Fonds im Fokus


27.07.2017 | 16:22

NN IP: Open-Minded & Adaptable

Investment returns might seem hard to find, but remember that the future will look different from the current consensus view.

A decade of financial crises, down-drifting inflation and growing fears of secular stagnation in economic growth have driven interest rates to unprecedented low levels. To hold savings in cash or some form of savings deposits has never looked less attractive in terms of a future return perspective. Returns that are more than close-to-zero are hard to find if you want to play it safe with your savings.

At the same time ample liquidity provision, brightening growth prospects and a reduction of tail risks have caused many asset prices to trend higher in recent years – not all of them, and more so in some segments of financial markets than in others. But most asset prices are now firmly higher than just two or three years ago, which raises questions about how much prices can still be expected to rise and makes some people wonder what kind of returns can still be expected from global capital markets. If everything is expensive, you might at best be able to reduce your investment risk through smart portfolio diversification, but escaping from a low-return future would become close to impossible.

Even without making an assessment about the "valuation" of markets – determining whether they reflect underlying fundamentals well – it seems sensible to expect low future returns on most investments if there is less growth to come by in the world. Less growth leads to lower increases in future income streams for households, corporates and governments. If growth is not only lower in terms of activity, but also in terms of prices (what we call inflation) it means that expectations about future nominal cash flows will move lower as well. Since the discounted value of these future cash flows is what gives financial assets their value today, adaptation to a lower growth future creates direct challenges for asset prices and investor returns.

Taking these thoughts into account it does not seems so strange that from a macro perspective, markets are still priced for some sort of secular stagnation. It is a world of low "equilibrium" levels for central bank rates and bond yields, a world of low productivity growth and low inflation, and indeed a world where modest additional upside in future income and earnings growth caps returns on risky assets like equities and credit as well.

All this makes for depressing headlines for investors. Is there no way to rescue the future of investment returns? For starters it becomes even more important to prevent a potential negative shock from damaging your portfolio too much. It has always been hard to experience and recover from large drawdowns, but with less growth around, it might be even harder. If growth remains too cold for comfort, bond yields will remain low and risky assets might initially continue to receive support from low yields and a continuation of a rise in the profit share of GDP.

However, when the next downturn hits, risky assets will be very vulnerable and their mutual correlation will quickly converge to one. Meaning that most of the traditional diversification benefits will disappear exactly at the moment you need them most. Only smartly balanced portfolios that also strategically maintain exposure to relatively safe assets that offer positive returns in a sharp risk aversion environment will be allowed to limit the damage of such drawdown in markets.

At the same time, there could be positive surprise to the macro outlook. Despite all depressed expectations that have been built up over the last decade and the ongoing popularity of the secular stagnation thesis, technology and positive animal spirits can easily surprise us all to the upside. The remarkable “Goldilocks” economy that emerged in the 1990, which started with an equally depressed mood, is just one of the many positive surprise stories that economic history teaches us. Germany being seen as the "sick man of Europe" 15 years ago and its actual performance in the years that followed is another beautiful anecdote.

The big question going forward will be whether growth will break the ceiling under which it seems to have been capped in recent years. For that to happen, a sustained rise in productivity and a virtuous cycle in global final demand would need to coincide. And why not? It might sound strange at first, but next to the secular stagnation argument it should at least be acknowledged that the global economy looks better than it has for at least a decade. The global recovery is more synchronized from both a regional perspective (across DM and EM) and sectoral perspective (both consumption and investment contribution). Unemployment rates are at decade lows, profits are rising at a double-digit pace and sentiment in the household and corporate sectors is close to post-crisis highs. Moreover, strength in financial markets creates easier financial conditions globally that provide some addition tailwind for the current cyclical growth momentum.

This provides no guarantees on longer-term growth trends, but since our global economy is a complex adaptive system, it is always important to understand that such a system always has a lot of path-dependency. As a result, the constructive shorter-term dynamics might well contribute to pushing the economy on a stronger longer-term growth track. If all the new fascinating technological innovations in digitalization, robotics, healthcare, energy efficiency/sustainability, machine learning and many other things were fully leveraged by stronger and more persistent demand, a lost decade in productivity growth might well be followed by a solid productivity comeback in the years to come.

In that environment, bond yields can rise, while risky assets remain protected by higher productivity growth. What inflation will do along the way remains uncertain and will trigger occasional bout of volatility in global markets as central bankers adapt their thinking and policies in response to empirical observations. Still, it would lead to either a Goldilocks world or a reflation environment that would create ample opportunity to generate returns in risky asset space. Government bonds will struggle in these scenarios, but higher yielding credits, real estate and equities stand to benefit.

Absolute valuation levels compared to underlying fundamentals, risk premiums compared to cash or other asset class alternatives (like bonds and equities), and qualitative assessment on the degree of distortion stemming from policy (QE) or regulation (Basel III, Solvency II) are all important and should be taken into account. But all of this type of “mispricing” analysis will be overshadowed by the influence of the shift of the global economy into a Goldilocks or reflation regime. There is no certainty at all on either situation, but such a shift is certainly not something to ignore either. This leaves us with one simple message: stay open-minded and be adaptable!