Long term equity opportunities – emerging markets

Investors who lost out on US equities over the past decade could avoid repeating the same mistake by investing in emerging markets, whilst in the short term both riskier and real assets could help them to see gains

Developed economies such as the US, UK and Europe are being dragged down by their ageing populations, creating a risk that investors could lose out on equities over the next decade in the same way they did in the last one, the latest report from Barclays Capital has indicated. Having coined the phrase “the lost decade” for the period 1998-2008 in its Equity Gilt Study last year, highlighting the decade was one of the worst performing for US equities in 83 years, the bank has revealed it could happen again – based purely on demographics. The story isn’t all doom and gloom however, as long term opportunities exist in emerging markets and in the shorter term both riskier and real assets are predicted to do well.

Poor outlook for developed markets

Investors in developed markets risk seeing a grim return over the next decade, said Dr. Sreekala Kochugovindan, vice president at Barclays Capital. Using data to show a close link between a decline in 10-year annualised US equity return and the growth of retirees over the past 60 years, Kochugovindan warned ageing populations in the developed economies weaken the long run equity outlook. The baby boomers are shifting their asset allocations. Rather than saving and investing in equities, as retirees they are more risk averse and decumulating assets. As a result, US private equity returns could drop in line with the growth rate of retirees expected up to 2025 (the point at which the forecasting data ends).

It doesn’t just apply to the traditional developed markets like the US, UK and Europe. The Asian economies are ageing too. So where should investors look to generate a better return?

Emerging markets present a solution

Emerging markets, in particular the Middle East, Brazil and Africa, benefit from having younger populations who are investing and saving rather than creating a drag on their economies. As a consequence, investment opportunities lie in those regions, Kochugovindan said. Emerging markets, as well as Asia and China, have been the key drivers behind recent robust global growth, Barclays Capital has found. China’s role has dissipated somewhat, due to its policy drive to slow growth down as a correction to global economic imbalances.

Regardless of monetary stimulus, global growth would have occurred due to the role of emerging markets, Kochugovindan said. It is an indication of the key role they will play in generating growth within the global economy in future – Barclays Capital data shows the proportion of global growth becoming more evenly distributed between the regions in 2011 than it has been in previous years, despite a shrinking in growth as a whole (down to 4.1% from 4.7% this year).

Risk appetite rallies over short term

Current opportunities lie in riskier assets, Kochugovindan argued. Research from Barclays Capital suggests that monetary policy stimulus creates an appetite for risk from which traditional equities will continue to thrive over the shorter term, but questions are raised on the longer term outlook. According to the bank, in the US the initial reaction from the markets to the decision to inject a monetary policy stimulus caused a drop in equities. After the second meeting, it was far better received, off the back of which riskier assets rallied. Whether they do so again with further quantitative easing depends on if it is implemented as a shock or a steady drip.

The wider risk is the creation of a policy led bubble, said Kochugovindan. Using the experience of the Polish WIG (that country’s main stock market index) over 1994-5 as a comparator, she revealed that the market collapsed by 70% in less than a year period after soaring as a result of monetary stimulus. Policymakers now are challenged with how they conduct their exit strategy from quantitative easing, so that the bubble doesn’t collapse when stimulus is removed. Similarly, “inflationary pressures could be the big issue next year – if fuelled by monetary policy,” Kochugovindan said.

Whilst there may be questions over the longer term outlook however, investors looking to generate a short-term return could benefit from the rally in riskier assets set to continue over the next few quarters. You can’t sit on your investments, Kochugovindan urged. Research from Barclays Capital shows the outlook for the six months is bullish, though there could be a short bout of profit taking.

Real assets set to outperform

Real assets are given an encouraging outlook in the report. They are expected to outperform in the coming months, as fears of deflation give way to inflation hedging. Kochugovindan expects this shift to take place, even questioning whether the risk of deflation has been a myth, by using data for the US for Q3 to show its economy only exhibited three deflationary signals out of 11 potential indicators.

Asset classes expected to perform strongly over the short term (three to six months) include commodities such as oil and base metals. Oil prices are predicted to go highest of all the major energy commodities, driven by improving macroeconomic sentiment and upside demand indications. Anticipated non-OECD demand lies behind this outlook. The price of OPEC crude oil is expected to soar to $78/barrel, as output from the non-OPEC members weakens. Kochugovindan compares this experience to the OPEC supply shop generated in the 1970s. Over that decade, oil prices increased steadily, from $3.35/barrel on 1 January 1970 to $32.5/barrel on 1 December 1979.

Base metals are similarly predicted to go higher across the board, but copper and tin are tipped to see the greatest price upside. Import demand from China is expected to continue into Q4, as well as demand from the OECD economies. Mining supply constraints are likely to lie behind the better performance of copper and tin.

Gold remains a safe haven

The recent strong performance of gold, which hit a new record high of $1383 on Thursday, is set to continue and even surpass that high. Kochugovindan said the outlook for the precious metal is positive until at least year end, and is likely to remain so into January or February of next year. The perception of gold as a safe haven amid uncertainty over the wider economic recovery and fears of deflation has been behind the rush. A shift to inflation hedging will cause investors to further look to gold, Kochugovindan said, though in the longer term it is difficult to gauge whether its performance will be sustained as the perception of it as an inflation hedge could change.

In other precious metals, Barclays Capital has backed palladium over platinum due to strong demand growth in gasoline-based auto markets. An opportunity could present itself in palladium investment as supply from Russia weakens, but the bank advises waiting until the price ratio between palladium and platinum stabilises.

Agricultural markets are also expected to do well over the coming months. Demand from China has boosted corn recently, and other grains importers are likely to buy up the foodstuff to compensate for shortfalls in wheat. Cotton prices, having already reached 15 year highs, could go higher still based on short supply, strong demand and steady US export sales.

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