when geopolitical tensions are elevated.