Five ‘Ds’ raise risks and opportunities for investors

GLOBAL markets are up by 50 per cent since the start of the 2020s. US nominal gross domestic product has expanded by 30 per cent, and US corporate profits have risen nearly 70 per cent. All that in spite of unprecedented global lockdowns due to the Covid-19 pandemic, the outbreak of wars in Eastern Europe and the Middle East, and the largest spike in interest rates and inflation in decades.

These market and economic developments have led some to term the decade so far as the “Roaring 20s”, marked by high economic growth, strong market returns and improving productivity.

However, as we approach the midpoint of the decade, the future from here looks rather complex. Deglobalisation, debt, demographics, decarbonisation and digitalisation – the 5Ds – will be significant forces that present risks for investors but also opportunities. In aggregate, although we expect the trends to lead to higher growth and periods of higher inflation over the long term, they also offer opportunities in certain business sectors.

Globalisation arguably peaked in 2008 with the global financial crisis. Since then, the world has become less global, influenced by the pandemic, rising nationalism, geopolitical tensions and technological changes. These factors have led countries to prioritise domestic interests, resulting in trade barriers and protectionist policies. The election of Donald Trump, with his “America First” approach, could further accelerate these changes – or what is commonly known as deglobalisation.

Active conflicts in regions such as Eastern Europe and the Middle East add to this trend, creating instability and discouraging international collaboration. Technological advancements, while facilitating global communication, have also enabled more self-sufficient economic strategies.

Any increase in trade and capital flow restrictions could lead to higher costs for consumers and businesses, slower global growth and increased inflation. We also expect increased spending on defence to raise levels of inflation and government debt.

Rising government debt

Government debt has grown considerably since the beginning of the decade, fuelled by the extraordinary fiscal stimulus to address the Covid pandemic, ageing populations, and increased defence spending. Higher taxes could be one way of accounting for higher debt levels. There is also a higher risk that governments lean on central banks to finance deficits based on the principles of Modern Monetary Theory, which posits that government spending should not be restrained by fears of rising debt.

But with debt levels now much higher, governments have reduced capacity to deal with a future recession or inflationary shock. There is therefore a greater risk of swings in long-dated government bond yields on periodic fiscal sustainability concerns. Boosting exposure to real assets in portfolios is key, as real assets have a better chance of meeting or exceeding inflation.

Demographics are slow-moving, but we have already seen significant shifts in demographic patterns since the turn of the decade. According to the United Nations, the global population over 65 has grown by around 100 million in the past five years. How societies – individually and collectively – choose to manage migration will play an important role in determining the impact on economic growth and inflation. We believe ageing populations will likely contribute to the growing emergence of a transformational innovation opportunity in the field of human longevity.

Since the start of the decade, renewable energy has accounted for a greater share of the global energy mix, with fossil fuels accounting for a lesser share. Looking ahead, we anticipate that regulatory pressure to decarbonise will persist. Several factors could drive up the prices of scarce resources, including resource protectionism, environmental taxes, higher insurance costs and restrictions on certain energy sources.

Higher energy costs

It remains uncertain whether societies are prepared to accept higher energy costs, especially if energy demand rises owing to increased use of artificial intelligence (AI). Despite these challenges, the substantial investment needed to meet rising energy demand and sustainability goals could also stimulate economic growth.

Large AI data centres are significantly boosting electricity demand. A single Nvidia GB200 graphics processing unit (GPU) can consume as much power as an average US household in a year, and a server rack can hold 72 GPUs. Cooling a modern hyperscale facility can require transferring heat equivalent to melting 36.3 million kg of ice daily. We also expect growth in electric transport, heating, cooling and energy efficiency equipment.

And that leads to what we believe could prove to be one of the most influential innovations of the century – AI. While most market attention so far has focused on the firms enabling the technology, we ultimately expect AI to drive efficiency, innovation and new business models across sectors, from automating routine tasks to enabling advanced data analytics.

If AI’s potential can be realised, we believe it could augur a productivity revolution and contribute to lower prices for various goods and services and higher rates of economic growth. Historical examples can provide some context for the potential magnitude. The PC increased labour productivity by 18 per cent from 1986 to 2000, and the Internet by 20 per cent from 2000 to present. Assuming a 15 per cent productivity boost from AI, we estimate the value creation could amount to US$4.4 trillion.

Despite the complexities and challenges posed by the 5Ds, investors can build resilient and profitable portfolios by thoughtfully embracing near-term opportunities within the framework of a well-crafted strategic plan.

The writer is regional CIO South APAC, UBS Global Wealth Management. He is also Adjunct Associate Professor, Nanyang Business School, Nanyang Technological University