Adapt to thrive – the era of abnormal returns is ending

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By Pictet Asset Management chief strategist Luca Paolini

Investors looking to replicate the returns of the last five years in the next five should embrace the mantra ‘adapt to thrive’. This is because a considerable amount of disruption looms with slower growth, more volatile markets, less business-friendly governments and a squeeze on corporate profits.

But investors who know where to look can still navigate the pitfalls by seeking exposure to select pockets of growth with emerging market stocks, particularly in Asia, poised to deliver double-digit returns annual returns to the end of the decade. Pictet Asset Management’s Secular Outlook for the coming five years identifies the key trends and how to harness the best opportunities.

“The next five to 10 years are going to be a very difficult time for investors but we still believe there are some very interesting opportunities,” said Pictet Asset Management chief strategist Luca Paolini.

Key trends and opportunities for the next five years include:

  • Developed equities have further to run but at a slower pace than we saw in recent years. We expect a mid-single digit annualised percentage return in dollar terms to 2020.

Working against developed market stocks are their high valuations in the wake of a multi-year bull market. Political risk also plays a part. In the face of rising income inequality, governments are under pressure to shift the tax burden away from individuals onto companies, raise minimum wage levels and tighten regulation, all of which eats into profit margins.

That said, we could see positive surprises with growth exceeds expectations. Companies are investing heavily in research and innovation that should deliver operational improvements. With research and development as a percentage of GDP in the US at an all-time high, there is scope for a significant boost to returns if this translates into higher productivity growth.

  • Economic growth in the developing world will slow but low initial stock valuations bode well for emerging market equities which we expect to deliver 12-15 per cent annualised returns in dollar terms.

China is not expected to deliver the rapid growth rates of recent years which is not helpful for other emerging markets as it accounted for about half the developing world’s growth over the past five years. On the other hand, economies with reform-minded governments and favourable demographics, particularly India, look well placed. Against this mixed picture for economic growth, emerging market equities have reached extremely attractive levels and are around 25% cheaper than developed market counterparts on a price-earnings basis. This gap should narrow as emerging market corporates become more competitive thanks to cheaper EM currencies and improvements in productivity stemming from economic reforms.

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