Traditional economics has a fairly clean framework: supply, demand, growth, inflation, etc. However, the economy is becoming increasingly complicated, with powerful new forces now playing an influential role. Some of these new economic forces, which will shape the global economy in coming years, include the following.
Geopolitics: This is not necessarily a new factor, but it is becoming a dominant force after being dormant over the last few decades. During that time, businesses could organize their supply chain with the sole purpose of maximizing efficiency. Now, the robustness of the supply chain is becoming as important as its efficacy. The relationship between China and the U.S. has changed from cooperative to competitive in the last few years. Over the last month, Russia reduced its gas supply to Germany by 60%. On July 11, the supply went to zero as Russia began its annual maintenance. There is fear that the supposed 10-day maintenance could last much longer. Germany and Europe may go into recession quickly if Russia cuts off the gas it supplies.
Environment and climate change: The economy has been maximizing its efficiency without paying much of a price for environmental damage. That is changing now, which could result in the economy having slower growth potential and higher base inflation. As an example, Europe will reduce chemical pesticide use by 50% by 2030 to protect biodiversity, which is great news for the environment but will likely result in higher food prices. Additionally, large mining companies are pledging to maintain biodiversity for new mines. Again, this is great for the environment but will likely lead to higher prices for commodities. Lastly, record drought in many parts of the world is putting food supply at risk.
Social equity: Economists used to say a strong economy lifts everyone. However, there is now a greater focus on whether various stakeholders and subgroups of people equally/fairly share in the benefits of a high-performing economy. Governments in many countries are paying more attention to labor unions. With current high inflation and a tight labor market, numerous unions are requesting higher-than-usual pay raises, and many have used strikes as a bargaining tool.
Society’s attitude toward work and leisure: Economic theory states that each individual will work to maximize their financial well-being. However, we have been seeing the “great resignation” in the U.S., due partly to some Americans deciding to work fewer hours and earn less money for the sake of greater work-life balance. Meanwhile, in China, the popular trend of “Tang Ping” among younger demographics is meant to express their disillusionment with a culture of overwork for little reward. Ultimately, an increasing priority on leisure time versus work will reduce the output potential of any economy. The persistently low U.S. labor force participation rate, as shown in this week’s chart, might be yet another sign of a decreasing emphasis on work.
The forces listed above will slowly shape global economics in the coming decades. Over the last 20 years, growth investors (growth equities, venture capital, private equities, etc.) outperformed. The biggest tailwind for these investors has been low inflation and zero interest rates. In the coming years, I think a higher inflationary environment will favor traditional industries, value stocks and commodities.
Key Takeaway
The very low labor force participation rate is a key reason that the current labor market is so tight, and that market might not weaken too much heading into a recession. Inflation will come down during a recession, but multiple economic forces will keep it at a higher level than we’ve gotten used to over the last few decades. In my opinion, the next recession will provide a good opportunity to add commodities and sell duration.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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