FTAdviser.com

Advertising

Clouds are forming over the world’s major economies. Short-term forecasts are for below-trend growth, while markets increasingly expect rising inflation. This falling growth, rising inflation dichotomy looks set to become more pronounced in the near future.

The US economy is in recession, Japan continues to suffer from poor domestic demand and the weakness in the south of the eurozone—Italy, Spain, Greece—looks set to spread to the north. Regionally, we prefer the US, which is the most defensive region for equity investors and should benefit from the weak dollar, and emerging equities. Next is the eurozone, where the slowdown is still in the initial stages, and then Japan, where economic momentum is weak and the political stalemate and poor corporate governance are lingering.

Our outlook for emerging markets is much more optimistic. However we look at it, emerging markets look set to dictate global growth for the foreseeable future. The slowdown in developed economies has so far not held back most emerging countries. Moreover, personal income growth in emerging markets has broadly kept up with rising prices, and large national current account surpluses and foreign exchange reserves have provided protection against capital flight. The situation is not perfect. Economic sentiment in Asia is at its worst in five years and a series of cost shocks (mainly food) has driven inflation in the Bric countries towards 10 per cent. But with the fundamental re-rating having further to go, emerging markets remain our favoured region for equity investors.

As for government bonds, further economic weakness should continue to depress yields across the developed world. We regard the markets’ inflation fears as overstated. In our view, core inflation has peaked, reducing any upside pressure on yields from that front. While GDP strength in the first quarter has lifted eurozone yields, this is unlikely to be sustainable given the strength of the euro and weakening global demand. Therefore, investors selling equities could consider investing in government bonds.

Equally, credit markets have overreacted. Across-the-board selling during the height of the financial crisis has driven up implied default rates too high in relation to the fundamentals and historical levels. A forthcoming re-rating means this asset class has clear attractions.

In commodities, raw materials are in the middle of a bull market which could well last for years, but in the short term, slowing economic growth and their recent spike upwards argue for caution.

In terms of appeal, the most serious problems lie in the stock markets, where earnings downgrades are likely, high oil prices weigh on industries such as tourism and transport, and central bank reluctance to cut interest rates limits the potential for a recovery. Equities are not overvalued, but with company earnings looking stretched, investors could be wise to underweight the asset class.