The Decade Ahead

A new world will likely be one in which economies are less integrated. We think trade as a share of global GDP has likely already peaked—with reduced trade accelerated by the US, Europe, and China becoming accustomed to exchanging sanctions, tariffs, and export controls. Tensions between the US and China also risk splitting the world into incompatible financial, trade, and technological blocs.

But precisely how deglobalization shapes the world economy in the decade ahead depends less on whether it happens and more on why it happens.

Should deglobalization occur mainly for political reasons—for example, due to increased trade restrictions or subsidies—it would likely constrain the overall supply of goods, reduce potential growth, or periodically lift inflation.

However, if deglobalization occurs mainly for economic reasons—a result of companies leveraging automation; focusing on integrated manufacturing; reassessing costs in light of rising wages in emerging markets; or building more resilient supply chains—the consequences are likely to be different. In this scenario, the net result is likely to be higher supply, lower inflationary risks, and higher potential growth.

Demographics pose an increasing potential headwind in our new world. Half of the world economy measured by official GDP now has a declining population. Populations are shrinking in Japan, China, and several European countries. The ratio of retired to working-age people has risen globally from 11.8% to 14.8% in just the past decade, up more sharply in high-income countries from 23.2% to 29.1% over the same time period.

These trends represent a supply constraint. Economic growth is a function of growth in the labor force, capital investment, and productivity, so all else equal, lower labor force growth will mean lower potential economic growth. A higher proportion of retirees relative to workers will likely mean higher debt. In service-heavy economies, in which the potential for productivity growth is more limited, rising old-age dependency ratios could also contribute to higher inflation.

Whether the world economy can escape the negative supply-side effects of an aging population could depend largely on developments in our third D: digitalization.

The rise of artificial intelligence could presage an era of higher productivity. We see potential for an incremental annual increase of between 0.3% and 2% in the US alone.

If the full potential of AI is realized, it could help alleviate demographic challenges—supporting growth and driving disinflation in certain goods and services, despite shrinking working-age populations. Meanwhile, upfront investment in AI and related industries like semiconductors could boost demand in the near term.

However, the impact of AI may not be as profound if the technology mostly boosts supply in industries less affected by demographic challenges (e.g., chatbots supporting professional services) and fails to boost supply in areas facing greater pressures (e.g., physical robots supporting healthcare).

Either way, for investors, we think the rise of AI should support overall corporate earnings growth and opportunities in companies enabling, offering, or benefiting from AI technologies.

The drive toward clean energy and zero carbon emissions has been reinforced by fears over energy security and extreme weather events. In the years ahead, we expect public and private capital to continue to support the energy transition.

In the short to medium term, we believe the energy transition could disrupt supply, as energy storage and grid connectivity obstacles constrain the reliability of renewable energy even as costs and operational risks for fossil fuels rise. At the same time, investments in the sector could help keep global demand robust.

In the longer term, we see the drive toward decarbonization as a net positive for global supply. Enabling a more abundant supply of energy at lower cost should contribute to higher potential growth, lower inflation, and more robust supply chains. For investors, solution providers as well as early adopters should stand to benefit most.

The future for the fifth D—debt—may depend on how the other four contribute to different growth, inflation, and interest rate outcomes. Global total debt has risen as a share of GDP since the global financial crisis in 2008, as the world has grappled with weak demand. Fortunately, abundant supply and low interest rates have meant that interest payments in proportion to government revenue have so far stayed close to all-time lows.

Looking ahead, demographic challenges and investment needs related to decarbonization, digitalization, and deglobalization look likely to mean rising government debt as a share of GDP. If rates and yields do not fall in the way we expect in the coming years, higher interest payments could start to pose a challenge for governments in the second half of this decade.

Debt will need to remain affordable, not least because many voters prefer low borrowing costs. The preferred path to achieve this is through robust economic growth, which could materialize with the widespread use of AI, abundant green energy, and localized supply chains. Failing these, then some combination of financial repression, taxes, surprise inflation, or default may be needed. Here, the answer may be less about markets and economics and more about politics, with different countries likely to choose different paths.

Cash rates are currently attractive, but we believe that interest rates are likely to fall in the year ahead. We also expect that cash, over the long term, will underperform other major asset classes like stocks and bonds, especially in scenarios in which central banks use financial repression to manage rising debt burdens. We recommend that investors hold no more than two to five years of expected net portfolio withdrawals in a liquidity strategy.

High yields bode well for government bond returns over the long term, and we also expect good returns in the near term as inflation and growth fall from today’s levels. But while we expect yields to drop, we still expect them to stay higher than the pre-pandemic era, as increased investment needs related to deglobalization, digitalization, and decarbonization contribute to greater bond supply and higher estimates for the real neutral rate. We think this means an environment of consistent, attractive total returns for government bonds.

Credit spreads are currently relatively tight compared to historical norms. While we expect spreads to widen in the near term as growth slows, we still believe credit exposure is valuable in the context of a long-term diversified portfolio to benefit from both carry and diversification. Refinancing risks, slower growth, and less certainty about central bank intervention may contribute to higher fixed income volatility in the years to come, favoring an active approach to the asset class.

We expect equities to deliver the highest return among major asset classes in the decade ahead. Aggregate earnings growth should be well supported by robust growth in companies driving technological, energy, and healthcare disruption. That said, like-for-like, equity valuations are likely to be lower than in the past decade, given higher interest rates than pre-pandemic norms. Global diversification will be important to navigate a deglobalizing world. Emerging market stocks, for example, are trading at sizable discounts to historical levels, and we expect them to deliver the highest rates of return over the next decade.

We estimate that allocating a 20% exposure to alternatives in a balanced portfolio could increase expected returns by about 50bps a year over the long term, for an equivalent level of portfolio volatility. An environment of higher rates and attractive returns for traditional assets bodes well for hedge funds, which we think will remain an important portfolio diversifier in the years to come. We also see attractive opportunities in entering private markets today, where secondaries are trading at a compelling 16% discount to net asset value (NAV), while new private loans are yielding 12.5%. Investors should be aware of the added risks borne in alternatives, including illiquidity, the use of gearing, and less transparency than in public market investments.

We expect the US dollar to depreciate over the longer term due to its elevated valuation and concerns over deficit financing. However, this view is largely compensated for by USD interest rates, so our expected returns for most asset classes are similar in hedged or unhedged terms. We also expect the JPY to catch up in the years to come given its significant undervaluation.

We think prices will stay high over the decade ahead amid higher climate, supply chain, and defense spending. Given the cyclicality of the asset class, we favor investing in commodities via active approaches, or via equity sectors or in countries and currencies with high commodity exposure.