Note: This article was originally published on Oliver’s Insights on June 9 2015 and has been republished with permission from the original author.
It’s part of human nature to give more weight to the short term rather than the long term. The desire for instant gratification is being accentuated by the immediacy provided by modern technology. This in turn is making it even harder to turn down the noise surrounding investment markets. But doing so is essential for successful investing. With this in mind, this note looks at longer term themes that will likely impact investment markets over the medium term, say the next 5-10 years.
Ageing and slowing populations
Ageing and slowing populations have been long talked about and they are now starting to have a big impact. Thanks to medical advances people are living longer healthier lives (eg average life expectancy in Australia has risen from 77 years in 1990 to 83 years now and is projected to rise to 89 years by 2050). And reduced fertility rates are leading to lower population growth. The impact is more significant in some countries, which are seeing their populations slow and age faster (eg Japan and Italy) than others (eg Australia, where immigration and higher fertility is providing an offset) and others still where population growth remains rapid (eg India, Africa and the Middle East).
Source: Intergenerational Report, AMP Capital
Implications – at the macro level this means: slowing labour force growth which in turn weighs on potential economic growth; increasing pressure on government budgets from health and pension spending and a declining proportion of workers relative to retirees; a "war for certain types of talent"; and pressure to work longer. At the industry level it will support growth in several industries including healthcare and leisure. At the investment level it will likely see a focus on strategies aimed at generating income (yield) while at the same time providing for "more stable" growth to cover longevity.
Slower growth in household debt
Some have named the surge in household debt relative to incomes seen in the decades prior to the GFC as the "debt super cycle". This was fuelled by low starting point debt levels, financial de-regulation and the shift from high to low interest rates but it now appears to have run its course as the GFC and constrained economic growth have left consumers wary of adding to already high debt levels and bank lending standards have toughened. This has seen growth in debt slow and households running higher savings rates than prior to the GFC.
Implications – slower growth in household debt likely means slower growth in consumer spending, lower interest rates and central banks having to ease more to achieve a desired stimulus. Slower credit growth may also be a drag for banks.
The commodity super cycle has turned down
The surge in the supply of commodities in lagged response to last decade’s commodity price boom is now combining with somewhat slower growth in China and emerging countries to result in a downtrend in commodity prices. Notwithstanding, cyclical bounces, this could have further to go consistent with the long term pattern seen since 1900. This will act as a constraint on inflation and on growth in commodity producing countries (eg, South America, Russia, Australia) but benefit commodity user regions (the US, Asia, Europe and Japan).
Source: Global Financial Data, Bloomberg, AMP Capital
Implications – favours traditional global shares (dominated by commodity users) over emerging market and Australian shares and suggests that the downtrend in the $A has more to go and helps keep interest rates low.
Technological innovation & automation
Technological innovation is having an ever increasing impact. It seems everything is getting connected to the internet. 75% of the world’s population has access to a mobile phone and by 2030 50% will access the internet. The work environment is being revolutionised enabling companies to increasingly locate parts of their operation to wherever costs are lowest and increasingly to automate and cut costs via robotics, nanotechnology, 3D printing, using GPS systems to manage logistics, etc. The intensified focus on labour saving is likely good for productivity and profit margins but ambiguous for consumer spending to the extent it may constrain wages and worsen inequality. There is also the complication that with so many “free” apps (eg my phone has a navigator that would have cost several thousand dollars in my car a few years ago), growth in activity (ie GDP and hence productivity) is being under measured/inflation overestimated and consumers are doing a lot better than weak wages growth implies.
Implications – another reason for inflation to stay low and profit margins to remain high. But also a potential positive for growth.
Globalisation and offshoring
There is nothing new in globalisation, but it is set to continue as companies under ongoing pressure to cut costs look to emerging countries with lower wages and high education levels to feed into their production chains. While this was once limited to manufacturing, it has now shifted into services and going up the value chain (from call centres to areas like medicine, research and finance). Technology is the key enabler.
Implications – positive for companies that can shift functions across boundaries. Will help keep inflation down.
Asian ascendancy (but messy emerging countries)
Given relatively lower levels of urbanisation, income and industrialisation the emerging world offers far more growth potential than the developed world. However, while favouring emerging over advanced countries was easy 15 years ago it’s now more complicated as big parts of the emerging world have dropped the ball on reforms (with Brazil and much of South America returning to the populist policies of their past) and Russia wanting to go back to its Soviet glory days. They all need another reform stimulating crisis. However, the reform and growth story remains alive in Asia – from China to India.
Source: Angus Madison (2001, 2005), AMP Capital
Implications – favour non-Japan Asian shares (allowing of course for risk).
The environment and social values
While the GFC slowed momentum on global carbon pricing, consciousness of the impact on the environment is continuing to grow. At the same time higher social standards are being demanded of governments and corporates. This reflects a range of developments including increasing scientific evidence of the impact on the environment from human activity and the long term welfare consequences, younger generations demanding higher social and environmental standards and social media that can destroy reputations in a flash.
Implications – this will favour companies that adhere to high environmental, social and governance standards.
The energy revolution
This is real. Renewables account for more than 30% of power produced in Europe. This will only grow as alternatives like solar continue to collapse in cost and solar energy storage becomes mainstream. Likewise advances in battery technology are seeing a massive expansion in the use of electric cars which will feed on itself as this drives more charging stations.
Implications – this has huge negative implications for oil and coal and will accentuate the commodity price downtrend.
Backlash against free markets
Francis Fukuyama’s declaration of the “End of History” with a global consensus in favour of liberal democracy seems a distant pipedream now. Since the GFC in particular we have seen a backlash against unfettered free markets with left of centre parties vacating the middle ground and moving to the left and a general focus on more regulation and more taxes. Witness the calls to end or curtail tax concessions in Australia. Rising inequality may add to the pressure on governments to impose more onerous personal tax rates.
Implications – backsliding on reform could slow growth rates.
Geopolitical tensions
A multi-polar world – the end of the cold war and the stabilising influence of the US as the dominant global power helped drive globalisation and the peace dividend post 1990. Now the relative decline of the US, the relative rise of China, Russia’s attempt to hang on to its Soviet past and efforts by other countries to fill in the gap left by the US are all creating tensions and a more difficult environment geo-politically – what some have called a multi-polar world. This is evident in: increasing tension in the Middle East between (Sunni) Saudi Arabia and (Shia) Iran; Russia’s intervention in Ukraine; and tensions between China & Japan and in the South China Sea.
Implications
Of course there are more megatrends than this – education and obesity to name a few – but I have focussed on the main macro themes. (For those interest in thematic investing see “Thematic investing – principles for long-term investing”, by Andy Gardner, AMP Capital Insights Papers, November 2014). At a general level there are several implications for investors.
- First – several of these trends will help keep inflation low, eg the commodity price downtrend, automation and globalisation.
- Second – several are also consistent with constrained economic growth, notably ageing and slowing populations, slower growth in debt, the backlash against free markets and geopolitical tensions. This is not universal though as increasing automation is positive for profits and the commodity price downtrend is positive for commodity users.
- Taken together this is all consistent with ongoing relatively low interest rates (albeit there will still be a cycle in rates) and relatively constrained medium term investment returns.
- Finally, several sectors stand out as winners including health care, leisure and multinationals. Producers of energy from fossil fuels are potential losers.
