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By Anthony Bolton
Published: October 16 2009 18:12 | Last updated: October 16 2009 18:12
In an attempt to dig us out of the financial crisis, the governments of many developed economies have mortgaged their futures. Their unprecedented fiscal stimulus has significantly increased the ratio of public debt to national income. Consequently, I believe that the growth rate to which these developed economies will return "“ once the short-term recovery phase is over "“ will be lower than in the past.
This has important asset allocation implications for investors in developed market equities.
To understand the nature of the recovery that we have been experiencing over the past six months, we need to examine the decline that preceded it. The downturn was very much corporate rather than consumer-led. Across the globe, and simultaneously, the financial crisis led chief executives of companies to cut inventories, capital expenditure and staff numbers.
As a result of this synchronised action, the economic data in the last quarter of 2008 and first quarter of 2009 looked terrible.
More recently, conditions have reversed as companies have regained their confidence and started to rebuild inventories, leading to a slowing in the growth of unemployment. However, the financial crisis has left us with longer-term problems, particularly relating to the consumer, which will overshadow world economies once the initial recovery phase is over.
My contention is that a combination of consumers rebuilding their balance sheets, slower credit creation in this upturn than was historically the case, and governments being forced to cut spending or increase taxes will lead to lower growth than before the crisis.
The big question now is whether the relative growth advantage of emerging markets over the developed world has increased.
I think it has "“ particularly for emerging markets that are driven by domestic demand and investment. I am less keen on those markets where exports or commodities are the main drivers. One reason these are less attractive today is the fact that commodity shares and industrial companies were the leaders of the last bull market.
In my experience, it is unusual for sectors that are the stars of one bull market to take the lead in the next, particularly if share prices in the late stages of the previous bull market enter a "bubble" phase as they did in 2006 and the first half of 2007.
In the first phase of a new bull market, investors sometimes do return to play the winners of the last cycle but this does not prove sustainable.
The best conditions for commodities are either synchronised above-trend world growth "“ as we experienced in the last bull market, and which we are unlikely to see any time soon "“ or strong inflation.
My view on inflation is that it may be a longer-term threat but that it is unlikely to be a problem in the next couple of years because of the low growth environment and excess capacity in the west.
Finally, from a shorter-term perspective, some of the extraordinarily rapid credit expansion in China this year has been used by companies to stockpile commodities. As this credit expansion now slows, and as Chinese companies use up their excess inventories, I expect demand for commodities in the near term to be softer.
I don't think that low growth in the US and Europe is necessarily bad for equity investment in general. Low interest rates that will accompany this sub-par growth will lead investors to seek the higher returns offered by risk assets such as equities, corporate bonds and property. I have been arguing that this will drive a multi-year bull market (especially as cash on the sidelines is still high and a number of professional investors remain very cautious).
Even so, the equity market may need a sustained period of consolidation, probably next year, as this first phase has been so strong.
In an environment of lower growth, I expect investors to seek out companies, sectors and countries that can grow faster than average. So, in the next stage of the bull market, growth will be rewarded "“ and I expect that it will be rewarded by investors with higher valuations than is normally the case.
If that is the case, then UK investors' typical exposure to emerging markets, of about 15-20 per cent of an equity portfolio, could prove too low. Perhaps, for the next few years, they should consider having a majority of their exposure to markets that can provide higher growth.
But if all investors in developed markets make similar changes to their asset allocation, I believe we will have all the ingredients necessary for a new bubble to develop over the next few years in these volatile but rewarding markets.
Fasten your seat belts "“ we are in for a bumpy, but enjoyable, ride.
Anthony Bolton is president, Investments, at Fidelity International. Under his management, the Fidelity Special Situations fund was the top performer in its sector from its launch in 1979 until he stepped down at the end of 2007. He now has a full-time role mentoring Fidelity's younger fund managers and overseeing Fidelity's investment process.
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