Trading places: Assessing investment risk in an uncertain world
21 March 2017 | Portfolio construction
Vanguard's Asia-Pacific chief economist, Qian Wang, PhD, and economist Jessica Wu discuss some of the risks to economic growth and investment portfolios.
Do international trade negotiations present a risk to the global economic and market outlook?
Qian Wang: As we outlined in Vanguard's 2017 economic and market outlook, we expect the global economy to continue growing around its recent trend of about 3%–4% amid geopolitical uncertainties and long-term structural challenges such as slowing productivity growth and demographic headwinds.
But the rollout of a trade renegotiation agenda under the new administration in the United States does represent a significant risk to economic growth this year, along with European elections and Brexit negotiations.
Jessica Wu: The world will be watching US-China trade talks keenly, and positive recent developments suggest that both parties are ready to sit down and negotiate on all fronts – trade, investment and opening up the financial sector.
Does the trend towards populism in politics also represent a risk?
Qian Wang: Rising populism is one of the biggest risks for the global economy. It's fuelled by a feeling among some that they have been left behind, and they blame globalisation for the growth in inequality.
But reality doesn't match perception. Only 13% of the job losses in the United States can be explained by globalisation, with 87% explained by technological advances.1
While the public may perceive immigrants as a threat to the labour force, the reality is that lower-skilled jobs are being replaced by machines including robots and computers. The kind of jobs that are thriving are those that can't be replaced by computers or those that use a computer as a tool.
Jessica Wu: Overall technological advances are good for the global economy. But recently the pace of change has moved faster than the average human's ability to adapt. The resulting frustration is contributing to anxiety over the gap between rich and poor in terms of income inequality. People want to find a scapegoat and they are pointing the finger at globalisation.
Qian Wang: This kind of populism risks compromising long-term objectives for short-term political considerations. And the risk is that it could slow the international flow of capital, labour and technology, leaving us stuck in a low-growth environment for some time.
So even though we believe we may see a cyclical uptick through 2017 and 2018, we remain cautious about the long-term global economic outlook.
How should investors react to political developments, and what's the likely impact on portfolios?
Jessica Wu: With US equities running hot in recent weeks, the markets seem to have been relatively unconcerned about trade issues. But the potential risks are still there and haven't been fully priced in by investors.
Qian Wang: This is a perfect time to tell investors to go back to core investment principles. In our 2017 economic and market outlook we outlined four potential scenarios for the US economy. It looks as though some investors have assumed the US has entered a 'cyclical acceleration' scenario, and they have been moving overweight to equities and underweight to bonds based on this positive reading.
But 'cyclical acceleration' is not Vanguard's baseline expectation, and we believe there's still a 30% chance the US economy may enter a recession because of a trade war or stagflation. If this happens, investors who have moved away from their strategic asset allocation would be left exposed. So investors would be well advised to make sure they are protected if the 'not so ideal' scenarios eventuate.
In such an uncertain year, the importance of diversification cannot be overemphasised.
1 Source: Vanguard, using data from the World Bank and Ball State University.
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