Make headwinds your tailwind
BMO Global Asset Management’s five-year outlook informs our longer-term strategic portfolio allocations and sets the guidelines around the active asset allocation opportunities that arise from our ongoing tactical work.
We have captured the thought leadership of our annual Global Investment Forum in three pragmatic scenarios:
- Firing on More Than One Cylinder High-conviction scenario with a 60% probability
- Policy Panacea Upside-surprise scenario with a 20% probability
- Debt is a four letter word Downside surprise scenario with a 20% probability
Scorecard: a look back at 2015
Our forecast of persistently low growth, low inflation and low yields has been accurate, as have our expectations for:
- Highly accommodative monetary policy
- Growth dampened by global debt levels
Where we added value:
- Overweight equities versus fixed income
- Overweight U.S. equities
- Underweight commodities and equites from both commodity-producing companies and commodity-focused countries
Other notes from our previous Five-Year Outlook:
- Anticipated Federal Reserve (Fed) tightening, though we expected earlier in 2015
- Increased likelihood of downside surprise; upping again this year
Firing on more than one cylinder (60% probability)
Our base case calls for a broadening of U.S.-led global growth into key geographies, particularly into Europe and Japan. View based on our belief that:
- U.S. economy is resilient and will continue to grow
- Japan’s reform policies begin to take hold
- Europe more measurably recovers from 2008 financial crisis
We expect “lower for longer” will be used frequently to describe energy prices, inflation and interest rates. With this, we expect the following:
Globally, (very) low energy prices to continue to be a:
- Positive catalyst for oil consumers – especially the U.S., Europe, Japan
- Negative catalyst for oil producers – including Canada
U.S. growth engine is solid, but will likely be slowed by:
- Debt overhang – combined government, corporate and household
- Typical late-cycle concerns – wage inflation, slowing housing sales, declining exports
China continues to be pivotal, and we are looking for a “soft landing.”
- Undergoing a dramatic shift from an industrial- to consumer-driven economy
- We believe they have the flexibility and firepower to contain a potential crisis
India shows considerable promise.
- Emerging as “China 2.0,” looking like China 15 years ago
- Favorable demographics driving savings and investment, benefit of lower oil prices, a British legal system, and increasing industrial production – whereas China’s is falling
- Populace is highly educated and English-speaking
Japan continues to benefit from Abenomics and a weaker Yen.
- Improving their competitiveness and aiding their recovery from China’s slowdown – supporting manufacturing and export growth
- Optimism is tempered by long-standing hindrances of high government debt-to-GDP ratio and adverse demographics
Europe begins to see past event-driven issues to recovery.
- Putting shock of Greek insolvency, unemployment and double-dip recession behind them
- Optimistic about stimulative fiscal policy with Germany as an austere role model, a commitment to quantitative easing by the European Central Bank (ECB) and help from lower oil prices
- Warily watching to see if the Eurozone can reduce unemployment and how they deal with the huge influx of refugees
Investment implications of our base scenario are constructed from our fundamental premise of a broadening of the economic recovery into key geographies, e.g., Europe and Japan. In contrast, growth will continue to slow in China, but in an orderly/gradual way. Also, the effects of low oil prices will permeate markets globally.*
- Overweight equity relative to fixed income
- Weak foreign currencies help Non-U.S. equities
- Selectivity among emerging markets is key
- Alternative strategies exhibiting skill at exploiting style premia
Policy panacea (20% probability)
Our upside-surprise scenario is predicated on policymakers around the globe getting nearly everything right, both in the short and intermediate term. This scenario does not require all of the potential catalysts (listed below) to come into play, but several will be needed to move the needle beyond our high-conviction scenario.
Europe, as the keystone region to this scenario, will need to stand by its “do whatever is necessary” commitment – holding interest rates low and expanding quantitative easing. Along with ECB policies, devalued currency and low energy costs further stimulate growth and trim unemployment. In turn, European governments:
- Continue to enact prudent budgets, putting their growth dividend to work retiring debt
- Allow forgiveness of Greece debt without the risk of contagion
U.S. growth coincides with a methodical, well-communicated series of interest rate hikes by the Fed as on-trend GDP growth continues.
- Higher interest rates boost capital investment, while consumer spending and housing trends remain strong
China successfully continues to move toward capitalism. That means slowing overall investment, but focusing on more productive projects.
- Slower growth, but still a global growth leader
India, as previously mentioned, steps toward becoming China 2.0.
- Their advantages allow India to attract foreign capital – further increasing their positive impact on domestic and global growth
Japan becomes emboldened by the promise of Abenomics.
- Policy stimuli and structural reforms spark manufacturing and export growth, and may even spur much needed inflation
The upside surprise is that low oil prices foster higher industrial output and consumer spending. Over time, this increases demand for energy and aids the economies of commodity-producing countries.
Investment implications of the upside scenario are best summarized by a full “risk on” asset class exposure, focusing on cyclical sector equities, non-U.S. companies with high, domestically generated revenues, particularly commodity producers.*
Debt is a four-letter word (20% probability)
Our downside-surprise scenario addresses the possibility that a policy error or two results in a surprise to the downside. And given the number of consequential policies being contemplated, there are many opportunities for miscues.
U.S. Fed is explicitly recognized in this scenario walking a tightrope as it reacts to a maturing expansion and a tightening labor market. If their actions are too quick/too slow or too large/too small, the outcome will be potentially disastrous. The U.S. growth engine is also vulnerable to:
- Debt overhang – cumulative impact of government, corporate and household indebtedness
- Typical late-cycle concerns – wage inflation, slowing housing sales, declining exports
Other potential missteps include:
- Globally – if our theory that debt is sustainable turns out to be false, and our debt burden quashes global growth
- China – if policymakers are not able to repurpose their economy from investment led to consumer, the result could be a “hard landing,” and an Asian-led global recession
- Japan – if Abe’s “three arrows” miss their mark and Japan reform efforts fail, deflation/recession are worsened by debt
- Europe – if quantitative easing fails and ignites a social backlash, or Grexit and/or Brexit become a reality
Investment implications of the downside scenario are driven by a flight to quality and safety. This includes long-dated U.S. treasuries and large cap equities from the U.S. and core European countries, such as Germany and the Netherlands.*
*See the complete report for a thorough discussion of investment implications, including a table of geographies, asset classes and sectors we over emphasize and under emphasize.
Visit: www.bmogamviewpoints.com/five-year-outlook
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