For many investors, summer has been more about a double dip recession than a dip in the pool.
“People are more bearish than ever about growth," says Jacky Tang, equity strategist at Bank of America' Merrill Lynch.
Tang needs to look no further than his firm's fund manager survey, which in July registered its first pessimistic reading since February 2009.
“The most important takeaway is that a double dip on growth is a consensus,” says Tang.
The survey shows that when you weigh the managers who expect growth to pick up in the coming 12 months against those who expect growth to decline, a net 12 percent think global growth will weaken over the next year.
Two months prior to that, a net 42 percent expected growth to pick up in the year ahead. Slower growth doesn’t mean no growth at all -- a net 70 percent say a recession is unlikely in the next year—but prospects are certainly a lot more cloudy.
“The U.S. has now jointed Europe and China in capitulating on growth expectations,” concludes the survey, which represents the views of 290 asset managers with a total of $530 billion under management.
That’s quite a wall of money to bump up against. So where do investors turn? Equity strategists say growth prospects look better in emerging markets, particularly Asia.
Emerging Markets (Hot Vs. Cold)
Baring Asset Management is among them.
A recent survey shows that emerging markets and Asia are now the favorite destinations for independent financial advisers, with 66 percent recommending clients should increase their exposure to emerging markets, and 55 percent advising clients to increase their exposure to Asia.
“What we have had is an extreme period of underperformance in emerging markets,” says Todd Martin, Asia equity strategist at Société Générale. “I would say markets from an Asian perspective still look pretty buoyant.”
He notes that from November 2008 through May 2010, emerging markets underperformed the MSCI World equity index by 21 percent. That situation is changing as the year wears on; since May, they have rebounded 8 percent.
"High growth, low inflation, infant credit cycles and low interest rates are secular positive for emerging markets."
That could mean markets such as China are ready to outperform.
“I’ve been telling investors A shares have now bottomed as of last month,” says Martin. “Foreigners were already starting to buy into China as the market was nearing its lows back in June and July.” (As of late July, the Shanghai Composite indexwas down 20.8 percent.)
The Brazilian and Russian markets may not yet be ready to rebound, since their economies are powered by commodities, which have yet to bounce back from the 2008 bust that accompanies the economic downturn.
Currency swings, however, should add to the attraction of emerging markets. According to an HSBC report, the U.S. dollar, which has been a safe haven despite generally poor U.S. economic figures over the summer, is due for a decline.
“As the U.S. economy slows and others in the world raise [interest] rates to fend off inflation, the dollar will come under pressure,” says the HSBC report. Dollar-denominated holdings such as US equities would therefore become less attractive for global investors.
Australia, Brazil, Taiwan and India, as well as Canada and New Zealand, have raised rates since the beginning of June, so their currencies should strengthen, according to HSBC.
China has also made much-trumpeted moves to allow the yuan to gain, adding to the attractiveness of assets there, and deflecting criticism the government manipulates the currency by keeping it weak to boost exports.
In fact, many Asian economies are starting to worry about inflation and hot money rather than any threat of a “double dip” recession. Hong Kong, South Korea, Indonesia, India and Australia, as well as China and Singapore, all saw sizable capital inflows in 2009 and the first half of 2010 because of their growth potential.
“People looking for growth will go to emerging markets for a secular growth story,” says Tang. “In terms of our global strategy, we have a moderate overweight in emerging markets. The reason is that high growth, low inflation, infant credit cycles and low interest rates are secular positive for emerging markets.”
Asia (North Vs. South)
Investors, however, may be wondering if some emerging markets may have already produced most of their gains already.
This year’s run has been very strong in Southeast Asia, bringing stock prices close to what market watchers say is their intrinsic value, based on expected earnings growth.
As of the end of July, Indonesia was the best-performing market in the world in 2010, with the Jakarta Composite Index up 26.2 percent; Thailand's main index is up 19.7 percent; Malaysia's 14.5 percent and The Philippines' 13.0 percent.
“We also see that emerging markets and Asia are, in terms of price, at fair value,” conceded Tang “We are still concerned about how much upside there is, and we are little bit concerned in terms of valuations.”
Bank of America Merrill Lynch is overweight Singapore, whose economy is benefiting from government investment in the biomedical, electronics and construction sectors. The city-state has also received a boost from the opening of two casino resorts, run by Genting Singapore and Las Vegas Sands. The government expects the economy to grow by 13-15 percent this year. Despite all that, the Straits Times index was up 6.3 percent in the first half of 2010.
“The equity-market dividend yield is now higher than the bond yield, which is quite unique in Asia,” says Tang. “In other Asian markets, bond yields are currently higher than dividend yields.”
Martin at SocGen recommends overweigh positions in China, South Korea and Taiwan, all economies that stand to benefit from the better-than-expected numbers reported in the technology sector in the second quarter. He recommends being underweight in Japan, where the strong yen is hurting exporters and domestic demand remains weak.
“I would be neutral weighted in Southeast Asia,” following strong first-half gains, says Martion, “There is still a continuation in those markets, but I don’t think there’s as good potential as there is in North Asia.”