As economic imbalances and income inequality have accelerated in recent decades, Northern Trust Asset Management (NTAM) chief investment officer Robert Browne believes social discord and disruption are likely to spur the U.S. economy to drift in the direction of European socialist economies in the next five years. That’s one reason why NTAM expects to see subdued returns from financial assets between now and 2025.

These imbalances have existed for more than a decade, but the pandemic has only served to exacerbate them, Browne observes. In an interview in early September, he outlined how the public health crisis has influenced changes in the asset management giant’s five-year outlook.

Is The Capitalist System Broke?
The pandemic “has highlighted flaws in the capitalist economic system itself,” according to NTAM’s five-year capital market outlook. “Specifically, it has called into question capitalism’s once sacred maxim (first promoted by economist Milton Friedman) that a company’s sole focus should be profit maximization. If companies focus on maximizing profits, other societal aims will take care of themselves.”

That outcome clearly has failed to materialize, NTAM maintains. The “winner-take-all’ business environment that has emerged has left less competition and fewer consumer choices, as oligopolies dominate industries ranging from beer to online advertising to cable television.

The profit maximization model formerly worked in an era when large amounts of investment capital were required to launch heavy-asset businesses. But today’s light asset companies create a different dynamic. Intel and Netflix have roughly the same market capitalization. However, Intel employs 110,000 people while Netflix has 8,600 workers.

Browne thinks that shareholders, driven partly by the ESG, or environmental, social and governance investing movement, will push companies to refocus on stakeholders, not just shareholders. This will translate into a world that “may mean less profit but also a more sustainable economic system,” the NTAM report says.

These shifts are unlikely to be favorable for economic growth, which has already been slowing for two decades. One of the points “we are trying to make is that we had pretty low growth trends going into Covid-19,” Browne says.

Going forward, consumers are likely to remain cautious when it comes to spending. Corporations, meanwhile, may be motivated to alter their supply chains—and their motivations may not be enhancing their bottom lines.

“If you went into this [the pandemic] in a strong position, you’re doing great,” Browne says. If your business was experiencing weakness and, secular disruption, “you’re in trouble. Macy’s and Nordstrom’s position did not improve. Apple’s and Amazon’s did.”

In the short term, NTAM does expect the U.S. economy’s strong growth trajectory in the third quarter to continue into the fourth quarter. That expectation factors a continuation of massive fiscal and monetary stimulus in 2020.

“The impact will wear off in the second half of 2021 and then we are back to the slower growth for longer trend by the second quarter of 2021,” he says. The good news is that NTAM doesn’t expect another significant dip.

The bad news is that brisk short-term growth could take unemployment down to the 7% area. If activity moderates in early 2021 and growth returns to the 2% area, any return to the 4%-5% level of unemployment the U.S. has experienced since 2015 could take years.“From a social and political perspective, it will not be tolerated,” Browne predicts.

Citing the work of economist Hyman Minsky, who became famous for his work on financial crises after the Great Recession, Browne says the European model may not be better. “But it is kinder, softer and more socially and politically acceptable,” he says. “You [may] have a different set of losers from today’s. You may not have extreme winners.”

Neither Browne nor the NTAM report specifically addressed the issue of small businesses, who traditionally have generated an estimated 50% of the jobs in America. They also have provided much of the political support for so-called Friedman-style market capitalization.

During the pandemic many of these businesses have been deemed non-essential by the government and their owners have been forced to watch their customers go to the Amazon's, Target's, Home Depot's and McDonald's of the world. Many small business owners as likely to blame the government for their problems as much as the concept as capitalism. But whatever happens, bitterness is likely to linger.

Globalization Peaks, ESG Takes Off
In NTAM’s view, tensions between America and China are likely to remain high. Until recently, the two economic giants have managed to co-exist in relative harmony. But that relationship was based on a hopeful belief that China would gradually move in the direction of quasi-democratic capitalism like Taiwan and South Korea. Today, it’s clear China isn’t going down that path.

Doing business in China could well become a “make it or break it” ESG issue in the next decade and companies may be forced to make supply chain decisions. “Facebook and Google may have to decide to do business in one place or another,” Browne says. Partly because of the different nature of its device business, Apple may be able to continue operating in both places.

NTAM doesn’t expect global trade to unravel, but it is likely to plateau. As a share of global GDP, “it has already peaked,” Browne notes.

Deglobalization and a loss of faith in Milton Friedman-style capitalism aren’t the only threats to equity prices in the next decade. NTAM sees climate risk as perhaps the biggest threat. “Particularly vulnerable are natural resource and emerging market stocks,” the report states. “Relatively fragile economies could be especially sensitive to climate-related regulation as they are still in the early stages of maturation.”

Investors could be well-advised to get out in front of any asset repricing caused by climate change. Avoiding certain companies and industries permits investors from engaging in the “fruitless task of attempting to map out every global warming scenario.”

With wildfires raging and once-in-a-century hurricanes occurring every few years, Browne doesn’t think any serious arguments exist about the reality of climate change. “People will demand change; they are connecting A and B,” he says. “There will be a policy response even without a change in administration.”

States, companies and foreign governments already are initiating changes. “NextEra Energy is the best-performing public utility,” Browne observes, noting that it’s positioned as a green energy company and trades at 30 times earnings. “Other utility CEOs will take notice.”

Lower Equity Returns
All that said, NTAM sees U.S. equities returning 4.7% over the next five years, compared with 5.4% in Europe and emerging markets and 3.8% in Japan. This in spite of the firm’s belief that U.S. “valuations are elevated.”

In a low-return, low-interest rate world, a 5% return “means you get to keep everything you’ve earned and get a net return over inflation,” Browne says. But price-to-earnings multiples are likely to contract.

It’s natural that in a slow-growth economy the market is willing to pay a premium for companies that can consistently grow faster than GDP. But this concept has its limits.

“Visa’s net income has doubled in the last five years, but its valuation has more than tripled,” Browne says. “Can that happen again?” Maybe so, but it’s not “a prudent bet.”