3 Investment Trends Driving Portfolios in the Coming Years
Potential Investing Threats and Opportunities
Over the next five years, we think investors must navigate economic, environmental, and political threats and opportunities to achieve their goals. As part of our Capital Market Assumptions Five-Year Outlook research, we identified those threats and opportunities through broad investment themes we believe will drive portfolio risk and return. We explore three of those themes.
No economic variable has changed more rapidly or created more volatility for investors over the past year than inflation, leading to . Just as investors thought inflation caused by pandemic-related supply disruptions would eventually settle down, the war in Ukraine triggered soaring commodity prices and forced investors to recalibrate their inflation assumptions. High inflation has sparked aggressive responses from central banks globally, increasing interest rates and volatility for stocks and bonds.
The war has primarily increased inflation through higher commodity prices, which may last for years. Before the war, Russia supplied 12% of global oil and 17% of global natural gas exports. Russia and Ukraine combined supplied 29% of global wheat and 19% of global corn exports.* This supply is at risk of disruption — both in the short term because of disruptions to planting, harvesting and exporting and the long term with potentially persistent Russian boycotts in reaction to economic sanctions by the U.S. and Europe. Russian boycotts will more likely influence the five-year horizon more, as it further entangles a global supply chain already snarled by the COVID-19 pandemic. The war has also notably widened the already-growing “West-East” divide, jump-starting a dramatic rebuilding of energy and technology self-sufficiency to lessen dependence on imports from political adversaries.
Automation and digitization are still impactful disinflationary forces, but can take time to overcome the recent shocks of stressed global supply chains, tight commodity markets and depressed labor supply. Recalibration will likely take much of the five-year horizon
Exhibit 1: THE END OF AN ERA
The end of persistently low inflation means investors must recalibrate their invesment assumptions.
Automation and digitization still produce powerful disinflationary forces, but these forces need some time to overcome the shocks of stressed global supply chains, tight commodity markets and depressed labor supply. While inflation may take years to return to normal, we believe the worst has passed.
To fight inflation, central banks have decisively shifted their focus from supporting the pandemic-damaged global economy to fighting global inflation. This has created a Monetary Drought, in which central banks have increased interest rates, cutting to a trickle the previous flood of monetary support. Investors must adjust for higher interest rates when making investment decisions, such as valuing equities, and no longer depend on central banks to come to the rescue if the economy falters.
The “terminal” forecasts found in Exhibit 2 represent where we believe policy rates will be at the end of the five-year period, which can somewhat obscure our year-by-year policy expectations from start to end. For instance, we expect the Fed will end the five-year period at 2.5% but will push rates up over the next year before slowly coming down. The average (green bars) takes into account our forecasted trajectory (2.8% in the case of the Fed), providing a better indication of the average monetary policy environment expected over the five-year horizon.
The Federal Reserve's policy rate is the federal funds rate, the interest rate at which depository institutions such as banks lend reserve balances to other depository institutions overnight. The Fed adjusts the rate as a way to implement monetary policy, which may impact economic growth and inflation.
Exhibit 2: CENTRAL BANK PIVOT
Central bank policies and the resulting short-term rates are taking a more restrictive turn, and we think investors will need to adjust for higher interest rates in the coming years.
Green Transition Still a Go
Russia’s attack on Ukraine has brought forth a new political landscape alongside new security concerns, and the sits right in the middle of it all. Russia’s cutback of its energy supply to Europe has forced politicians to ensure that energy demand can be met — whatever the source.
We believe the approach to the green transition will diverge by region. Europe and Asia in the short term are seeking to fulfill their energy needs any way they can. They are importing liquefied natural gas and increasing production at coal-fired power plants. At the same time, however, the high prices of fossil fuels have encouraged massive public and private investment in renewable energy, such as solar power, and conservation. Even more, governments are signaling they understand the role renewable energy and nuclear power must play in achieving energy security. As a result, despite the short term pullback, investors should expect a bolstered green transition in the medium-term.
In the more politicized U.S., some use energy security as the justification to commit more deeply to “made in America” fossil fuels instead of renewable energy. Opposition by the Republican party to green energy threatens the pace of the green transition. However, with fossil fuel prices likely to stay elevated, we think the U.S. will naturally shift toward green alternatives such as wind and solar as well as electric vehicles.
While we believe the urgency to source energy in today’s political climate will slow the pace of the green transition in the short-term, war in Ukraine has also pushed fossil fuel prices higher and spurred a renewed focus on energy security. This potentially drives private and public investment in renewable energy and energy conservation, for reasons beyond their clean-energy merits. We expect this to accelerate the green transition — and green investment opportunities — in the medium- to long-term.
The green transition aims to mitigate climate change and environmental degradation through the development of green technology and sustainable industries.
Inflation, volatile interest rates and the green transition likely will impact investors’ portfolio decisions for years.
These global trends may spark turbulence for equities and bonds as central banks calibrate for economic changes and surprising political turns. While investors may frame this uncertainty as threats to their portfolios, we think alert investors can uncover plenty of opportunities.
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