Richard Dobbs, senior partner at business consultants McKinsey & Company, looks at the disruptive changes sweeping the world and the potential investment effects.
Four powerful forces are disrupting the global economy, upending many of our most cherished assumptions, including those about investing. We need to reset our intuition – and quickly.
Each of these forces would rank among the greatest changes the world has seen. Our challenge is that we are seeing them all happening at the same time, and in some cases they amplify each others’ effect.
The first is the shifting locus of economic activity to emerging markets. By 2025, China will be home to more companies with revenue of $1 billion or more than the United States or Europe. Already, a Chinese company has chalked up the largest IPO in history: Alibaba’s $25 billion flotation on the Hong Kong stock market in September 2014.
The second great disruption is the acceleration of technological change and its adoption. Consider that it took more than 50 years after the telephone was invented before it achieved 50 million connections. Radio took 10 years. The iPod took five years and Skype just two. Faster still was the mobile game Angry Birds Space, which took only 35 days to attract 50 million users.
For the first time in human history, ageing could mean that the planet’s population plateaus. The greying phenomenon, the third disruptive force, has been evident for some time in the developed economies of the West, but now it is spreading to China and soon Latin America. This is a drag on global growth and puts pressure on governments’ ability to fund public services and pension systems in some countries.
Fourth is the accelerating and deepening interconnections through trade, capital, people, political systems and, increasingly, information. Between 2005 and 2014, flows of data grew 45-fold, and have now overtaken traditional trade in physical goods. Cross-border flows between emerging markets have doubled in just 10 years.
What are the investment implications of these dizzying changes? We believe investors will have to lower their sights after a 30-year Golden Age in which US and Western European stock and fixed-income returns have been considerably higher than the long-term average.
After a period of exceptional profitability, the strongest since the late 1920s, US and Western European corporations face tough new margin pressures from emerging market competitors, technology firms moving into new sectors, or smaller companies using digital platforms such as Amazon – and Alibaba – to turn themselves into ‘micro-multinationals.’
Changing demographics could crimp GDP growth, which in the past was driven by population growth alongside rising productivity. At the same time, the steep decline in inflation and interest rates that contributed to capital gains over the past 30 years is unlikely to continue.
This new lower-returns era will prove challenging for a wide range of investors and for governments. A 30 year old today needs to save nearly twice as much for their pension as a 30-year-old 30 years ago. US educational endowments could receive around $15 billion a year less in income. US public employee pension schemes could face a deficit of $3 trillion.
All investors face the need to save more or live on lower investment income. Greater emphasis also needs to be placed on seeking out lower-cost investment vehicles and asset classes, such as infrastructure, emerging markets and hedge funds, with a greater likelihood of outperformance.
New factors may yet give a boost to investment returns, such as strong earnings growth driven by technological innovation.
What is important is for investors of all types, individuals and institutions, to revisit their assumptions, reset their expectations, and take appropriate steps to avoid being caught short in an era of unprecedented disruption.
Richard Dobbs is a senior partner in McKinsey & Company’s London office and a member of the McKinsey Global Institute Council.
The paradox of change
Ian Tabberer – Co-Manager of the Henderson World Select Strategy
The central tenet of our investment philosophy is understanding and appreciating the impact of change. We believe that global stock markets are semi-efficient: that is, they are very good at discounting the earnings and cash flows of businesses operating in a steady state, but relatively poor at appreciating the impact of forces disrupting profit pools, industries and business models. Change is, paradoxically, a constant. The technological, demographic and capitalist forces that drive capital markets and the human race forward rarely rest at a point of equilibrium.
Research shows that, compared with the mid-80s, we now receive five times as much information every day. The world is so complex that the human brain has to adopt cognitive shortcuts to deal with all the new information it receives. The mind is hard-wired to cut through the data deluge and resolve contradictions – sometimes too quickly. The tendency to overgeneralise means the brain predominantly focuses and leans on linear-based outcomes. It is this cerebral ‘short cut’ to understanding complexity that allows for mis-valuations to occur within investment markets. Our detailed research probes the market for potentially mis-priced stocks. For us the ‘winds of change’ are not to be feared, they provide the steady flow of opportunity upon which our global equity strategy thrives.