A potential US recession, Brexit and decarbonisation are among six key drivers for markets over the medium-term that BMO Global Asset Management believes will inform their asset allocation decisions over the coming years.
Globalisation
The first theme identified by the BMO fund managers, strategists and economists from around the world is the decline of globalisation in recent years.
Having been one of the dominant themes helping drive markets higher in the quarter century since the collapse of communism, globalisation has come under attack from a surge in populism in recent years.
Supported by the birth and growth of the internet, globalisation has driven the “unprecedented expansion in trade and financial flows”.
“But the pendulum now appears to be swinging against it, with voices from both the political left and right rejecting it for being either too capitalist or too centralised,” the firm noted.
“The retreat from global leadership by the US is arguably accelerating the process. As China also turns more introspective in its economic policies, globalisation is starting to give way to regionalisation.”
While globalisation is unlikely to go away, the next decade will not see the same level of expansion that it experienced previously, according to the asset manager noted.
“While we do not expect globalisation to be reversed, it has stalled and the break-neck economic expansion of the last two decades and is unlikely to be repeated,” the firm added.
Decarbonisation
Climate change has dominated the headlines in 2019 and is likely to remain an important theme for some time to come, as awareness in markets continues to rise.
As such, decarbonisation should be an important issue for markets in the years ahead, with BMO noting that to reach the Paris Agreement’s targets the global economy will need to have net zero carbon emissions by around 2050.
“The pace of change in the past decade, and even the past couple of years, has been huge, with some bold corporate and government commitments helping to provide the confidence to invest in innovations,” the asset manager noted.
“Will the world reach net zero or will we bust the budget? Either way, there are big changes ahead to our energy systems and lifestyles.”
US recession
“Fears of a US recession are widespread,” noted the asset manager, highlighting the ongoing US-China trade stand-off and the potential impact on the economy.
“The most dangerous joker in the pack has been trade wars,” the firm said. “The tariff spat between the US and its major trading partners – notably China – may have had a relatively modest direct impact on US growth, but business confidence has weakened, taking global investment growth down to zero.
“Trade tensions increase the risks, a full 25 per cent tariff would reduce Chinese growth by one per cent and US growth by 0.5 per cent. Their direct impact may be limited but they have hit business confidence and investment.”
The inversion of the yield curve during the summer worried many economists and analysts given its role as a closely watched indicator for a US recession.
However, a yield curve inversion may no longer have its prophetic abilities as the low interest-rate environment and years of quantitative easing (QE) have distorted the market.
While it remains unclear whether a recession is imminent, it may be avoided (temporarily) by any resolution to the trade stand-off and an accommodative policy stance by the Federal Reserve.
An auto breakdown in Germany
The engine of Germany economy has been driven by it auto manufacturers in recent decades, said BMO Global Asset Management’s strategists, but that could now be under threat due to the emergence of electric vehicles.
The sector faces disruption thanks to new technology and the already mentioned decarbonisation trend that is making electric vehicles more viable and more attractive.
“We think the impact could be so great that France, with its low reliance on auto exports and recent labour market reforms, could assume the leadership of the eurozone economy,” the firm noted.
A surge in fiscal spending
More than a decade since the global financial crisis the tools that were used to underpin the global economy are now starting to come under greater scrutiny.
As such, BMO Global Asset Management fund managers believe that greater government spending and tax-cutting might now be turned to by more opportunist politicians to stimulate the economy.
This has been seen with the rising popularity of so-called ‘Modern Monetary Theory’, particularly in the US, which argues that a country issuing its own currency cannot run out of money and should not be worried about government debt.
“With low and stable inflation giving the more flexibility, central banks are talking up the need for fiscal expansion,” the firm noted. “Central banks are talking up the need for fiscal expansion, and speculation is rising that it could also be used to fund green policies.”
Brexit
The final medium-term driver of markets highlighted by BMO Global Asset Management is Brexit, which continues to rumble on with no end yet in sight.
“The only certain thing when it comes to Brexit, is continued uncertainty,” they noted.
Digging into the “economic fundamentals” of the Brexit landscape, BMO said that if the UK was to leave with no deal then the market would expect the Bank of England to cut interest rates and ease monetary policy in other ways.
However, the firm warned that a wide current account deficit and rising wage inflation gives the central bank little room for manoeuvre.
“Life will never be the same following the referendum but the longer-term outcome depends on a possible new government and the policies they pursue,” the firm noted. “Whatever happens, it represents a significant change for the UK.”