For this mid-year outlook, we break down our findings into two key themes: a long-term view of the future, and the more near-term influences of the business cycle. This dual focus helps to shape our strategic positioning and clarifies investment perspectives for the year.
A long-term view of the future
We start off with a bird’s eye view on today’s situation by looking at economic growth and its drivers. If we look at overall real GDP growth trends over the past two decades, the general evolution seems positive at first glance—albeit with significant dents during 2008 and 2020. The exceptions to these downturns, notably China, can be attributed to massive fiscal stimuli, such as those seen in 2010. The United States has also shown robust performance recently, again supported by substantial fiscal stimuli. However, a closer look reveals that the pace of real GDP growth is moderating, particularly outside the United States.
To better understand real GDP growth, it's useful to break it down into three main components: ‘population growth’, ‘productivity growth’, and ‘debt growth’. Unfortunately, both population and productivity growth are on the decline across the West, posing a challenge to sustained economic expansion. The United States, in particular, is at a juncture where it cannot afford a slowdown in growth if the US wants to keep its hegemony. On the other hand, debt growth is increasing, raising questions about its implications—whether positive or negative.
1. Population growth
As the first of three components, population growth is crucial to GDP as it directly influences the labour force, impacting economic output and consumption. A declining population presents significant challenges: it reduces the workforce, limiting the economy's ability to produce goods and services. Additionally, with an ageing population, there's a rise in healthcare and pension costs, supported by fewer workers. This could result in higher taxes or reduced services, undermining economic stability and growth.
Overall, today's fertility rate is concerning—rapidly decreasing across Western nations and dropping in nearly every region except Africa and parts of Asia. Notably, the decline is most pronounced among the working-age population. While the United States currently still shows a positive trend, a downturn is expected in the near future—one that’s likely to persist for decades to come. This demographic shift poses significant questions about future productivity levels.
2. Productivity and innovation
Just like the population, there is a visible downtrend in productivity, measured as real GDP per hour worked. A downtrend in productivity reduces GDP growth as it lowers output per labor hour, hurting competitiveness and leading to wage stagnation. This can suppress consumer spending and discourage business investment, further impacting economic stability.
However, it's not all doom and gloom. Innovation, including advancements in AI and robotics, has the potential to bolster growth and help economies emerge from their current productivity slump. This change would certainly be welcome: since productivity tends to be disinflationary, an increase in this area would be a positive development in today's inflationary environment, potentially reversing the trend in the medium-term.
3. The rising importance of debt
Today’s need for increased debt arises from several critical areas: defense, climate transition, infrastructure maintenance, and the implications of a declining population. After decades of dominance by monetary policy, fiscal policy is starting to take a more prominent role, potentially overtaking its monetary counterpart. Someone must manage the implications of this mounting debt, and it appears the Federal Reserve has taken on this responsibility. The US national debt currently stands at USD 34 trillion, which is 122% of GDP. And that number won’t go down anytime soon, with the US also facing a substantial budgetary deficit of around 5% annually.
As the United States braces for its next presidential election, many speculate on the potential impact the result could have on the nation's escalating debt. In truth, whether the White House welcomes back Donald Trump or retains Joe Biden, the current deficit is likely to persist. Given the current level polarisation in the US and the deep political divides, major cuts in social security or Medicaid seem highly unlikely to come from either side of the political spectrum. The outlook remains grim, with projections for 2028 painting a worrying picture: a national debt that is expected to balloon to USD 46 trillion and annual interest payments skyrocketing to USD 2 trillion. This is a considerable leap from today's comparatively low interest payments of USD 0.74 trillion.
Short term influences of the business cycle
Turning to the financial markets, we currently reside in an era of fiscal dominance, characterized by growth while inflation prints remain stubbornly elevated, notably in the US. Ideally, productivity growth re-accelerates steering global economies towards a disinflationary boom, characterized by robust economic activity with controlled inflation levels—an intriguing scenario for financial markets, embodying what might be considered the 'natural state of capitalism.'
It's clear that the business cycle is in an expansion phase, as indicated by the PMI new orders graph holding comfortably above the 50 mark. This reflects ongoing growth, particularly in the U.S., although there are some signs of a slowdown across both the U.S. and Canada. Meanwhile, Europe and China are experiencing a slight upturn, though they are rebounding from near-recession and definite recession states, respectively. On the other hand, India continues to benefit from its demographic dividend, showing steady growth.
Focusing on monetary policy, central banks, including the Federal Reserve, traditionally react to lagging indicators such as unemployment and inflation. However, leading indicators suggest an upcoming rise in unemployment and a slowdown in wage growth, likely leading to lower inflation. This could enable the Fed to halt quantitative tightening and reduce interest rates later this year, potentially buoying both equity and fixed income markets.
Liquidity, rather than earnings, serves as a more transparent indicator at this time. There's an available pool of USD 700 billion poised for investment ahead of the upcoming elections, likely driven by strategic moves from key economic and political figures to bolster the Democrats' position. This infusion is expected to sustain market momentum for the time being.
In commodities, gold, alongside modest interests in copper and silver, remains appealing, especially with gold's recent 15% appreciation. Equities have also shown resilience, driven by surpassing expectations and innovations in the field of AI and GLP1. In contrast, real estate and fixed income have seen a slow start of the year since their strong showing in late 2023. We could envision a turnaround for both asset classes in the latter half of this year, especially with the ECB's recent rate cuts.
However, several risks loom on the horizon. Both Chinese and U.S. real estate markets are weakening, and U.S. regional banks have faced challenges throughout 2023. Additionally, the low volatility index (VIX) and high equity exposure among U.S. households signal high levels of complacency.
Where does this leave us? If we consider the dichotomy between long-term trends and the current business cycle's nuances, it’s definitely a lot to take in. From a long-term perspective, challenges such as decreasing population and productivity growth threaten to stifle economic expansion. Fortunately, these might be offset by potentially transformative innovations in AI and robotics, which hold the promise of reviving productivity, essential for offsetting demographic declines and sustaining growth. In the short term, we are witnessing an expansion phase within the business cycle, highlighted by strategic fiscal maneuvers and robust market activity, which may temporarily cushion the impacts of structural economic shifts. However, active management and a discerning approach to economic indicators will remain important to make guide investors in the months ahead.
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