“If you put all the numbers together and add it to demographics that aren’t great, like the U.S. working-age population, which has been a shining star over the last 10 to 15 years and is expected to grow zero over the next five, then add in high debt levels, it all says slow growth,” he said.
Meanwhile, inflation, historically held at 1.7% over the last 10 years, will settle at 3%, Hunstad predicted. The other side of that coin, however, will be the positive real returns on bonds that come from higher interest rates.
“But it is a higher inflationary environment,” he reminded. “Which leads to our view on monetary policy.”
Calling the outlook a “monetary drought,” Hunstad said that he expects central bank policy rates around the globe to be measurably higher than in the past because of the desire to dampen inflation.
With those first three themes addressed, Hunstad moved on to two pressures that will continue to impact the economy. The fourth theme was the new emphasis on regional relationships to create stronger supply chains in the long run. “Reconsidered trade relations will have significant impact, prompted by concern of supply chain security,” he said. “We will see more friendly-nations deals, more on-shoring.”
The fifth theme considers the use of energy, where it’s coming from and the transition to renewable sources. “As we think about what’s going on currently with concerns about security, there’s a short-term headwinds to the transition to green because countries need to keep their people warm in winter,” Hunstad said, adding that over the long-term those concerns over security and higher fossil fuel prices will make the affordability of alternative energy sources more obvious, and this will help speed up the transition.
And finally, the sixth theme was that of the near-demise of negative yields. In 2020, he said, 26% of global sovereign bonds had negative yield. That has dropped to 3% or less.
“We think that is a constructive development in several respects,” he said. “It will lead to more appropriate and rational capital allocations because there will be a more real cost to capital, it raises the yield available in the fixed-income markets, raises the yield available in cash, and has some implications where there is a positive real return in investment grade bonds and asset classes like hedge funds are now going to get a really nice boost from higher returns on their cash portfolios.”
With all this in mind, strategically, Northern Trust is following an asset allocation with stronger risk control (2% cash, 34% investment grade bonds, 5% inflation-linked fixed income) with cautious risk assets (5% high yield bonds, 27% U.S. equities, 13% developing ex-U.S. equities, 6% emerging markets equity, 2% global listed infrastructure, 2% global real estate, 4% global natural resources). Zero percent is in gold.
Tactically, however, a few categories are overweight or underweight, including a little more (2%) added to cash and a lot more (7%) added to high-yield bonds, funded by a 6% reduction to the investment grade bond allocation and a 4% reduction to emerging market equity.
Northern Trust, an investment and wealth management firm based in New York, has roughly $1 trillion in assets under management. The firm’s mission statement is to ensure clients are compensated for every risk they take, across all market environments and investment strategies.