How would you rank the global markets by attractiveness?
We are overweight the US market in our asset allocation. I think if the fiscal cliff deal is consummated, which is likely over the next eight weeks, then actually the dollar is likely to strengthen. The IMF says that the equilibrium exchange rate for the euro is about 1.18 — we’re now at about 1.27. A lot of people question why the euro is so strong in the face of the problems that they’ve got. So, I’d rank the US quite high.
In terms of the Asian markets, to some extent the valuations in Latin America, such as Peru and Colombia, are more attractive, but the macroeconomic fundamentals in Asia are clearly superior. China’s macroeconomic fundamentals, at least in the short term, have been modestly improving, but because it’s been decelerating from such a high base, the Chinese market has de-rated on an A-share basis, though not on an H-share basis. H-shares have actually outperformed some of the emerging markets.
So, my point is that it’s highly country specific and one can’t make any sort of systematic generalisation, except to say that the US market is not unattractive at this point, given that an investor can expect in the next three weeks substantial policy-related volatility.
Which asset classes do you find most attractive?
Right now, we have a significant overweight to US equities at the expense of US nominal bonds. We’re overweight credit — we still think there’s a value in high-yield and investment-grade credit. And we do have an overweight to commodities.
In terms of current positioning of portfolios [within emerging market equities], we have an overweight on Russia, which is trading at about five times earnings, and we have an overweight on Brazil, reflecting a pick-up in economic activity. Turkey is another one, as well as China. But the most important thing for investors is to gain the exposure — one is better off dealing with a professional money manager, or buying a broadly diversified basket [of assets].
Another overweight is Korea, and we have an underweight to Taiwan and Indonesia. We are quantitative investment managers, probably about 80% quantitative and 20% qualitative, so we look at what’s known in the industry as factors, valuation metrics — things like earnings growth or credit strength, etc.
What is your view on China?
The consensus has China decelerating to around 8% next year. China is 10% of the world economy in nominal GDP terms, and is larger than the three Brics combined. My own view is that China is likely to successfully navigate the current slowdown in the manufacturing sector. If you look at the service sector, it’s actually doing fine. While there are people who think there’s a 30% chance of a hard landing in China in the next 18 to 24 months, I think at least as far as next year is concerned, they are unlikely to see growth fall below 7.5% in China.
So if you have the US on track and China on track, that’s about 38% to 40% of the world economy. But Japan is problematic. Japan is exacerbated by well-known problems; particularly the situation with China does have some economic impact. Japan has the demographic problems and has the endemic weakness of the political system, and it has deteriorating relations with China. So it’s going to continue to grow slowly and may, in fact, fall back into recession.
Will China’s new leadership bring about change?
I think first of all they’re faced with enormous challenges, and they’re likely to be quite cautious. I think the appreciation of the renminbi in the short term is likely to slow, and they recognise that the economy needs to be rebalanced.
Of course, China now has a number of foreign policy issues. Previously, China wanted to take a less visible role on global foreign policy issues, but given the size of the economy and its impact, I think it’s increasingly difficult for it to ignore what’s going on in Syria, for example, or wherever it might be.
The conduct of macroeconomic policy in China in general has been skilful. They avoided the Asia crisis, and they kept things going through the global financial crisis. The Chinese economy is going to grow more slowly in the next 10 years, instead of growing at 10%, for example. But I don’t see, at least in the short term, a collapse in China.
What is your view for 2013?
The way I would put it is that liquidity trumps macroeconomic fundamentals, and that there is a potential for upsides surprise in terms of the fiscal cliff and in terms of China. But I think it’ll continue to be a difficult year.
The principal pre-occupation in the US will be the tax reform act, which absolutely needs to be done because we have trillion dollars worth of tax expenditures. It’s extremely politically contentious, but if it’s properly handled and putting the US on a sounder financial footing, I think it’s actually quite favourable for global equities. Now, if it’s chaos and scorched earth, then obviously the converse is true. But the markets will impose ultimately the discipline for it having to get done.
What about in Europe?
Internal devaluation or fiscal austerity can be self-defeating. You have to offer people hope and we need a way, which [ECB President Mario] Draghi has found to some extent, of breaking the perverse interaction between the sovereign debt cycle and the banks.
I think the Germans ultimately are going to find a way to get most of, if not all of, what they want, and in the process finance Europe during this transition period. That’s the core view at this point.
