How can institutional investors make sense of the structural shifts in the global economy? Eric Lascelles, RBC Global Asset Management’s chief economist, gave pension plan trustees an overview of the shifts—both short and long term—at the Phillips, Hager & North Trustee Education Seminar 2012 last week at the Fairmont Royal York in Toronto.
Short term
In the short term, investors need to keep two risks on their radar. The first is Europe, which, Lascelles said, has several problems: there is too much debt, the banks have too little capital, their economies are uncompetitive and the eurozone is unsustainable in its current form.
“We’ve seen some forward progress,” Lascelles noted. “Markets are feeling a lot less panic.” But he was quick to point out that although this is good news, it’s important to recognize that even if the market was perfectly content, there would still be problems. “There are still countries with too much debt out there and countries that are not competitive,” he said, indicating that Greece has fallen about 30% behind Germany in competitiveness over the last decade.
Managing volatility in equity portfolios
Getting growth from fixed income
Volatility and the individual investorChina is the other concern. It has grown nicely by extending credit through the 2008 credit crisis. In fact, in 2009, its credit grew by more than one-third. However, this has resulted in local governments with too much debt, he said, and the housing market is overdone. According to Lascelles, China should avoid a “hard landing” for its current housing bubble, but may succumb in five to 10 years.
Long term
Looking long term, Lascelles turned his focus on the U.S. While in the ’80s and ’90s, the U.S. had an average 3.23% growth rate, it has slowed over the years, and its average has levelled out at roughly 0.07% since the financial crisis in 2008.
Lascelles said that though the growth of the ’80s and ’90s may not return, the future economic growth will average out at about 2%-plus per year. We’re in a time of permanently slower growth, he said.
But this slower growth means challenges, and the main one is demographics. This is not great for fiscal coffers, he said, as there are more people retired than working. And an aging population will have more of a preference for bonds, which will depress yield by about 50 basis points, he said.
For markets, slower economic growth usually means bond yields are lower, and central banks are not raising rates any time soon, Lascelles continued. And when rates are raised, they’ll generate capital losses for fixed income investors.
On the volatility front, market fluctuations have been very high in recent years, and it is increasingly clear that volatility can never be completely eliminated from the economic cycle. So investors may still experience more volatile returns than what was once considered the norm, but investors shouldn’t overreact.
Remember, Lascelles said, after many disasters in history (e.g., the Spanish Flu, World War II), growth bounced back. “Don’t think we’ll always be in a crisis.”
Also, there are exceptions in the chain of causation. Economies don’t always grow more slowly after a financial crisis, he noted. And there may be variances in experience; while many economies will grow more slowly, not all of them will.
Finally, Lascelles said to look for the opportunities: profiting from volatility, looking for the exceptions or investing internationally—or considering emerging markets. Emerging market economies have a good outlook for investors, said Lascelles. These countries have sidestepped the worst of the financial crisis because of their faster population growth. Their fiscal position is better, he explained, because their debt load is half as high as that of developed countries.