Northern Trust’s Capital Market Assumptions working group releases its perspective on risk-return assumptions for key asset classes.
The political environment will be the prime driver of financial markets during 2012 and beyond, according to the latest five-year outlook by Northern Trust's Capital Market Assumptions (CMA) working group.
Solutions to global problems, such as deleveraging, will be shaped by region-specific economic constraints and constituency beliefs. Difficulties in forming global political consensus on key global issues raise the risk of continued economic stagnation, while the "go-your-own-way" politics may cause regional economic growth dispersion.
The political environment is one of seven key themes the CMA team identified as key drivers of economic activity and financial market returns during the next five years.
"The economic prospects of the global economy, to a significant degree, lay in the hands of elected officials," said Northern Trust Chief Investment Strategist, Jim McDonald. "Their task is to convince the populace that there is a long-term plan to deal with mounting debt levels, while not cratering the economy in the meantime through overly stringent austerity measures."
Each year, the Northern Trust CMA group develops long-term risk-return assumptions that factor into the firm's investment models, new product development and strategic portfolio optimization. Other themes identified in the 2012 edition of the five-year outlook include:
Fiscal and Demographic Obstacles: The deleveraging process across most of the developed world will be drawn out but persistent over the forecast horizon and beyond — effectively putting a ceiling on growth. Aging developed-economy populations are more of a psychological — and longer-term — headwind than a practical headwind. However, overall demographics are not conducive to "growing our way" out of fiscal problems.
Sneaky and Sticky Inflation: Monetary policy has effectively become a non-variable over the foreseeable future as rates in most developed markets are expected to remain on hold throughout most of the forecast horizon. Such accommodative monetary policy will result in global inflation that is both sneaky (reducing purchasing power and debt loads) and sticky (higher than expected in slow-growth environments).
Alternative Sources of Yield: Persistent low interest rates will force investors to reposition their portfolios to meet their income needs. The debt of multi-national companies will increasingly substitute for traditional sovereign fixed income. Risk assets also may benefit, as investors need riskier portfolios to generate necessary returns.
Can We Capitalize on Technology?: Various technologies — affecting everything from energy supply to data storage/retrieval to communications — have the potential to enhance productivity and offset slowing (in some cases, declining) workforce growth. But implementation of these technologies may be hindered by an uncertain growth outlook, regulations and a lack of political wherewithal and ability to provide funding.
G2 Dependence and Interdependence: The global economy will be increasingly dependent on American and Chinese demand while Europe restructures itself and Japan continues down its slow-growth path. As such, the economic policies of the two economic giants will be heavily scrutinized — as will their relationship — as the "state-capitalist" China closes the economic gap on the "free enterprise" United States.
Separation of Company From Country: Companies with diverse geographical revenue streams are well suited to withstand economic weakness in their country of domicile; furthermore, true multinational companies have the ability to capitalize on the revenue, cost and tax factors contributing to overall earnings. Increasingly, the potential exists for bifurcation between those equity indexes that provide broad exposure to global economic growth and those that provide more targeted exposure to the growth of individual economic regions.
The themes help Northern Trust's CMA group in its assessment of how the next five years might differ from historical experience, both in terms of economic factors and asset class returns.
For more details on Northern Trust's forward-looking investment commentary, download our Five-Year Outlook: 2012 Edition.