The global economy will experience 2.6% real average annualised growth over the next five years, along with a continuation of controlled inflation and accommodative monetary policy, according to Northern Trust’s Capital Market Assumptions Five-Year Outlook. The firm predicts that interest rates will remain low, with the US Federal Reserve not raising its federal funds rate for at least five years. And, despite several emerging forces trying to raise inflation, it expects it to remain below central bank targets as these forces are offset by the impact of technology and automation, weak consumer demand, and a slow employment recovery.

The Capital Markets Assumptions report, featuring five-year average annualised return expectations and forecasts for a wide range of asset classes, is produced annually. Rooted in the firm’s capital market analysis, it informs the investment decisions and asset allocation recommendations made by Northern Trust, which as of 30 June 2020, had US$1.3 trillion in assets under management.

On a global basis, the report foresees average annualised equity returns in the mid-single digits except for emerging markets in Latin America - 8.2% - and in Europe, the Middle East, and Africa (EMEA) - 7.1%. The next highest equities forecasts are for Australia at 5.8%, the UK at 5.6%, and Europe, excluding the UK, at 5.4%. The lowest forecasts are for Japan at 3.8% and the US at 4.7%. The forecast for overall emerging markets is 5.4%.

In fixed income, except for a 5.6% return expectation for global high yield, including 5.5% for the US and 5.2% for Canada, the report is calling for returns mainly in the 1% - 3% range. Emerging market debt is an exception at 4.5%. The highest cash return expectation is a paltry 0.2% for Australia and Canada, followed by the US and the UK at 0.1%. Negative cash returns are expected for Japan (-0.1%) and Europe (-0.5%).

Except for the 8.2% return expected for Latin American emerging market equities, the highest return forecast is for private equity at 7.9%. In contrast, the forecast for hedge funds, the other main alternative investments asset class, is much lower at 2.6%.

The report also includes real assets for which expectations range from 3.6% for natural resources to 5.8% for global listed infrastructure to 6.3% for global real estate.

Investment themes

The Capital Market Assumptions report’s asset class forecasts are driven by, and its strategic positioning is informed by, the following six key themes that Northern Trust has identified as shaping the investment landscape for the coming five years, and perhaps beyond. 

Retooling global growth 

This is about companies prioritising stability over profitability, resulting in long-term global economic growth being tempered. Northern Trust believes that companies will look to re-route supply chains, move production inside their home countries and build healthier balance sheets. And, following the surge in growth expected from COVID-19 economic relief measures from countries across the world, the firm expects global growth will settle at low levels, with a five-year annualised rate of 2.6%. 

“Investors need to come to the realisation that many of the jobs lost because of the virus are never coming back, with the permanent loss of many brick and mortar retail stores a major reason,” said Jim McDonald, chief investment strategist at Northern Trust. “And we can’t forget that the pandemic stimulus packages have added trillions of dollars to what were already staggering government debt levels in many countries.”

Massive monetary toolkit

As shown during the pandemic, central banks have not been hesitant to reach into their “toolkits” to provide monetary support to countries ravaged by COVID-19. 'Massive monetary toolkit' is the phrase that Northern Trust coined to describe this second investment theme. But, beyond monetary policy, it includes coordination with fiscal policy since central banks can purchase securities through money that they have newly created. The Northern Trust forecast notes that this de facto monetary-fiscal policy approach will prevent exogenous shock-driven recessions from becoming depressions.

Stuckflation

This remains a theme in this year’s Capital Market Assumptions report, appearing for the fifth consecutive year. It is built on, among other things, the continued failure of most central banks to meet 2% inflation targets, along with technological innovations and troves of data enhancing price transparency and discovery. 

“While we recognise the fact that all of the fiscal and monetary stimulus money that has been pumped into economies to combat the dire impact of the pandemic could drive up inflation, we expect this to take years because of such counter inflation forces as supply chain stability as a result of advances in technology, consumer spending hesitancy, and a slow return of jobs,” said Wouter Sturkenboom, chief investment strategist for Europe, the Middle East, Africa, and the Asia-Pacific region at Northern Trust.

One world, two systems

Northern Trust sees no lessening in tensions between the US and China, hence this fourth investment theme. These tensions, which now extend beyond trade into blame for the virus, not only impact the two countries. Other countries and multi-national companies will be forced to pick a side or remain neutral. Regardless of their choice, they, along with the principal combatants, will suffer from lost economic opportunity or economic inefficiencies, and very likely both.

Reimagining capitalism

This fifth theme is aligned with the efforts of the US Business Roundtable, a group of CEOs from the world’s most influential corporations, to redefine the purpose of a corporation beyond just serving the interest of shareholders. In its new “Statement on the Purpose of a Corporation,” the Roundtable stated, “While each of our individual companies serves its own corporate purpose, we share a fundamental commitment to all of our stakeholders.” 

With this view becoming global, the report’s theme recognises that such a shift in purpose may mean less profit for companies across the globe. “But, empirical evidence shows that when you take environmental, social, and governance factors together, you often achieve better risk-adjusted performance over both the long- and short-term with companies that rate higher on these sustainability metrics,” said Bob Browne, chief investment officer at Northern Trust. “We expect that an increasing awareness of this will lead to a more sustainable economic system, as business leaders, the ultra-wealthy, and politicians will find a way to forge a new capitalism that works better for all.”

Stay focused on climate change

Sustainability is also the core of this, the report’s final theme. With COVID-19 tragically showing how severely large, non-financial events can hurt not only investment returns (despite the subsequent recovery), but the overall economy as well, we expect that most countries will act with considerable urgency to mitigate climate change risk. Post-pandemic economic rebuilding will force leaders to confront it. This will be a headwind for some industries and a tailwind for others.