The global economy and financial markets could be entering an era of potentially radical change that will make the next decade look very different from the last, according to US asset manager PIMCO. 
Investors who assume that the next decade will resemble the post-crisis era could be in for a series of “rude awakenings”.
Over the secular horizon, PIMCO said, investors should expect a very different macro landscape to emerge, for better or worse.
In market parlance, the adjective “secular” is used to describe events or activities that persist over a long time and, therefore, tend not to be seasonal or cyclical.
To help prepare for the challenges ahead, the company has highlighted five secular trends and one “supersecular” factor that have the potential to disrupt the global economy, financial markets, and investors’ portfolios during the next three-to-five years.
China
China has the potential to disrupt the global economy and markets in at least three different ways, according to the firm.
Firstly, while PIMCO assumes “a controlled gradual slowdown of China’s economic growth over the secular horizon,” it acknowledges that the path may be bumpier than expected, especially if the US-China trade war escalates further.
“In the case of a sharper slowdown, the massive build-up of internal debt over the past decade would be more difficult to digest and could aggravate a downturn,” the firm noted.
An aggressive currency depreciation, it said, “would send a deflationary shockwave through the global economy”.
Second, assuming a growth scenario, China’s efforts to move up the ladder to higher-value-added manufacturing with the help of leading-edge technologies will likely disrupt established producers in Europe, Japan, the US, and south-east Asia.
Thirdly, China’s ambition to establish a global sphere of influence, could disrupt the established geopolitical order dominated by the US, and could lead to continuing economic and political tensions with its western counterpart in the coming years.
Investors will have to contend with the resulting bouts of market volatility, the firm warns.
Populism
While it is unclear whether populism has already peaked, PIMCO said, populist movements, parties and candidates will likely continue to disrupt national and international politics and policymaking over the next three years.
Populist movements on both sides of the political spectrum are inward-looking and prone to erect barriers. However, depending on the form they take, they could result in either positive or negative economic and financial outcomes.
In one scenario, “economic growth and asset prices would be supported if populist governments, or traditional governments under pressure from a populist opposition, tackle overly zealous regulations, reduce the tax burden, or address excessive inequality”.
Other forms of populism would, instead, hinder growth and depress asset prices, “especially when they are aimed at slowing or reversing globalisation by increasing impediments to immigration, cross-border trade in goods and services, and capital flows”.
In addition, the various forms of populism are likely to lead to more divergent economic policies and outcomes across countries.
“Over the secular horizon, we expect more varied and, in some cases, more extreme policy approaches, which could increase the importance of the country factor for asset price determination and also produce larger exchange rate variability,” it further noted.
Demographics
In many major economies, slower population growth and higher life expectancy are significant contributors to slow economic growth, low inflation and a “global savings glut” that depress neutral interest rates.
“This is likely to continue to force the major central banks to keep policy rates low or even negative and to engage in asset purchases during or even outside recessions whenever the lower bound for interest rates becomes bounding,” said PIMCO strategists.
As these trends last, they become more disruptive in several ways.
“First, low interest rates and flat yield curves for longer pose challenges for the financial sector, which is an important transmission channel for monetary policy,” they explained.
“Second, low rates for longer have contributed to rising corporate leverage and pushed many investors into riskier asset in search for yield, which increases the vulnerability of private sector balance sheets in the event of major asset market corrections.
“Third, with central banks having limited tools in a low-rate environment and government borrowing costs low, both the calls for and the temptation to engage in more active expansionary fiscal policy are increasing.”
The report concluded that of the major advanced economies, the eurozone looks most likely to be disrupted by “Japanification,” defined as a demographically challenged macroeconomic environment of low growth, near-zero inflation, and very low interest rates.
Technology
As new technologies get better, cheaper, and therefore more accessible to a wider range of companies, their benefits for productivity growth are becoming increasingly visible.
“The other ominous side of the coin of technology is that it disrupts existing business modes in the corporate sector and, while it produces winners, it will create many losers as well,” the PIMCO strategists said.
A corollary of this global trend is the potential for emerging market economies and companies to “leapfrog” competitors in the advanced economies with the help of new technologies.
“Moreover, potential jumps in productivity growth, which are not our base case but a distinct possibility, could lead to temporary or longer-lasting technological unemployment,” they added.
Financial market vulnerability
“Looking over the next three to five years, the Fed’s pivot and the likelihood that it will end its tightening cycle at close to the ‘new neutral rate’, rather than tightening policy to an outright restrictive stance that would elevate recession risk, has the potential to lead to greater excess in valuations,” PIMCO highlighted as its final secular trend
While we are not there yet, acknowledged the firm, “it makes sense to watch very closely for excesses and the potential for corrections, in terms of macro drivers but crucially as part of a disciplined investment process”.
Today, financial market valuations are still reasonable – despite “pockets of excess” – but there are valid concerns about market structure, “particularly in credit markets, given liquidity concerns, which raise the risk that any significant change in sentiment and large-scale attempt at risk transfer will be very difficult to accommodate without significant market disruption”.
Dealing with climate-related disruptions
Finally, PIMCO’s “supersecular” factor that investors should prepare for focuses on climate change and its potential impact on markets and global economy.
“Climate-related shocks may become not only more frequent but also more persistent and severe, increasing the probability of ‘fat tail’ catastrophic events,” they said.
A ‘fat tail’ event is an irregular, unexpected occurrence of significant magnitude.
Investors, suggested PIMCO, will have to factor in additional government responses to climate and other environmental risks in the form of regulation, carbon taxes, and public investment.
“These will create many winners and losers in the corporate sector, which in turn will require active management of credit and default risks,” they concluded.