Riding the once in a century wave

How much do you pay attention to historical cycles?

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These phenomenon – both long and short – underpin structural change across demographics and drive potential impact for investors.

"The most salient point? It’s now almost eight decades since the conclusion of WWII; and, according to some, the next great crisis could be upon us.”

Cycles occur everywhere across markets and economies – showing up in labour forces, the accumulation of debt, inflation dynamics and corporate profit margins to name a few.

In fact, it’s often the cumulation of smaller cyclical changes that lead to larger structural shifts.

Ignore this change at your peril, as the non-linear pace of structural change tends to sneak up on investors – the artificial intelligence (AI) surge a recent example.

Because of this portfolios should hold exposure to investments exposed to short-term, cyclical and structural change.

The first cycle is debt and its importance for global growth. In its simplest form, economic growth is the transformation of human capital into productive output using financial capital.

Debt cycles occur on both a cyclical and structural basis, with numerous short-term cycles sitting inside a longer-term cycle. And although difficult to pinpoint exactly where we are in the current cycle, we need to note the incredible debt levels that corporates and consumers have accumulated across the globe.

This extreme leverage hasn’t been as dangerous in recent years due to the low inflation and low-rate environment, as lower rates can enable higher debt levels to be sustained for a period. However, when combined with weak income growth, this makes households and corporates more vulnerable to changes in economic conditions.

To everything there is a season

It’s not just financial capital that moves in cycles. Pay heed to the theory of “The Fourth Turning”, a 1997 study on generational cycles that have shaped Western history.

Historically, a major crisis for humanity has developed every 80 to 100 years.

The Civil War was almost 80 years ahead of WWII, the American Revolution some 80 years before that, and the Glorious Revolution 80 years earlier, preceded by the Armada Crisis some 80 years prior.

The most salient point? It’s now almost eight decades since the conclusion of WWII; and, according to some, the next great crisis could be upon us.

The turn of the historic cyle

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Sources: The Fourth Turning,, ANZ CIO

Like the debt cycle, this longer phase of 80 odd years is typically interceded by shorter cycles punctuated by a new generation entering adulthood. What drives the tipping point in the longer-term cycle is a sudden change in the priorities and ideologies of society as a new generation enters adulthood.

These priorities are typically formed during the period each generation is exposed to prior to adulthood. Depending on these lived experiences, significant structural change to government policies, human behaviour and corporate conditions may occur.

On this occasion, the structural change is inextricably linked to the debt cycle. This new generation – call it Gen-X and beyond – have arguably not benefitted from massive asset appreciation fuelled by low rates.

Growing wealth inequality has already led to a significant rise in populism since the turn of the millennium.

With Millennials and Gen-Z forecast to control the voting power in the US by mid-2030, this change and reprioritisation of ideologies will accelerate across Western democracies over the next decade.

We can expect policy changes to focus on solving for these inequalities in society – something seen in Australian politics more recently.

And this disparity links to a current point of contention – the share of income between corporates and employees.

In Australia, the share of gross domestic product (GDP) going to workers is at record lows. In the US, corporate profit margins have recently experienced all-time highs and the share of income going to labour has been trending lower since the 1970s – accelerating markedly since 2000. 

The share of Australian GDP going to workers is at record lows

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Sources: Centre for Future Work, Australia Institute, ABS, ANZ CIO

This income disparity should rebalance in the decade ahead. The current trend has come about as disinflationary tailwinds including globalisation, the removal of trade barriers and favourable demographics – across developed markets and China – all assisted corporates in retaining heady profits.

Forecasts, including the total dependency ratio (the number of dependents relative to the working age population), which is expected to rise markedly across most developed markets in the coming decades, show demographic challenges ahead.

Bargaining power grows

Conversely, except for China, the supply of human capital isn’t expected to be a concern for most emerging and less-developed economies as workforce percentages are set to remain strong for some time.

This may allow humans to have greater bargaining power in developed countries, while higher working populations across less developed nations should provide opportunity for better growth outcomes and could possibly transform many working-class economies into consumption-led powerhouses. This phenomenon transpired across many emerging market economies over the prior two decades.

The downside? Corporate profit margins, particularly across developed markets, look susceptible to these waning disinflationary forces and demographic headwinds. Structurally higher inflation and elevated borrowing costs, combined with declining working populations and a new generation of voters seeking to shift power back to workers could leave corporate margins vulnerable. 

Emerging markets have transformed from working-class to consumption led economies

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Sources: FactSet, ANZ CIO

Our portfolios are expected to have lower allocations to developed market shares and higher allocations to those regions less encumbered by demographic headwinds in the years ahead.

We have begun increasing emerging market equity exposure and it’s likely to become a more structural overweight across portfolios in time.

Alongside a higher allocation to emerging markets, an increased exposure to alternative and private market assets is necessary in future, as traditional drivers of portfolio returns are challenged, and higher structural inflation leads to more persistent and elevated volatility. This includes diversified exposure to companies or assets that are positively exposed to structural change such as demographics.

The wild card of robots and AI

The one wild card that is yet to be played is technology and the potential disruption it might bring. If this technology – which includes AI and robotics – can be harnessed in a manner that allows productivity to lift and inflation to remain modest, then the good times for corporates could continue. And potentially the bargaining power of workers may continue to be compromised.

Of course, when it comes to AI and robots the question must be asked – is this simply the next generation rising to power? 

Lakshman Anantakrishnan is the Chief Investment Officer at ANZ Private.

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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