Buy Emerging Markets and the Dollar: Six Views on 2015’s Markets

Jerome Booth, author of the recently published

Jerome Booth, author of the recently published "Emerging Markets in an Upside Down World: Challenging Perceptions in Asset Allocation and Investment," says prejudice underlies the shunning of developing markets.

Harry Borden/Bloomberg Markets

In its 2015 Annual Guide, Bloomberg Markets spoke with six investors and strategists on what they’re expecting from various sectors of the financial markets next year.

1. Don’t Bet the Farm on China

Frances Hudson’s investment horizon stretches to decades. One reason, says the global thematic strategist at Edinburgh-based Standard Life Investments Ltd., is that demographics and other long-term drivers of securities markets are easier to predict with accuracy than factors that affect markets during shorter periods.

For example, many market watchers expect that China’s growth will lead to an increase in global demand for food commodities, Hudson says. The thesis is that the world “needs more food to satisfy growing middle-class appetites for meat—which I think is wrong,” she says.

Why? Consider a population pyramid for China, Hudson says. The biggest slice in the graph represents people born around 1985. That bulge in the population is forecast to remain the largest segment until 2065, meaning that China will become an increasingly elderly society.

Put that together with the fact that aging populations tend to consume less, and it leads you to a forecast of declining demand for meat, milk and other agricultural commodities in China over the next few decades. “Culturally, China is far more likely to have appetites that evolve in the direction of, say, South Korea than to have appetites that evolve in the direction of America,” Hudson says.

China’s per capita protein consumption is already very close to the level of South Korea, Hudson says, evidence that its demand for meat is near a peak.

2. Put Half Your Money in Emerging Markets

Eighty-five percent of the people in the world live in emerging markets, Jerome Booth says. They account for more than 50 percent of global gross domestic product, more than 50 percent of energy consumption and more than 50 percent of industrial production. So the emerging markets are not an asset class, he maintains: “It is the bulk of humanity, the bulk of economic activity on the planet.” They’re collectively huge and individually multifaceted, he says, and should be treated as such by investors.

Booth is the former head of research at emerging-markets fund firm Ashmore Group Plc and the author of the recently published Emerging Markets in an Upside Down World: Challenging Perceptions in Asset Allocation and Investment. He retired in 2013 and now manages his own money through London-based New Sparta Ltd.

He warns financial professionals against using asset classes and indexes as the building blocks for investment decisions. They should instead focus on what investors typically want, which is future income, he says. The best guide to future income is past income, and the best measure of that is GDP. “That means you need to be 50 percent in EM—not 5 percent,” he says.

The shunning of developing nations comes down to prejudice, Booth says, as all countries are inherently risky. “The emerging markets are the ones where that risk is priced in,” he says.

3. Beware of Regulatory Risks

Sonia Kowal, the president of Zevin Asset Management LLC, says her firm’s focus on environmental, social and governance factors has helped reduce risk in client portfolios. Analyzing ESG factors, she says, can help flag companies likely to fall under regulatory scrutiny for polluting, for example.

Managers and analysts at Boston-based Zevin begin with companies’ self-reported ESG data, but that’s just a starting point. “It also has to be counterbalanced with an external view,” she says. To do that, her team checks news stories and consults with nongovernmental organizations.

Zevin oversees $550 million and categorizes itself as a socially responsible investment company. That term traditionally means that a firm imposes limits on its investment universe, excluding companies involved in such industries as tobacco and firearms. Focusing on ESG, by contrast, means using nonfinancial indicators, such as the ratio of greenhouse gas emissions to sales, to evaluate companies. “You can do both, but they’re not necessarily two sides of the same coin,” Kowal says.

When applying ESG factors to investment decisions, a piece of data may be more important for one company than another. Exposure to carbon taxes and climate regulation would be critical for an oil producer, Kowal says, whereas supply chain management would be more relevant for a maker of consumer goods.

“If you’re really going to do it properly, you have to do a deep dive into every metric that you find important,” she says.

4. Make a Run at Frontier Markets

Heidi Richardson is preparing for an ascent in Kenya. Richardson is training for the Kilimanjaro Marathon, and as a global investment strategist at BlackRock Inc., she also expects stocks to climb in the east African nation. “For longer-term investors, I like the frontier markets very much,” San Francisco–based Richardson says, singling out Argentina, Kuwait and Nigeria as well as Kenya. “Those are the truly emerging of the emerging markets.”

Exchange-traded funds are an easy way into those four markets, Richardson says, although she cautions that the liquidity is critical. Investors who have been out of the broad emerging markets should build up there first. “Valuations of emerging markets haven’t looked this attractive, on a relative basis, in the last 10 years,” she says.

Among developed markets, the U.S. and Japan are the best bets, while Europe will struggle, Richardson says. Within the U.S., she recommends a tilt toward extra-large companies that tend to pay high dividends and are more resilient in a time of market gyrations. “Managing volatility is going to be an important consideration,” she says.

Within the ETF market, a notable trend has been the use of fixed-income funds by institutional and retail investors. Bond ETFs can provide a “parking space” when moving money between managers and strategies.

A veteran of marathons on seven continents, Richardson says running and investing have something in common. “If you can pace yourself and be disciplined, then you’ll easily finish the race,” she says.

5. Count on Another Strong Year for the Dollar

The U.S. dollar’s world-beating rally has only just begun, Sue Trinh says. The senior currency strategist at Royal Bank of Canada says the greenback’s surge in 2014 was driven mostly by investors exiting bullish bets on other currencies, including the euro, yen and Australian dollar. The second leg of the U.S. dollar’s gain will come when the Federal Reserve begins its tightening of monetary policy, she says. “That’s going to be the only game in town, really, with the rate hikes that we expect from June onwards,” says Hong Kong–based Trinh. The dollar climbed against all its major counterparts in 2014, and the Fed’s actions in 2015 will continue to ripple through currency markets, Trinh says.

The yen fell to a six-year low in 2014, reaching RBC’s end-of-2015 forecast of 110 per dollar ahead of schedule. South Korea’s won has also suffered versus the dollar, though the currency is likely to benefit as the nation’s economy shifts toward a service-sector model, Trinh says. “That’s going to put it in good stead to be able to compete meaningfully with China by moving up the value chain,” she says. “The longer-term story for Korea is still quite positive.”

As for China, the yuan is likely to weaken to 6.20 per dollar in 2015, but that doesn’t indicate bearishness on the economy. “That reflects our broader cyclical view that the U.S. dollar is going to enjoy a modest uptrend throughout 2015 right across the board,” Trinh says.

6. Prepare for a Big Drop in U.S. Stocks

The surge in market volatility that saw $5.5 trillion in global equity value wiped out from September to October in 2014 is just a harbinger of things to come, Gerald Buetow says. Stock valuations are still too rich and are artificially supported by central bank stimulus in the U.S. and Europe, says Buetow, chief investment officer at Innealta Capital.

Investors are waking up to the reality that monetary policy is ill-equipped to fix the problems plaguing developed economies, he says. “Once the markets understand that basic fact, they will react violently negative,” he says.

Buetow founded Innealta in 2007. It was acquired two years later by Austin, Texas–based AFAM Capital Inc. Innealta is a quantitative firm that manages four mutual funds made up entirely of exchange-traded funds. The firm’s traders look at the risk/reward characteristics of sectors and countries and rotate investments among them. Given Buetow’s dour assessment of equities, it’s not surprising that the funds were heavily weighted toward bonds as of the end of the third quarter.

Most of the opportunities for stocks lie in developed Asian economies and in emerging markets, he says. Innealta likes Russia, which Buetow acknowledges is a head-scratcher for some. Russia’s resources put it in control of the energy supply across its borders. “That opportunity is going to pay off in the not-too-distant future,” he says. Risks are turned the other way in the U.S.

“It’s going to unwind very noisily,” Buetow says. “That’s when the opportunities are going to present themselves.”

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