Macro Outlook 2020 Central scenario

Each year, we study a number of themes that could potentially have a major impact on the economy and the financial markets. The common thread running through all these is that the causes and solutions almost always lead us back to policymakers. Central banks and governments occupy the principal roles in all our scenarios. 

Populism and deglobalisation
In 2018 we discussed the rise of populism and deglobalisation. If there is one thing that stands out this year, it’s that politics continues to dominate the economy and the financial markets. The political centre is increasingly fragmented. There is a smaller chance of maintaining the status quo and this causes uncertainty on the markets. The greatest threat is the current trade war. What started out as a trade
dispute, aimed at plugging the gap in the US balance of trade, is escalating into a wider battle about technology and ultimately the global balance of power. In our central scenario for 2020 we expect trade disputes to keep flaring up periodically and there to be more barriers to free trade. It’s probably a
bit dramatic to talk of a new cold war, but the similarities cannot be ignored. A further escalation in trade wars remains our main risk scenario.

Capitalism for the people
Calls for more and in particular different measures to boost the economy are becoming ever louder. It’s clear that unconventional monetary policies have failed to trigger widespread economic growth. Inflation targets remain out of reach and inequality has increased. The clamour for a different type of policy is growing, especially from the middle classes. Kempen describes this as Capitalism for the people. Use of terms such as Modern Monetary Theory (MMT) and the People’s QE or Green New Deal is now commonplace. They are all variations on the same theme: greater government stimulus and less of a focus on budget deficits. In other words, old Keynesian theory given a new look. More expansionary monetary and fiscal policies in the long term are a given for us. If governments really do apply their budgetary policies less strictly, as is the case in the most likely alternative scenario, interest
rates and inflation will both finally start to rise.

The impact of new technologies can be seen all around us, except in productivity figures. An upturn in growth and inflation generated by higher productivity, i.e. techno-optimism, would seem to be a more distant prospect. Competition and investment are the driving forces behind productivity growth. Growth forecasts are low, as is investment due to the high level of uncertainty about the future. Competitiveness plays a role as well: businesses simply have no need to innovate. The
winner-takes-all dynamics enable companies to consolidate their current dominant positions easily. The question is whether the free market always works as it should and how dynamics can be restored. Perhaps there is a role here for governments to act as a kind of market manager.

Growth and interest rates will remain low for a long period
The reality is that the main input variables for potential growth, growth in the working population and productivity growth remain small. The nuance can be found in the response from policymakers. In spite of the trend away from globalisation towards regionalisation, prices continue to be squeezed. Longer periods of low growth in the wake of a financial crisis and deep recession are not unusual. Yet it is now over a decade since the crisis and the uncertainty persists. Luckily, we are seeing that
companies are again daring to borrow. Unfortunately, this debt is not being used for additional investment in the economy. In short, there is little inflation in the real economy but some inflation in the financial economy. The money generated earlier continues to be pumped around the financial economy and is mainly causing low interest rates and pushing up the prices of financial securities. Something odd is happening with capital market interest rates: these have lagged behind nominal economic growth for years. This is bad news for savers and good news for borrowers. And completely in line with what Reinhart and Rogoff [2011] called financial repression. Kempen also sees no reason why interest rates should exceed growth for the time being. On the one hand this is due to the (excessive) levels of private savings (businesses and consumers) that are finding their way to the financial market, as well as the tighter regulations governing pension funds, insurers and banks. On the other hand you have the supply side in which governments (with the exception of the US) are still using their budgetary leeway to a limited extent. The upshot is a small supply of new bonds, while a large number of bonds are still held on the balance sheets of central banks. High demand and low supply, and few signs of this balance changing. We expect interest rates to remain below nominal growth over the next few years. Low interest rates are bad news for savers, but do help investors. This is because low interest rates mean less pressure on valuations.

Unconventional policy
There is no escaping the fact that an upturn in the business cycle is followed by a more sluggish period. The present business cycle has now lasted for an exceptionally long time, but we have yet to identify any major problems. The economy is not overheating, nor are there excesses on the financial markets. Growth is slowing and uncertainty increasing, however. There is little leeway for policymakers to provide stimulation in the event of a downturn; negative interest rates are a largely ineffective weapon. Interest rates consequently cannot fall much further. This means that central banks will again have to resort to quantitative easing when the next downturn occurs. Yet this weapon has become very blunt and we have grave doubts as to whether it would be able to provide the required boost to growth. Ultimately, it will be up to politicians to pursue more expansionary budgetary policies. These would eventually result in the long-awaited reversal in interest and inflation rates. Let’s not get ahead of ourselves though. A great deal needs to be done before more expansionary budgetary policies can be pursued. Especially in Europe, where budgetary discipline remains a sensitive subject.

Climate policy
For investors, ten years is a long investment horizon. Yet a decade is the blink of an eye in terms of climate change. We do not anticipate our living environment being so materially affected by climate change over the next ten years that it will have an impact on our expected return. Yet if nothing is done, the consequences are incalculable. Calls for a decisive climate policy are becoming ever stronger, and more measures will have to be implemented in the next ten years. What these measures will be depends on many factors and remains very uncertain. If governments actively decide to make the economy more sustainable, this could lead to higher government spending. This means investment and in turn higher growth and inflation. A carbon tax could also be an option. Companies are taxed on the burden they place on society and in doing so contribute to combating climate change. The need to restrict our impact on the climate is clear, the question is who pays. In our central scenario, we assume that the economic effect of more investment on the one hand and higher taxation on the other will have
a minor impact on the expected return. 

Realistic returns

If we combine our growth, inflation and interest rate forecasts with current valuations, the outcome is moderate returns over the next decade. When we assume lower interest rates for longer, we are less negative about government bonds and more optimistic about equities. 

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Lars Dijkstra
Joost van Leenders
Kempen Capital Management N.V. (KCM) is licensed as a manager of various UCITS and AIFs and authorised to provide investment services and as such is subject to supervision by the Netherlands Authority for the Financial Markets. This Outlook is for information purposes only and provides insufficient information for an investment decision. This information does not contain investment advice, no investment recommendation, no research, or an invitation to buy or sell any financial instruments, and should not be interpreted as such. The opinions expressed in this document are our opinions and views as of 23 September 2019. These may be subject to change at any given time, without prior notice.