At the beginning of each Chinese New Year, AsianInvestor asks a broad set of market experts for their views on a set of 10 questions. We then decide which opinions we feel to be the most convincing and offer our predictions as to how each topic will play out over the coming 12 months. 

We begin our set of 10 questions with a subject that is close to the heart of all investors and fund providers: the areas of the mainstream asset markets that are likely to perform the best over the next year.

For institutional investors, wealthy individuals and fund professionals alike, getting this question right could make the difference between a year to celebrate, and one to try and forget.  

What will be the best performing mainstream asset class, on a risk-adjusted basis?

Answer: Emerging market stocks

2017 was a banner year for global equities as returns soared in markets around the world. Driven by accommodative central bank policies, improving company fundamentals, and synchronised global growth, the MSCI World, USA, and Emerging Markets indices saw returns of 23.07%, 21.9%, and 37.28%, respectively.

However, valuation levels are an increasing concern for investors who see less and less room for earnings growth as price to earnings (PE) ratios continue to balloon. For example, the cyclically adjusted PE ratio for the S&P 500 index was at 34.52 as of January 29, well above its average of 16.82. 

Central banks are also beginning to wind down their quantitative easing policies, with the Fed kicking off their balance sheet tapering in October 2017, the ECB in January 2018, and the Bank of Japan purchasing fewer bonds than expected that same month. Rising interest rates and geopolitical risks in the Korean peninsula, the Middle East, and the South China Sea, as
well as the threat of protectionist trade policies, could all introduce volatility into the markets
this year.

Even so, AsianInvestor believes equities will continue to be the best performing mainstream asset class in 2018, due to a solid macroeconomic environment and monetary policies that will create headwinds for fixed income.

Global GDP grew by around 3% in 2017, according to the World Bank, and it forecasts
the economy to expand by 3.1% in 2018. At the same time, central banks have well communicated their interest rate hike intentions over the last year, and an aggressive rate hike policy is not expected, which will keep interest rates at relatively low levels. This should be enough to drive another year of double-digit earnings growth for global equities.

In fact, the gradual increase in interest rates is likely to lead to more headwinds for the fixed income market as the US Treasury yield curve continues to flatten and credit spreads tighten.

Emerging market and Asian equities are most likely to see the best performance this year, as a result of global growth and its impact on export-oriented economies. Increasing commodity prices are also a positive for these stocks, as the Brent Crude Oil benchmark increased by around 19% in 2017, and is expected to increase from an average of $54 per barrel in 2017 to $60 per barrel in 2018, according to US energy statistics agency the US Energy Information Administration.

In terms of the monetary stimulus cycle, emerging markets have lagged behind the US, Europe and Japan, meaning the former remain in monetary loosening mode. As a result another year or two of emerging markets growth, particularly in Asia, looks likely.

Despite the positive outlook on global equities, investors have been slow to allocate due to caution about the extended cycle. Equity allocation is rising, but it’s not at the levels seen at the last financial crisis. Asian equities allocations, in particular, are still under-allocated, though experts say it is close to neutral.