More stocks and styles will fail in the new world

There's much to learn from history, but every time is different when it comes to markets. Inflation in the 2020s has been very unlike that of the 1970s. The inevitable recession that did not occur was likely prevented by unprecedented fiscal stimulus. Going forward, short-term interest rates will likely fall, but long-term rates might rise. Equities are unlikely to revisit the frothy heights of 2021 and market breadth should widen. As cyclical inflation subsides, structural price pressures driven by reglobalisation and the energy transition will collide with the deflationary force of AI. The backdrop for investing will require investors to identify how the outlook today intersects with our experiences of the past and where it differs. This time is different because every time is different. - Ronald Temple, Lazard. Earn 0.50 CE/CPD hrs on Portfolio Construction Forum

What a difference a year makes. In February 2023, investors were preoccupied by the risks of rising inflation, monetary tightening and recession. This year, the focus is on disinflation, monetary easing and economic growth. The US economy remains resilient, and the Federal Reserve will likely ease policy in 2024 as inflation declines. The European Central Bank will also cut rates, boosting eurozone growth in the second half of the year. The outlook is more challenging in China, where the economy remains hindered by structural problems in the property sector. However, the generally bullish macro backdrop favours equities over fixed income. Portfolio construction practitioners should not let heightened geopolitical risks cloud what is otherwise a positive outlook for markets. - Ronald Temple, Lazard on Portfolio Construction Forum

Investors spend too much time trying to predict the future, using history as their guide. Instead, they should focus on what is actually happening in the world, and think differently about portfolio construction. Much of current economic and markets thinking is rooted in the post-Global Financial Crisis era. Practitioners need to let go of that history and instead embrace the fact that four trends – weak population growth, deglobalisation, the end of "free money", and the decoupling of asset prices from economies – are fundamentally changing the long-term outlook for markets. - Wayne Fitzgibbon, CAS Market Insights on Portfolio Construction Forum

Changes in central bank thinking, higher inflation volatility, and a reversal of the global savings glut are creating an investment environment like that of the pre-Global Financial Crisis period – in which interest rates remain higher for longer and central banks make more frequent policy adjustments, to keep inflation under control. In such an environment, bonds will offer higher levels of both income and diversification, within a multi-asset portfolio. - Chris Iggo, AXA Investment Managers. Earn 0.25 CE/CPD hrs on Portfolio Construction Forum

Contrary to wide opinion, globalisation is not "history" but is being reinvented. Since 2010, rising Chinese nationalism, the Covid pandemic, and Russia’s invasion of Ukraine helped bring an end to 30 years of hyper-globalisation. Weaponised interdependence and the derisking of global supply chains mean location matters again. Rather than relying on highly-efficient global supply chains, governments and firms must now carefully consider how they source resources and goods – whether it’s energy, semiconductors or electric vehicles – as well as risks and vulnerabilities in the US dollar financial system. For investors, a less interconnected world has significant implications for corporate capital expenditure and country allocation. - Kevin Hebner, Epoch Investment Partners. Earn 0.25 CE/CPD hrs on Portfolio Construction Forum

When seeking exposure to the energy transition, investors typically think of wind and solar farms, and hydrogen and battery production. However, elevated interest rates increase the costs of such projects, reducing their future investment returns. By looking more deeply down the value chain, with a focus on earnings and value, the best risk/reward energy transition opportunities can be found in sectors which at first seem counterintuitive, including fossil fuel production and mining. - Brian Arcese, Foord Asset Management on Portfolio Construction Forum

As risks related to over-indebted governments, the Russia-Ukraine war and Brexit fuel instability in Europe, the opportunity set for private credit investors is growing. While many people think that investing in challenging deals, complex capital structures and distressed situations is too difficult or too risky, unravelling the complexity of European private credit can unlock attractive risk-adjusted returns. - Fabian Chrobog, NorthWall Capital on Portfolio Construction Forum

In most cases of macro forecasting, historical evidence (data) is and must be the starting point for arriving at a forecast. The fundamental problem with contemporary economics is that historical evidence is not only its starting point, but also its terminus. Why has economics become so data-driven? Underlying today's historicist bias was a very important theory that permeated economics in the 1970-2000 period. This was the theory of Rational Expectations developed largely at the University of Chicago under the influence of Professors Sargent and Lucas. They wanted an absolutely rigorous (mathematical) theory on which market analysis could be based. Given the mathematical difficulties in creating their theory, they had to introduce an innocent-sounding axiom widely known as "Rational Expectations". This assumption was tantamount to saying that the dynamics of the economy were "stationary". This is the statistical term for saying that its dynamics and underlying relationships do not change over time. This in turn says that the correlations unearthed via data analysis will never change. All this implied that there was absolutely no reason for investors to doubt the conclusions based upon historical data for the best theory available said that structural changes in effect did not exist. But the fact that structural changes do exist and that historical data are often of limited relevance presents a major opportunity for investors seeking to outperform others. We can develop superior inferences about the future by using historical data as a starting point, and then incorporating new theories as to how ongoing structural changes will alter forecasts based upon historical data. To arrive at superior macro forecasts, these theories must be causal in nature. Unless they are causal, they cannot explain why historically-based theories will fall short. Another way of saying this is that investors seeking higher returns from better forecasts must think their way to such forecasts. - Dr Woody Brock, SED on Portfolio Construction Forum

The Investing Roundtable explored key challenges and opportunities in multi-asset, multi-manager portfolio construction that practitioners should be thinking about, given they can do anything, but not everything! Our research analysts each articulated a challenge or opportunity related to researching and identifying quality investment management solutions that they believe portfolio construction practitioners should be thinking about when building quality multi-asset, multi-manager portfolios:  If you do anything, consider an allocation to global small cap equities; If you do anything, use returns-based style analysis; and, Don't generalise, it's time to optimise portfolios. - Bronwen Moncrieff, John Laver, Michael Furey and Naomi Finnigan. Earn 0.75 CE/CPD hrs on Portfolio Construction Forum

Why does our industry exist, why do we as industry professionals get up in the morning, how often do you speak with your clients, what about the actual end-client? As professionals we need to stand with our clients and share our voice to ensure risk-aware approaches – and the ability to provide security to our clients' investment journeys – remains part of our investment landscape. We must whole-heartedly embrace risk AND return multi-asset portfolio construction. - Anthony Golowenko, MLC Asset Management. Earn 0.50 CE/CPD hrs on Portfolio Construction Forum