The relationship between ‘prime actives’ and ‘dependants’ is beginning to have wide implications on the demand for assets
In periods of low interest rates, high volatility and strong correlations across asset classes, it is vital to understand the factors driving global change. A portfolio that benefits from global trends is a prerequisite for the generation of stable and positive returns.
Understandably, there is some nostalgia for the ‘golden age’ of investing between 1982 and 2007, when the returns generated in the equity, fixed income and real estate markets far exceeded the rate of inflation.
However, this phase – which was shaped by globalisation, economic stability, the growing acceptance of capitalism and record corporate earnings – came to an abrupt end in 2008.
The very factors that had allowed this megatrend to develop proved unsustainable. One of the most striking aspects of the 25-year boom was the economic stability that accompanied it. Thanks to the disinflationary impact of globalisation, central banks were able to stimulate the economy at will without compromising their mandate to combat inflation.
When the dotcom bubble burst in 2000, the US Federal Reserve (Fed) immediately cut key interest rates to avoid a deeper recession – laying the groundwork for a bubble in the real estate and credit markets. These actions encouraged growing levels of debt which, in turn, smoothed the economic cycle by artificially boosting growth. As a result, the US recorded only 16 months of recession between 1982 and 2007. This is equivalent to around five percent of this period, compared to the occurrence of recessions during 35 percent of the period from 1854 to 1982.
Unfavourable demographic factors
The demand for assets is determined to a significant extent by the proportion of prime actives relative to the number of dependants within a country. In industrialised nations, the size of the economically active generation is constantly decreasing relative to the proportion of the population that is of retirement age: in Japan, it has been decreasing since 1990, and in Europe and the US since 2010. In China, the proportion of prime actives relative to the number of dependants is expected to start declining from 2015.
In most emerging markets, increasing numbers of young people are entering the labour market, but this alone is not enough to compensate for the unfavourable age structure in industrialised nations. As a result of this demographic trend, pension schemes that were established at a time when factors such as life expectancy and the cost of ageing were fundamentally different will come under mounting pressure. A few countries began adapting their pension systems after the 2008 crisis but further unpopular reforms are now unfortunately needed – posing a real challenge for democracies where the election cycle does not coincide with the timeframe for such reforms.
Investments with zero interest rates
Industrialised nations have pushed their debt levels to the limits of what is sustainable – or have gone beyond them in some cases. Consequently, they are unable to further increase government spending in order to avert an economic downturn.
The US Fed, the Bank of England, the Bank of Japan and the European Central Bank have all helped to mitigate the fallout from the 2008 crisis by reducing interest rates to zero.
When this measure also proved insufficient, they resorted to unconventional monetary policy measures such as quantitative easing or long-term bank refinancing operations.
This leaves them with little – if any – firepower in the event of external shocks like a surge in oil prices. Scenario analysis as well as portfolio construction should take the economic cycle and factors such as shorter durations and higher volatility into consideration. ‘Buy and hold’ strategies are unlikely to be successful in the future.
What is the value of savings if short-term interest rates are at zero for the foreseeable future? What is the attractiveness of long-term government bonds yielding below two percent with inflation running at or above two percent and central banks promoting policies which might eventually result in higher inflation? The current situation poses a major challenge for wealth preservation – not to mention the growth of wealth in real terms.
We are currently witnessing a shift in economic momentum towards Asia – a powerhouse that currently accounts for two-thirds of global economic growth. Population growth, coupled with a rising standard of living, is leading to higher consumption of commodities, while supply remains tight.
The identification of such trends is a prerequisite to achieve positive investment returns. However, this alone is not enough: one needs to carefully evaluate which economic agents are the true beneficiaries of rising commodity prices – it may not be mining companies but rather manufacturers of mining equipment, or countries that are altering tax regimes to capture a higher portion of commodity revenues.
Core investment beliefs
As an independent, globally active private bank, Vontobel is committed to thinking and acting independently. In doing so, we are always focused on one objective: helping our clients, whether private individuals or institutions, to realise their financial goals. To this end, we use our expertise to identify promising trends that will ultimately be reflected in client portfolios. We believe that the current investment environment poses challenges that require more than a ‘traditional’ asset mix and portfolio structure.