Global Asset Class Strategy
Macro Outlook: Six months after the Federal Reserve signalled that it would be prepared to taper its US$85bn/month quantitative easing programme, the dust has yet to settle entirely. As we had warned prior to the taper announcement (see Thoughts On Global Bond Markets, May 20 2013), high leveIs of foreign ownership of domestic debt in emerging markets, combined with rising US yields, make the developed over emerging market economic and asset class story increasingly compelling. Bond movements over the past few years have been reminiscent of the mid-1990s, in which sudden Fed tightening pushed yields up sharply and forced major dislocations in the emerging world. While we do not envisage a 1990s-style correction for EM, our core view is that the structural growth story in EM is changing for the worse, with major imbalances from Asia to Latin America that need to correct. Fed tapering concerns are a case in point - whether the Fed is buying US$85bn/month or US$75bn/month should make little difference in the grand scheme of things, but the fact that it is causing such concern for emerging markets exposes the degree to which their economic models are vulnerable. Regardless of when the Fed decides to taper - in December of this year or in March/April 2014 (our core view) - US yields have bottomed, and will head higher depending on the strength of the US recovery.
As it stands, the Fed is still expanding its balance sheet substantially every month, while the ECB and Bank of Japan are likely to ease further going into 2014, so policy globally is not becoming substantially tighter at this stage. We assess the risks of a 'melt-up' scenario to be higher than that of a meltdown in the near-term, particularly if the Fed decides to hold off on tapering asset purchases until much later than we currently expect. The global growth outlook has improved in the past few months, in line with our constructive view, which combined with relatively liquid conditions, inexpensive valuations, good technicals (for developed markets at least) and relative lack of retail participation in equities, suggest that risk assets have further to climb. The biggest challenge to this view is our below-consensus view on Chinese growth, which is being confirmed somewhat by poor technical outlooks for China-sensitive market instruments such as copper and Latin FX.
Equities: Equities are our preferred asset class. Over the long run, we continue to favour developed over emerging market stocks, as the structural underpinnings in DM turn into tailwinds, while those of EM turn into headwinds. In fact, as the accompanying chart shows, developed world equities are breaking out technically against their EM counterparts after a brief pull back. Apart from the US, upon which we have been bullish for a few years now, we maintain our more recently-adopted positive stance towards European equities, with our bullish eurozone financials view up 8.0% since September 24, and Eurozone over US equities up 2.7% since August 15.
|Developed World Powering Ahead|
|MSCI World Over MSCI EM Ratio (LHS) And MSCI EM Index (RHS)|