Over three days a selection of our investment managers, economists and strategists congregated in London for our annual Global Investment Forum (GIF). The GIF is designed to tune out the day-to-day market noise and focus on key market drivers over the medium term.
Topics and findings included:
The rise of ‘intangibles’
Some of the most successful companies in the world don’t use much conventional capital and often don’t actually produce anything physical. If we look at Facebook, for example, their profitability is based on the intellectual property that drives their networking technology. As ‘intangibles’ grab a growing proportion of the global economy, their almost infinite scalability should drive longer growth cycles.
Inflation in ‘Goldilocks’ territory
The specter of deflation has all but disappeared from the world economy. Inflation is rising in the advanced economies but even in the U.S., pressures remain modest and under control – not too hot and not too cold.
A U.S. recession is not inevitable
The U.S. is well into its second-longest growth phase since World War II and the consensus is saying recession will arrive in late 2020. We disagree. Declining union power and increasing corporate concentration are limiting wage pressures. The rising role of intangibles means that supply can respond rapidly to strong demand without putting pressure on inflation. Indeed, inflationary pressures are mild and the U.S. Federal Reserve is ahead of the game.
Emerging markets revival
Emerging markets (EM) are still the standard-bearers of global growth with attractive demographics and the ability to use technology to leapfrog in areas of education, finance and agriculture. Many are recognizing the importance of improving governance to ensure that the interests of managers are aligned with those of shareholders as well as society more generally. Reducing reliance on imported fossil fuels will also make them more resilient in the face of oil price shocks. They still face headwinds from Trump’s trade war, a strong dollar and rising U.S. interest rates. But many EM assets are cheap and offer good opportunities on a selective tactical basis, though we are cautious on the biggest EM of them all – China.
No more cheap oil?
The U.S. shale oil boom kept oil prices low from 2015 to 2017. It also depressed investment by the rest of the oil industry. That has lowered their production today and this, combined with OPEC output reductions, is limiting supply while the robust world economy is boosting demand. This looks set to push up the oil price in the short to medium term.
Europe still on track
We don’t believe that Europe’s stellar performance in 2017 was a false dawn. Growth may have been disappointing this year, but that has more to do with transient issues such as inclement weather and trade wars than with fundamentals. While Italy’s disaffection with the European project is a significant risk, the region’s economy is now on a firm enough footing to withstand the gradual removal of unprecedented monetary support.
Trade wars will fade
We think that global trade wars will have a limited impact on the world economy. Chinese companies look set to be the most affected but their exports to the U.S. are a small share of GDP and will be diverted to other markets, especially if the 25% tariffs (due in January 2019) go ahead. China will also take policy action to offset the impact on their economy. Meanwhile, reduced U.S. demand for imports from China is more likely to benefit other foreign countries rather than U.S. domestic producers.
UK and the shadow of Brexit
Brexit is the dominant influence on the UK economy and much will hang on whether the government is able to avoid crashing out of the EU without a deal. The uncertainty is leaving UK financial assets somewhat in limbo, with the future direction of UK interest rates and sterling being subject to the success or otherwise of the Brexit negotiations.
Asset allocation
Benign inflation and a robust world economy point to a positive environment for risk assets. Equities should generate reasonable returns, albeit limited by rising interest rates. Government bonds are likely to suffer as central banks, led by the U.S., move gradually to normalize interest rates and reduce their balance sheets. We expect fixed income in general to underperform. Corporate credit could offer the worst of both worlds: we think credit spreads are too tight and are underweight in both developed and emerging markets. In our view, corporate risk is best taken in equities, while credit is inferior to government bonds as a hedge against recession risk.
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