We believe the future of the U.S. and global economies will likely follow one of four different scenarios.
Four main scenarios
For each scenario, the position of the bubble shows the combination of growth and inflation that we expect to see in the next one to three years.
The size of the bubble illustrates our view on the likelihood of this scenario occurring – this is subjective, and is intended just to illustrate our thinking.
Growth is expressed in relation to the potential for each country. For example, a growth rate of 4 percent would be low for China but very high for Europe. Similarly, inflation relates to a country’s individual inflation target.
Implications for investment returns
The tablebelow summarizes the expected returns of the major asset classes under each of our four main scenarios.
The circles in the boxes show the expected return over the next three years, relative to the long-term expected returns*. Light green means higher than long-term expected returns*, while light red means lower.
In most scenarios equities are the most attractive asset class. But valuation support is limited, exposing equities to a potentially sharp correction.
1. Favor equities
We continue to favor equities despite their demanding valuations:
- Abundant liquidity and repressed interest rates in our “muddling through” and “new monetary world” scenarios continue to support equities.
- Improved earnings prospects in our economic renaissance” scenario should also boost equity prices despite the prospect of higher interest rates.
- This pattern applies particularly to the US market. It is the most overvalued region but prices could continue to rise if the “economic renaissance” scenario becomes increasingly likely.
2. Be cautious on bonds
- We are avoiding long-maturity nominal bonds because they would be negatively affected by a normalisation of monetary policy in our “economic renaissance” scenario.
- Within fixed income we continue to like shorter-maturity corporate bonds. This part of the market has two attractive features. First, there is still a decent yield advantage relative to government bonds. Second, the short maturity would offer some protection against rising interest rates, especially in our “economic renaissance” scenario.
3. Maintain exposure to real assets
- The still sizeable probability of our “new monetary world” scenario lies behind our ongoing exposure to real assets such as gold, real estate and possibly inflation-linked bonds.
- We are also confident that over an economic cycle equities continue to offer protection against inflation.
- Additionally, we are focusing on hedge funds that have the flexibility to adjust to an unexpected increase in inflation.
4. Maintain hedges
Although we believe the “depression” scenario is the least likely, its impact would be so disruptive that it must be considered within our investment strategy. Notably, equities are not well supported by current valuations, while monetary policy is limited by high debt levels and interest rates that are already close to zero.
Therefore, we recommend hedging strategies that can limit the potential losses from your portfolios.