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August 12, 2011 5:59 pm
It has been my view for some time that we are living in a two-speed world. In this world, the different rates of growth of developed and developing economies will increasingly make investing in emerging markets relatively attractive.
Growth in the developed world, especially in the US and Europe, will continue to be held back by policymakers’ attempts to restore the health of economies in which sovereign debt spiralled during the financial crisis.
In these countries, consumers remain over-leveraged and the housing market continues to be weak. I am looking for developed world growth rates of about 2 per cent rather than the 3-4 per cent we have generally experienced in the past.
Emerging markets cannot expect to be unaffected by this lower growth, particularly those that are dependent on exports or commodity prices. However, in a generally low-growth world, their higher relative growth will look very appealing.
A number of commentators is talking about “double dips” and a return to recession in the developed world. I think this is unlikely given the backdrop of low interest rates and an absence of the conditions that normally precede recessions. Indeed, most of the recession-predicting models that have been helpful to me in the past still indicate that the probability of a renewed slump in the west is low.
So what should investors make of the extreme stock market conditions of the past week or so?
Firstly, never underestimate the ability of markets to confound investors’ expectations. If markets simply repeated past patterns, investors would become better and better at anticipating their movements. The majority, by definition, cannot successfully predict markets.
Secondly, the amount of money invested on a very short-term basis has increased significantly in recent years. I believe these flows magnify market movements and produce greater short-term volatility. I’m afraid we will have to get used to markets that are more volatile than in the past.
If investors cannot tolerate this volatility, then maybe they would be better not to own equities. However, the majority of the technical, sentiment and valuation indicators that I look at suggest that this is not a time to be shaken out of markets but to hold one’s ground.
With hindsight, I believe investors will see that this week’s movements will have presented one of the more attractive long-term entry points for equities.
I don’t think I can add a lot to the debate around the downgrade of US debt by Standard & Poor’s other than to say that this formal confirmation of the deterioration in the finances of the US is not a big surprise.
Rating agency downgrades often confirm what most investors already know. I don’t think the relative attraction of US Treasuries has been much changed and I must say that I am more sanguine about the US outlook than Europe’s.
The euro experiment is a financial disaster and there is no easy or obvious solution to Europe’s problems.
I agree with others that a necessary first step is the recapitalisation of many European banks, so that they can take the writedowns they need to on their holdings of peripheral European sovereign debt. Some sort of fund needs to be set up to rebuild the equity of these banks.
Also a type of “Brady” plan lookalike is needed to solve the debt problems of these countries. How long the German electorate will continue to foot the bill for all of this is questionable. I think we should not rule out the possibility, before the decade is out, of the rebirth of currencies such as the drachma, lira and peseta.
The trouble with emerging markets is that, so far, their stock markets have not decoupled and, in fact, have tended to underperform during periods of risk-aversion.
I believe that this will change over the next few years and I continue to expect a flow of money from investors in the developed world into emerging markets.
In particular, I remain of the view that China, despite its own challenges, looks to be one of the better places to invest. As a soft landing in China becomes the majority view, its relative performance will improve.
What else besides a decent exposure to emerging markets should investors look for in this scenario? Companies that can show steady predictable growth in a low-growth world will, I think, be attractive. This includes many high-quality, larger developed-world stocks, a number of which have dividend yields well above the relevant government bond yield.
In a low interest rate environment, I think these could become very valuable and, at some stage, be rewarded with much higher valuations.
In summary, I don’t see any of the normal warning signs that mark the end of a bull trend. It may seem strange (and perhaps foolhardy!) to be talking about a continuing bull market after the large falls of the past week but that is still my view – provided we see a recovery in markets over the next
Anthony Bolton is president, investments, at Fidelity International and manages the Fidelity China Special Situations fund
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