There is some consensus in the marketplace that a fundamental rebalancing of the global economy is taking place under this generation’s noses from developed to emerging markets.
Yet there is considerable disagreement in the asset management industry over its implications and how investors should best position themselves. As if to hammer this point home, AsianInvestor received two contrasting reports by email yesterday.
One, from Legg Mason Capital Management, extolled the relative value that investors should seek in US equities as the stalled US economy shows few signs of sparking to life without a government kick-start.
The other, from consultancy Mercer, warned that institutional investors were limiting returns and retaining unnecessary risks in equity portfolios due to their continued bias towards developed economies.
Nick White, principal in Mercer’s investment consulting business, reasonably suggests that investors should ensure they have access to broad equity market returns.
He believes there is a strong argument for diversifying away from large-cap developed markets to preserve performance potential – in other words increasing exposure to emerging, small-cap and low-volatility strategies.
“It is a brave investor who would take such a significant bet against the emerging world and other growth engines,” he opines.
Yet David Nelson, chairman of the investment policy committee at Legg Mason Capital Management, estimates that large-cap US stocks will provide returns of 7-8% annually over the next decade, with 5-6% coming through earnings growth and 2% from dividends. (Implicit in this forecast is that the earnings multiple of the stock market remains constant).
Comparing potential stock returns over the long term with those currently offered by long-term government bonds – as Nelson does – presents a compelling argument. “We believe that current buyers of 10-year US Treasuries – which yield about 2.72% at the time of writing on September 7 – are making a bad bet,” he states.
He suggests downside is mitigated by the low esteem in which stocks are held by the investing public, while upside is enhanced by the fact that stocks are as attractively priced relative to corporate bonds as at any time in the last 60 years.
A delegation of portfolio managers from BlackRock spent much of a Hong Kong visit last week underlining their expectations that developed economies would continue to flounder.
Interestingly, though, Dennis Stattman, head of BlackRock’s global allocation team, confirmed that the firm had increased its exposure to US equities from 13% five years ago to 35% now, level with its Asia (ex-Japan) equities allocation.
There are a number of large global firms in the US trading at eight to 12 times earnings that pay good dividends, said Stattman, adding: “They represent a good long-term entry point.”
What appears clear is that the environment is ripe for stock-pickers. Alex Boggis, a director at Aberdeen International Fund Managers, notes both the daunting macro environment for the US, UK and Europe and the harsh currency effect on listed shares (though he adds that many corporates are earning in diversified currencies to mitigate this).
“Most of all, perhaps, sentiment is either bad or getting worse,” says Boggis. “We look for opportunities in such an environment.”
For its part, Baring Asset Management has consistently forecast much higher returns for Asian and emerging-market equities than their developed-market peers.
Khiem Do, head of Asian multi-asset at Baring in Hong Kong, says economic tailwinds will help sales growth in Asian and emerging nations in the long term, whereas headwinds will negatively impact top-line sales growth in the US, Japan and Europe.
“Yet despite the differing fundamentals, the US and other developed markets continue to trade at the same valuation multiples as those of Asia, and are more expensive than emerging markets,” he adds.
Meanwhile, according to RCM’s long-term model, earnings growth in both emerging and developed markets is expected to pick up significantly from 2012 onwards. Its model suggests that earnings growth in developed markets will outpace that of emerging markets, assuming reducing margins in emerging markets due to wage and cost pressures.
However, RCM concedes that this likely underestimates underlying volume growth in emerging economies as policy shifts the emphasis away from export dependency towards domestic consumption.
Mark Konyn, RCM’s Asia-Pacific CEO, concludes that investors will allocate more to emerging markets, while economic de-synchronisation between major trading blocks will raise the influence of country and regional allocation on total portfolio performance.
Therefore he expects certain sectors, and companies within those sectors, to deliver above-trend growth, citing the technology sector as one example.
Clearly it's time for fundamental equity analysts to show their alpha-generating capabilities.