The US Federal Reserve finished its two day meeting with an announcement that interest rates would not be changed this month. That wasn’t a surprise for markets and is consistent with our view that the world economy is slower for longer due to four headwinds it faces
The US Federal Reserve also changed their forecasts for the US’s economic growth, down from 2.4% growth expected in 2016 to 2.2%, also lowering their forecast for 2017. And they lowered their forecasts of their own decisions to increase interest rates, down from their forecast in December of four rate increases in 2016 to just two now. They also lowered their long term forecast of rates to 3.25% down from 3.5%.
This new forecast from the Fed is in line with the market’s expectations for 2016. FIIG’s expectation is just one more increase in 2016 and one in 2017. The Fed’s forecast would imply a fair value for the 10 year US Treasury bond yield to be 2.63%pa; whereas the market is currently pricing at 1.91%pa. Our forecasts imply a fair value of 1.79%pa.
These changes to US growth forecasts were driven by concerns about the global outlook which they said “continued to pose risks”.
This is consistent with our long held view that the world economy would be slower for longer due to the four headwinds it faces for the next decade, at least:
Baby boomer retirement means less consumer spending. For much of Europe and for Japan, this is worsened by the fall in birth rates resulting in falling population numbers overall.
Government debt in particular is already at a high level and for the western economies with low growth and an aging population that will need more spending, not less, this will result in much less government fiscal support available to support economic growth.
- Emerging economies
The issue here isn’t a poor outlook, but rather that the very strong tailwind that supported world growth until 2010 has fallen and is not likely to return to former levels.
- Quantitative Easing
QE and ultra low or even negative interest rates create financial asset mispricing. This cheap debt and liquidity has wound up being invested in equity markets in particular, resulting in PE (valuation) levels that are very hard to justify given the persistently low growth outlook.
Investors in growth asset classes like equities need to adjust their expectations of future returns. Even over the past 10 years, the ASX200 Index hasn’t changed. It was 5,115 at the end of March 2006 and was 5,111 at the time of writing. Investors have earned around 4.6%pa returns from dividends, but that’s with volatility that has seen the market rise 32%, fall 55% and then rise back to where it started 10 years ago. With a weaker outlook now than we expected 10 years ago, the outlook for total returns doesn’t justify this much volatility, particularly for investors looking to protect their wealth.