November 01, 2016
In a just released report, the McKinsey Global Institute is warning investors they may need to lower their expectations anywhere from approximately 150 to 400 basis points on equities, and 300 to 500 basis points on fixed income investments-and in some cases even lower than that-as the forces that have driven exceptional investment returns over the past 30 years are weakening, and even reversing.
End of an Era
Given the waves of turbulence that have swept through financial markets in recent years, including the 2000 dot-com meltdown and the 2008 financial crisis, it may sound odd to describe the past three decades as a golden age for investors. But the reality is that total returns on equities and bonds in the United States and Western Europe from 1985 to 2014 were significantly higher than the long-term average.
An extraordinary confluence of favorable economic and business fundamentals created those returns. Inflation and interest rates declined sharply from peaks in the late 1970s and 1980s, and strong global economic growth was fueled by positive demographics, productivity gains, and rapid growth in China. Corporate-profit growth was even stronger, reflecting revenue gains in new markets, declining corporate taxes, and advances in automation and global supply chains that helped rein in costs.
The golden era has now ended.
The big decline in interest rates and inflation is reaching its limits, global GDP growth will be lower as populations in the developed world and China age, and the outlook for corporate profits is cloudier. While digitization and disruptive technologies could boost margins for some companies, the big North American and Western European firms that took the largest share of the global profit pool in the past 30 years face new competitive pressures from emerging-market companies, technology giants, and digital platform-enabled smaller rivals. These forces may curtail margins going forward, and could have profound effects on all investors, both individual and institutional. It is therefore critical for investors of all types to start managing their own expectations and the expectations of the people who will be affected by their investment decisions.