The Next 20 Years—Our Updated Capital Market Expectations

Executive Summary

  • The global capital markets are constantly evolving, which requires regularly updating forecasts of economic activity and long-term investment returns and volatility.
  • We believe three forces will dominate the evolution of the global economy over the next 20 years—the migration of the global population to cities, converging standards of living between the developed and developing world, and rapid technological development. All of these are likely to drive robust economic growth, particularly in emerging markets.
  • The biggest challenges to the global economy over the next 20 years will be political, not economic.

The recent turmoil in European debt markets and the debt ceiling circus in Washington reminded us all that the global capital markets are dynamic, reflecting the constant evolution of economies and the companies and people that operate in them.

Consequently, rather than taking a static approach to investment management, Aspiriant regularly re-evaluates the environment looking for opportunities for your benefit. As part of this process, we establish long-term (20 year) capital market expectations (CMEs) and re-evaluate them at least every two years. The purpose of the CME process is to:

  1. Ensure that Aspiriant portfolios reflect the constantly-evolving global capital markets;
  2. Provide portfolio expected returns to be used as one of the many inputs in our wealth planning process; and
  3. Guide our portfolio construction and investment manager evaluation process.

The process of developing CMEs is intended to be biennial, to balance the desire to adjust portfolios in response to current events against the need for stable long-term forecasts. However, the tectonic changes in the global economy argue for a more in-depth analysis at regular intervals. Therefore, we conduct a comprehensive analysis of the global economy every six years.

More frequently, we combine our own research with views from international governmental and non-governmental organizations, academia, and investment managers to develop the short-term view of the markets that may be reliably helpful to our clients when implemented through tactical strategies. We publish our near-term expectations in our semi-annual Market Viewpoint.1

Current events influence our CMEs through long-term consequences. Some events which might be very important over the short-run may influence our current allocations, but may not be a factor in our long-run expectations. For example, near term interest rate movements are reflected in our current fixed income implementation but not in our expectation of long-term interest rate movements. Other events might have a significant enough impact on the structure of markets that they change our long-term return or risk expectation for an entire asset class, e.g., the dislocation in the municipal bond market in late 2008.

The Future Global Economy — Much Bigger, But Different

The vast majority of returns from investing are ultimately provided by the economic activities of firms and entrepreneurs. While we expect the future to be bright for the global economy, we expect the future global economy to be much different from the economy of the 1990s and 2000s. The primary goal of this year's project to develop capital market expectations and portfolio mixes is therefore to evaluate the global economy prospectively, looking for quantitative and qualitative signals about the future investment returns which it will generate.

While there are cross currents which will provide both head and tail-winds to the economy over the next 20 years, we believe that three economic forces will dominate the evolution of the global economy:

  1. The migration of the global population to cities, making them more productive and easier to reach with products and services;
  2. The convergence2 of emerging markets, as producers and consumers, to standards in the developed world; and
  3. Technological change, which is increasing the productivity of companies in developed and emerging markets.

The Impact of Emerging Markets

According to a recent study by Boston Consulting Group3, one-third of the world's population (about 2.6 billion people) live in cities located in countries classified as emerging markets. By 2030, this number is projected to grow by another 1.3 billion. This population shift will fundamentally change the global economic landscape — consumer demand will increase rapidly as these workers use more productive technology (and therefore generate more economic value). As local companies compete with global corporations to meet the needs of the new middle class, the local companies will have an advantage. While it is the megacities (metropolitan areas with total populations in excess of 10 million people) that are often highlighted in the media, they account for just a fraction of the opportunity since a disproportionate amount of the growth is occurring in cities with fewer than 5 million residents. Local companies in these smaller cities that are positioned to serve these consumers will have tremendous opportunities to grow.

Rapid growth will further boost the population of emerging-market cities

Graph 1

Source: BCG (2010) based on analysis of United Nations, World Urbanization Prospects: The 2009 Revision; Economist Intelligence Unit; Chan, K.W. "Fundamentals of China's Urbanization and Policy," China Review 10:1, 2010; Mitra, Arup and Mayumi Murayama, "Rural to Urban Migration: A District Level Analysis for India," IDE Discussion Paper No. 137, 2008.

By adopting technology, processes and policies of the developed economies, emerging markets have been able to grow faster, for longer, than any civilizations in human history. In particular, the introduction of mobile phone and internet technology has allowed economic growth to reach a very large portion of the global population without the fixed costs associated with prior shifts in modes of production.4 The rise of the global middle class, which in China alone is expected to number over 500 million by 20175, has been made possible by the introduction of modern capital equipment and technology which enables labor to become more productive. And yet the largest and fastest growing emerging countries (China, India, Brazil) remain far behind on almost every metric of economic and social development.

While these changes have the potential to improve the lives of all, there will be pockets of the global population who suffer, at least on a relative basis, as their skills become less valuable or they are forced to compete with a larger pool of available labor. The losses from competitive change tend to be more concentrated than the gains, leading to protectionism and political strife. It is our belief that the biggest challenges over the next 20 years will be political, not economic.

An article elsewhere in this Insight delves further into emerging markets and their impact on the global economy.

The Developed Market

There are legitimate concerns about the developed economies' ability to grow in the aftermath of the financial crisis. With debt levels soaring, some market analysts have forecasted a "new normal" economy of lower growth rates and investment returns. This view, at least with respect to economic growth, is supported by the academic research which suggests that growth in the OECD countries will be weighed down over the coming decade6.

But the result for returns to companies listed on stock exchanges in developed markets is less clear. The last 20 years has seen a deepening of the capital markets in developed economies, providing more access to economic growth. The market capitalization of the top stock exchanges in the US7 rose from about 60% of GDP in 1990 to 185% in 2000 and is currently about 130%. The huge increase in market capitalization relative to GDP reflects a number of changes — public companies making up a greater percentage of economic activity, earnings growth, access to opportunities in emerging markets, and an increase in average P/E ratios. But it is clear that past relationships between, say, economic growth and local equity market returns must be reconsidered.

Asset Classes

Asset classes are groups of investments with similar risk-return characteristics, resulting from their similar relationship to economic activity.

The Relationship Between Asset Classes and the Business Cycle

Graph 2

Source: Aspiriant. In each column, asset classes in the top box are expected to outperform asset classes in the bottom box. For illustrative purposes only. Past performance is not indicative of future results. All investments can lose value.

This can result in somewhat different definitions than are found at other investment management firms or research organizations. For example, the set of investments sometimes called "natural resources" may be spread across each of Aspiriant's five core asset classes:

  • Debt or equity of publicly-traded commodity producers (fixed income or global public equity);
  • Oil and gas pipelines (real estate);
  • Debt or equity of privately-held commodity producing assets (private equity);
  • Strategies attempting to profit from the dynamics of futures markets over time (opportunistic); and
  • Ownership of commodities themselves (commodities).

Here we present a brief summary of our qualitative views about Aspiriant's five primary asset classes.

Graph 3

Implementation in client portfolios

In response to changes in our CMEs, we made adjustments to our strategic (long-term) client portfolios. Our goal is to create baskets of exposure to economic activity which provides the highest expected return for any level of expected portfolio volatility.

The "efficient frontier"

For individual clients, we connect the efficient frontier to our deep wealth planning work to form a recommendation for each client's strategic allocation. The strategic allocation takes into account the magnitude and priority of clients' financial goals, their ability to withstand volatility in their portfolio value, and idiosyncratic circumstances (e.g., large real estate investments or concentrated holdings of public stocks). We implement the strategic allocation on a discretionary basis, choosing investment managers, establishing trading and rebalancing procedures, and making small tactical changes over time. Your client service team will work with you in the coming months to review the themes underlying our new capital market expectations, review the expectations with you, and apply them to your specific investment portfolio.

Jason Thomas, Ph.D., CFA
Chief Investment Officer, Principal

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1 Our most recent Market Viewpoint, published in March 2011, is available here.
2 Economic growth theory predicts that a country with a lower stock of productive capital (machines, technology) than the rest of the world will grow more rapidly during the period of capital deepening. This "catch-up" is referred to as "convergence."
3 BCG (2010).
4 By comparison, the industrial revolution which started in Britain in the mid 18th century took over 50 years to be felt broadly.
5 OECD (2010)
6 Reinhart and Rogoff (2010) estimate that the relationship between government debt and real GDP growth is weak for debt levels below 90% of GDP. But, above this threshold, median growth rates fall by 1% and average growth falls considerably more.
7 Includes the NYSE, the American, and the Nasdaq exchanges


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Past performance is not indicative of future results. All investments may lose value. Indexes are unmanaged and may not be directly invested in.