Why volatility is here to stay

Geopolitical fracturing, the rise of sophisticated technologies, demographics and climate change all pose threats and opportunities as the world moves beyond the post-financial crisis regime of heavy central bank intervention, according to BNY Mellon Investment Management chief economist Shamik Dhar.

In an analysis of the current economic and geopolitical climate, Dhar said he did not expect to see any dramatic shift in market fortunes over the next two years, a period he believes is almost too short considering some of the larger issues facing the investing world.

"We have been in an unusual economic situation for the past 10 years, ever since the end of the global financial crisis (GFC) – which was probably the single most important economic event in 70 years.

While we do expect to see normality reappear at some point, the big question is when that will happen as this is not likely to happen any time soon. At a wider level, too often markets think we are back in the world of the 1980s when inflation was the main threat but I simply don’t believe that is the case. What is likely to change is the extraordinary monetary stimulus that we saw from central banks. This year should be the first in a decade where central bank balance sheets are shrinking."

According to Dhar, as the expansion of central bank balance sheets since the GFC helped suppress market volatility, its withdrawal may trigger its reappearance.

"We could be entering a period where we see slightly more volatile markets but it is also a market where active management and buying opportunities could abound more often than they have done," he added.

Within this climate, Dhar believes there is significant lost output to recover. "From 1962 until 2008 we averaged growth of just over 2.5%a year. Since the GFC we haven’t got close to this. In the US, in GDP per head terms, we are now roughly 8% below where we would have been if the financial crisis hadn’t happened.

Source: BNY Mellon Global Investment Strategy using data from US Bureau of Economic Analysis as at 31 December 2018
Chart shows real GDP per capita in the US with an exponential trend line.
Source: BNY Mellon Global Investment Strategy using data from US Bureau of Economic Analysis as at 31 December 2018.

Dhar expects real interest rates to stay very low to negative over the next 24 months, with inflation expectations remaining anchored. He also predicts bond-equity correlations will remain negative or low in the months ahead.

Commenting on the shape of the wider geopolitical landscape, Dhar added: "We are in a very different political environment than we were even five years ago. In some sense, against a backdrop of geopolitical fracturing, we are seeing the dismantling of the post-1945 economic and political settlement. How that will work out for the global economy and politics in the longer term remains unclear."

Faster innovation

Looking beyond this period to opportunities ahead Dhar said faster technological innovation could boost productivity but warned much of the most exciting innovation was still over a decade from implementation.

"We are in an incredibly exciting phase – the fourth industrial revolution. This is a world in which we are blurring the lines between the organic and inorganic, machine and human. While this is a completely new and interesting world, one point to remember is that we are only at the very start of it," he said.

On wider fears about automation and employment levels creating smaller workforces, Dhar remains optimistic, pointing to the compelling benefits of new technologies and their successful adoption in the past, though he accepts there are no guarantees this will continue.

"There is a lot of panic out there that the robots are coming and taking all our jobs. The short run picture is actually quite encouraging and unemployment is now at all-time lows, despite technological innovation.

"We have had 200 years in which there have been enormous scares about technological progress and we have never seen a case of mass technological unemployment. While some companies or sectors might see their workforces shrink, we believe broader economies will not. That said, the future is incredibly uncertain and this time might be different simply because this time we're talking about the potential mechanisation of human imagination " he added.

Beyond shifting technology Dhar said the rise of Asia and shifting demographics could pose both potential threats and opportunities to markets.

"We have an Asian century ahead of us and we are seeing probably the largest shift in human history of economic resources from the traditionally rich west to the growing and rapidly developing east and China. In turn, demographics are changing and Generation Z thinks very differently about investments and the world in general than baby boomers. In many places we also have an ageing population that is going to have some serious implications," he said.

Arguably the single biggest challenge facing mankind in the longer term is the threat of climate change. Here, Dhar sees rich potential in cheaper renewable energy going forward as demand rises and costs fall.

"The threat of climate change is a huge issue for all of us and will create both threats and opportunities. The ways in which the global economy will develop to cope with a changing climate is going to be increasingly important.

Cheaper energy

Renewable energy is one area more likely to get cheaper over the next decade. Investment rates in related industries can be incredibly high and the returns on innovation in the sector are high as well. Over the next couple of years we are likely to see a large jump in the share of electricity generated by renewables, simply because of the fall in price," he concluded.

ClearEdge Research and CompareMySolar UK, accessed 2019.


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Mellon was formed on 31 January 2018, through the merger of The Boston Company and Standish into Mellon Capital. Effective 2 January 2019, the combined firm was renamed Mellon Investments Corporation.