You might not have noticed it, what with one economic crisis and stock market meltdown after another grabbing your attention, but the last few decades have actually been great ones for investors. Thanks to a perfect storm of factors, investment returns for the period from 1985 to 2015 came in at well above the historical norm. The fundamentals are changing, however, and the next few decades are likely be quite different in terms of returns on both equities and bonds.
These predictions on the direction of the financial markets come from a new report from the McKinsey Global Institute (MGI), which chronicles why times have been good, and why there are likely to be less good in future. Of course, many people are probably surprised to hear that times have been so good. Over the past three decades there have been a number of economic and financial corrections which gave investors plenty of opportunities to lose wealth rather than build it. Still, as McKinsey documents, overall returns have been pretty solid Just looking at U.S. equities, for example, there was a return of 7.9 percrent over the period, as compared to 6.5 percent over the past century. For U.S. government bonds, the return was 5.0 percent compared to 1.7 percent.
The factors that caused the above-average growth are not factors that are likely to be repeated. For one thing, the past three decades have been marked by above-average global growth that has been powered in part by demographics. Countries, most notably China, have been able to draw on a relatively young workforce to hasten their industrialization process. Unfortunately, the world is getting older and as even newly-industrialized countries age, that advantage will lessen. As well, we have just come through an era of extraordinarily low inflation and interest rates that is unlikely to be repeated. Those factors aside, we are entering a period in which the corporations that once dominated will find the competitive environment much more difficult. Increasingly, new companies are springing up from the newly developing world, and as they do it will become increasingly difficult for North American companies to make the kind of profits that were once routine.
While I agree with all the assessments in the MGI report, the demographics argument is the one the one that I find the most compelling, and indeed is one that I speak on and have written on often. There is something called the ‘Demographic Window’ for a country that refers to the period when the mix of working age population is at a healthy level compared to younger people and those who have left the workforce. When the window is open you have the right conditions for growth, which ultimately powers the domestic and global economies. The window has been closed for years in Europe, and slamming shut in North America. What many people do not realize, however, is that it will also close in China within a decade, and in many other newly industrialized countries as well. As that happens, the prospects for growth start to diminish.
Although the McKinsey report does not touch on it explicitly, there is also evidence that having population in the right mix can make a big difference to the stock market. People in their 20s and 30s tend to be spending, those in their 40s and 50s are savers, and those in their retirement age tend to draw down their savings. As simplistic as that characterization may be, it tends to describe how people act over their lifetime when it comes to investments. Now, with baby boomers streaming into their retirement years and a smaller cohort to replace them, the prospects for equity markets – both in North America and around the world – look to be compromised.
McKinsey estimates that over the next thirty years, the returns on U.S. equities will be somewhere between 4.0 and 6.5 percent, as compared to the 7.9 percent over the previous thirty years. For fixed income securities, they look for a return of between 0 and 2.0 percent compared to the recent 5.0 percent. That is a relatively wide gap.
The implications of all this, while not exactly depressing, do suggest that there are some challenges ahead for investors. First, the fact that it is likely to be more difficult to obtain decent returns means that investors may need to at the very least be informed and proactive, and certainly to consider taking more risks. That may be a bit of a challenge, given that we will increasingly be talking about millennial generation investors who are wary about risks to start with, and who arguably will have less capital with which to invest. To obtain the same returns as their parents and grandparents though, they will clearly have to learn how be informed about the financial markets, and to be good savers as well.
MGI itself admits that its predictions are not written in stone and that a boost from technology or some other factor could make the future look considerably brighter for investors. Still, given that their reading of the megatrends is pretty much dead on, this might be a good time for everyone to take a good look at their portfolios and to make a vow to spend a little bit more time being involved in where their money goes. ‘Buy and hold’ may have worked for a time, but that time may well have come and gone.