
Key Takeaways
- A blend of cyclical fluctuations and structural forces are driving economies and markets. These factors can serve as important reference points to guide investment decisions.
- To ensure long-term success, we see opportunities for investors to position their portfolios on the right side of structural changes, including higher mean level of interest rates through the next number of business cycles as well as disruptive megatrends.
- The evolution toward a new structural paradigm is unlikely to occur in a straight line. In our view, investment flexibility and a heightened focus on risk will be needed in a dynamic environment.
Cyclical fluctuations and structural forces are changing the shape of economies, markets, and the way we invest. At this year’s Jackson Hole symposium, European Central Bank (ECB) president Christine Lagarde pointed out that elements of clarity, flexibility, and humility are required for robust policy making in an age of shifts and breaks.1 We believe these principles also hold the key to prudent investment management in a highly dynamic world. Longer-term paradigm shifts, such as structurally higher interest rates and disruptive megatrends, may call for a re-assessment of portfolio themes and asset allocation mix. Shorter-term fluctuations along the business cycle may require nimble actions to capture opportunities. Identifying these forces can give investors important reference points to guide their decisions and position for success.
Cyclical, Structural, and Long-Term Outlook
A potential starting point for investors is to consider the outlook for monetary policy. It is viewed as “neutral” and therefore neither stimulating nor restraining the economy, if the policy rate is aligned with the sum of inflation target and the so-called “r-star,” the natural real rate of interest. The US r-star rate is currently estimated to be around 0.5%, compared to nearly 4% in 2000 and even higher in the 1960s, according to the Federal Reserve Bank of New York’s Holston-Laubach-Williams model. Other studies have also found a similar downward trend over past decades.2 This may have been driven by structural factors such as demographic aging, a global savings glut, productivity declines, and so on. While it is difficult to state where r-star is heading, we believe some shifts in these factors are worth noting.
We expect higher fiscal deficits and government debt, including US national debt, to result in an increased demand for savings and potentially higher interest rates. The digitization of more activities across industries and the emergence of generative artificial intelligence (AI) may also have the potential to lift productivity. When coupled with deglobalization trends, this creates a different dynamic for central banks to deal with than past decades. These structural changes suggest that it is possible for the mean level of interest rates to shift higher through the next number of business cycles, which has potential implications for equity and bond portfolios.

Investment Implications
A world of potentially higher rates and slower growth may require long-term capital market assumptions to be re-evaluated, which could potentially lead to shifts in long-term asset allocation. The evolution toward a new structural paradigm is unlikely to be a straight line. For instance, with rates rising, concerns over the sustainability of fiscal paths forward have continued to build. Companies face higher cost of capital, making businesses with weaker balance sheets potentially more vulnerable to defaults. Opportunities for alpha generation in public markets may not only become more global but also more bottom-up and determined by profitability. Structurally higher interest rates have the potential to alter private market dynamics, too. Private credit yields have been increasingly attractive and private equity is evolving, with operational value creation levers poised to potentially become the main determinants of success in the new regime.
As investors recalibrate portfolios to a structurally higher interest rate environment, we believe being positioned on the right side of powerful megatrends may prove to be rewarding in the long run. However, capturing the best opportunities may require an understanding of the complexities associated with secular growth themes and certain industries, such as AI’s potentially transformative impacts on healthcare and life sciences. A focus on nuances in specific markets and countries may also uncover long-term opportunities. For instance, we expect Japan’s revitalized economy and corporate governance reforms will create winners and losers in the years ahead. Other opportunities may emerge in commercial real estate with some assets positioned to potentially capitalize on shifting demographics and sustainability trends, while others miss out.
In an uncertain world of cyclical and structural changes, it may be time for investment playbooks to change too. An environment of deviation, differentiation, and volatility may require a more active and diversified investment approach across public and private markets, in our view. Long-term success may depend on a mix of creativity and courage to look beyond convention, but also deep experience gained through previous market cycles. We can relate to Federal Reserve Chair Jerome Powell’s analogy of “navigating by the stars under cloudy skies”.5 Predicting precisely what lies ahead is unrealistic in a dynamic world. It’s important to contemplate a wide range of future scenarios and build up an expanded set of instruments and tools to help manage risks and capture opportunities.