Investing for the next 20 years

Will slower economic growth mean lower returns?

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Key takeaways

  • Forecasts of gross domestic product (GDP) growth may offer insight into how stock markets and bond yields could fare in the future.
  • Population and productivity trends may slow global GDP growth over the next 20 years.
  • Slower growth could mean lower-than-average interest rates and lower stock market returns than in recent decades.
 

Over the past 20 years, the global economy has grown at an average annual rate of 2.7% thanks to a variety of factors including rising globalization, advances in information technology, and increased trade. That growth has been accompanied by strong performances from both equity and fixed income markets. During the next 20 years, though, Lisa Emsbo-Mattingly, Dirk Hofschire, and Irina Tytell of Fidelity’s Asset Allocation Research Team predict that global GDP growth will slow to an average of 2.1% annually with potential consequences for financial markets. They base their forecast on productivity and population data from 40 countries and they cite demographic trends including aging populations in developed economies as a key factor that will slow growth. They also predict that the rapid growth rates that Asia's emerging market countries have enjoyed in recent decades may become more difficult to sustain as their pace of rapid industrialization slows.

Slower growth is not the same as declining growth, however, and the global economy is still likely to expand over the next 20 years. The US should average roughly 1.6% annualized growth and narrowly retain its status as the world's largest economy. Emerging economies will likely grow faster and account for a greater portion of global growth over the next 20 years. These countries are projected to comprise about half of global GDP by 2038, compared with about 40% now and one-quarter 20 years ago. This should help offset weaker outlooks for Japan and many European countries.

Why growth may slow

Economic growth results from increases in the number of people working and in the amount of output those workers produce. A country's labor force participation rate has the most direct impact on GDP growth. This statistic reflects the number of working age people who live there and the percentage of them who are either working or seeking work. In advanced economies, longer lifespans and low birthrates are producing aging populations that tend to lower labor force participation rates over time. Labor force growth rose rapidly over the past several decades, but developed economies such as Japan and parts of Europe are likely to see their labor forces shrink over the next 20 years as people live longer and birth rates remain low.

While predicting population trends that affect GDP is relatively easy, making predictions about productivity is more complicated. For most of world history, productivity grew extremely slowly and economies generally expanded in line with their populations’ growth. At the start of the Industrial Revolution in 1820, the largest economies were China and India, which also had the largest populations. After that, technological innovation powered rapid productivity gains and by 1900, the US was the world’s largest economy, despite having only one-fifth as many people as China. Some economic forecasters believe the US possesses an inherent dynamism that will maintain this type of high productivity growth over the next 20 years, perhaps boosted by artificial intelligence, robotics, and other technologies. Others believe the era of strong productivity growth is ending. They point out that per capita income has stagnated in the US and other developed economies, while technology seems less transformative than before. For instance, recent advances—such as mobile connectivity—have yielded consumer luxuries such as new smartphone apps rather than revolutionary innovations. Fidelity's analysts believe both perspectives suffer from a narrow focus on the US and do not reflect a global economy in which emerging countries account for more than one-third of output. Instead, they forecast productivity growth by looking at 3 proven drivers of productivity, which they call human capital, structure and catch-up potential.

Human capital reflects the educational and scientific achievements of a nation’s people, and the higher the human capital, the more productive its economy. Human capital tends to be greatest in the US, Japan, and northern Europe. South Korea also has a high human capital ranking and emerging economies including China, Indonesia, and Malaysia have made great strides over the past 20 years. This accumulation of human capital over the past 2 decades should boost global growth in the next 20 years.

Structurally complex economies are those that produce a variety of sophisticated products. They tend to be competitive, use technology effectively, possess healthy business climates and institutions, and are highly productive. Fidelity’s researchers believe that the increasing complexity of emerging economies such as South Korea, Malaysia, and China will contribute slightly to higher global growth over the next 20 years.

An additional driver of productivity growth is the ability of less-developed countries to grow quickly from low levels of development, adopt existing technologies, and catch up to the higher income levels of developed countries. This catch-up potential will likely contribute much less to future global growth than it has over the past 2 decades as economies such as China, India, and South Korea will have less catch-up potential in the next 20 years than they did in the past.

Why GDP matters for investors

Economic growth has a profound influence on corporate earnings, interest rates, inflation, and many other factors that affect the long-term performance of financial markets. Slower global growth may mean less support for stock market returns over the next 20 years than has existed since the end of World War II. Emerging market stocks and the stocks of companies with significant exposure to emerging market consumers may fare better if growth is concentrated in emerging economies, but that growth may prove to be unevenly distributed across emerging markets. Slower growth will also matter for bond investors if interest rates rise gradually from their current levels but remain lower than their historical averages.

To be sure, while GDP forecasts can provide guidance for investors seeking to set realistic expectations for future returns from their portfolios, other factors such as stock market leverage and valuation dynamics will also play a role in how stocks perform. For bonds, GDP growth has a tight, positive relationship with interest rates, yet fixed income investors should also bear in mind starting yields and other considerations. It’s also important to remember that the cyclical expansion and contraction of the business cycle will also move markets over the shorter term.

As someone—perhaps Yankee catcher Yogi Berra, maybe film producer Samuel Goldwyn or possibly physicist Niels Bohr—famously said, "It's tough to make predictions, especially about the future." However, those investors whose portfolios are well diversified across a broad, global opportunity set may be best positioned to take advantage of future growth, slower though it may be.

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