Emerging markets most likely to benefit under worse-case scenario

What do you do as a fund manager if your worst dreams come true and you are handling other people’s money? Jose Luis Jimenez, CEO of March Gestión, a Spanish family office, looks ahead and gives his appraisal of possible worse case scenarios.

The company has identified four “nightmare” scenarios and what the worse would mean for long term investments.
    
Eurozone breaks up
This first scenario would involve the break-up of the eurozone. The costs would be extremely high, Jimenez said. According to some calculations, Greece’s economy would shrink by 50% if it was forced out of the eurozone, but even Germany would see its GDP fall by 25% in one year if it abandoned the euro. It would be cheaper and more profitable for everyone to put more money on the table and cover all the debts rather than trying to start again from scratch. “We have no doubt that the euro will continue although the bill is going to be high,” he said. Scenario probability: close to zero.  

China implodes
The second scenario would be as a result of a major crisis in China. There is a lack of information and transparency about the Chinese economy which creates a lot of uncertainty and confusion, he said. But the government has a wide margin of manoeuvre and control over the economy which means that it should manage most difficulties. It is unlikely that China, because of the size of its economy, could cause major damage to the world economy. Scenario probability: low.

Inflation threatens
Inflation  is a dangerous two-sided coin. On one side there is deflation. “This is the worse thing that can happen because we don’t know how to deal with it,” Jimenez said. If prices start to fall, it is difficult to reverse as was seen with Japan since the 1990s. Printing money, as many economists recommended, did not work. “Japan is still in the same hole. They don’t know what to do and how to escape from that.” However, this does not appear to reflect conditions. Scenario probability: unlikely.

Stagflation with below-par growth and rising prices is more of a threat. Commodity prices are expected to rise, reflecting the growing role and importance of emerging markets. Most developed economies are facing a long period of low growth. At the same time there will be inflation due to the rising costs of raw materials, as well as because of the money that is currently being primed in the economy by central banks in the US, Europe and the UK. At some point this money will need to be taken out of the system, and that’s where there are doubts. “It’s easy to pump money in, but it’s difficult to take it out.” Scenario probability: the most likely outcome.

Though these projections are tentative, the probability of stagflation is reflected in long-term investment options. Under such a scenario equities will benefit and fixed income products will suffer. Not all equities will benefit though select companies in Europe and the US will. Gold will continue to do well and thematic investments as in the luxury goods sector are likely to profit as well. “If we have to choose a special region this will be emerging markets, Asia as a whole followed by Latin America as the two are well interconnected,” Jimenez said.

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