Where to unlock opportunities in a changing world

GLOBAL inflation has fallen since the energy-induced spike that followed Russia’s invasion of Ukraine in 2022, and financial-market participants have been pricing in and out expected interest-rate cuts by Western central banks, depending on whether inflation prints are higher or lower than expectations.

We think the real issue is not whether interest rates should be cut twice or three times in 2024, but whether the market is correct to have anchored longer-term inflation expectations to historic norms.

We believe that investors are now facing a very different market regime, and we are unlikely to see a return to the benign conditions of the previous decade.

It is not just monetary boundaries that have been reached or redrawn; economies are being influenced by several broad structural trends.

Tensions and technology

Among these key trends are growing geopolitical tensions. For several years, the US and China have been implementing restrictions against each other on the import and export of key goods and minerals.

Elsewhere, the war in Ukraine and conflict in the Middle East have led to heightened volatility and disrupted established trading patterns.

In this context, supply chains are evolving rapidly and new trading arrangements are being developed, often driven primarily not by costs but by perceived security.

In addition, investors face the prospect of disruptive structural change across a swath of industries. Artificial intelligence and other advances in technology could lead to valuable investment opportunities for those capable of identifying winners, in multiple sectors.

For example, technological developments are expanding the provision of financial services to previously “unbanked” populations across many Asian economies.

Demographic changes are another contributor to the shifting landscape. With birth rates in long-term decline, economies are becoming increasingly top-heavy.

Notably, China has one of the world’s most rapidly ageing populations, putting pressure on tax revenues and care for the elderly. This trend is also leading to investment opportunities, for example in the life-insurance sector.

Meanwhile, in the aftermath of the Covid pandemic, some regions have seen a significant drop in the number of people willing or able to work. Together with slower migration flows, such factors are influencing the price of labour, as well as affecting consumption trends.

Then there are ecological challenges such as rising temperatures and the depletion of key raw materials. These challenges are closely linked to economics: growth in the next few decades is likely to be different in quantum and nature from the past.

In major developed economies, growth may be slower, with a higher percentage linked to investment in “greening” energy and transportation sectors, and a lower percentage linked to consumption.

In Asia, Indonesia is an important growth engine that is likely to be critical for the global electric vehicle supply chain, given the country’s rich nickel resources and policies to prioritise commodity processing.

Beyond benchmarks

Investors are contending with a complex backdrop. A world that is less stable geopolitically and faces major structural challenges, is likely to be one that remains volatile and is potentially more inflationary.

Against this backdrop, different investors face their unique challenges. In order to meet their specific goals and challenges, investors must take a future-facing approach that is equipped for the world as it is and will be, not an approach that is founded on outdated assumptions from the past.

Although benchmarks can be a useful measure to compare asset managers’ performance, by their nature they are anchored to what has already taken place.

In an environment where the future looks very different from the past, a benchmark may not be the optimal starting point for portfolio construction.

For example, as a result of the recent AI frenzy, the S&P 500 index is today dominated by the mega-cap so-called Magnificent Seven technology stocks.

This has become a major bet on companies which may have high-quality business models, but may also lack the sustained underlying revenue growth to fully justify their lofty valuations.

While history may not repeat itself, a look at previous cycles suggests that market leadership can change dramatically. Internet and telecommunications stocks formed the dot-com bubble in late 1999, but did not lead the recovery when the market finally found its bottom in 2003.

If we are now in a more uncertain period where the overall market will not reliably deliver returns, then an investment approach with an unusually wide and innovative range of inputs in idea generation may be increasingly relevant.

The future is likely to call for much more far-reaching diversification across styles of investing, asset-class categories and alpha sources.

The writer is chief executive officer of Newton Investment Management, owned by BNY Mellon Investment Management