Investing in a bipolar world
Over the past year or two, fund managers and economists have been urging local investors to move some of their equity allocations offshore. The argument is twofold: first to take advantage of relatively better company valuations in developed economies, and second to avail of the ‘stronger for longer’ rand. It came as no surprise therefore, that Wayne McCurrie, executive director responsible for specialist investments at RMB Asset Management, dedicated most of his Financial Planning Institute (FPI) 2011 Annual Convention presentation to global markets.
McCurrie says markets have been influenced by two ‘events’ since the sub-prime scourge decimated the global economy in 2008. The first is ‘cheap money’. The authorities in developed economies responded to the financial crisis by cutting interest rates to the bone – near zero in many cases – in an attempt to bolster flagging business activity. The second ‘event’ is ongoing quantitative easing which resulted in record amounts of cash flooding to capital markets. But things must change. “At some stage, probably towards the end of this year, the US [and other developed economies] will have to increase interest rates. We cannot have zero rates forever – and we cannot have central banks increasing liquidity forever either,” says McCurrie.
Two very different investment outlooks
The solid equity performance through 2009/10, particularly in the US, has been underpinned by unsustainably low interest rates and massive liquidity. Analysts warn the acid test for equity markets will be what happens when liquidity is withdrawn. The consensus is global markets may stutter, or at the very least lose momentum, as artificial support dries up. This means investors will have to think carefully about their geographic diversification strategies. McCurrie tried to explains the juxtaposed economic situation in the developed and emerging markets with the phrase “investing in a bipolar world”!
He divides the world into economies that are doing too well and those that are not doing well enough. On the one hand we have emerging economies such as China, Brazil, India, Russia (and to a lesser extent South Africa) powering ahead – and on the other the likes of the United States, Britain and Japan just scraping by. Developed markets currently exhibit low growth, no inflation and low interest rates while emerging markets are in danger of overheating because their economies are growing too fast!
The main risk to the emerging markets, particularly China, is inflation. In contrast, the developed world is probably most at risk from mounting sovereign debt. Countries such as Germany and France have enough resources to bail out the PIIGS (Portugal, Italy, Ireland, Greece and Spain), but an implosion in one of these economies will not go unnoticed. Debt plays a central role in predicting economic growth worldwide. While developed markets are struggling with ridiculous levels of consumer and state debt, emerging market consumers have capacity to take on new debt. “The global saviour will be Chinese consumers taking on debt and becoming ‘American’ – they have the capacity for more debt,” observes McCurrie. “Ultimately the focus of the world to Chinese consumption growth by Chinese consumers taking on debt will be the driver for the next fifty years!”
On oil and commodities
The China story underpins the commodity market too. McCurrie says base metal demand should remain intact thanks to emerging economy growth. He warns, however, that you can expect serious ‘bumps’ along the way. A long-term investor hardly notices the swings and roundabouts in, say, the copper price. But on a month-to-month basis the corrections and recoveries can be pretty scary!
Oil presents a more serious challenge to the global economic recovery. Economies worldwide rely on the fossil fuel to meet energy needs and the price increase experienced recently is due to physical demand rather than civilian uprisings in the Middle East and North Africa (MENA) region. The consensus is that as long as Saudi Arabia remains ‘strong’ the oil price will trend higher in a predictable and controlled manner. Although higher oil prices impact on general price levels McCurrie says there’s no chance of sustained higher inflation in the US – and that means US interest rates should remain in check for the rest of this year. The amount of money in circulation in the United States has contracted significantly as consumers defer expenditure to service and pay off their debt.
What does the future hold?
McCurrie dismisses concerns of a repeat of the sub-prime recession: “I don’t for a moment think we will have a recurrence of 2008 – this type of decline is a once in a generation event…” He warns however that economic activity and markets could slow significantly in the event liquidity is withdrawn. He says investor strategies through 2011/12 will be guided by US interest rates, rising inflation in emerging markets and, of course, the outcome of sovereign debt problems across Europe.
Editor’s thoughts: Investment outlook presentations have become more and more subdued as the year goes by. Even though South Africa recorded a seasonally adjusted 4.8% GDP growth in the first quarter of 2011, analysts have been crimping their expectations for equity market returns. Their fears include sovereign debt in Europe, declining liquidity as Western governments reduce financial stimulus, and emerging market inflation. Do you think we’re in danger of a US-led second round recession? Please add your comment below, or send it to [email protected]
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