The great bull’s final fling
We are entering a new era of global economic prosperity. Growth over the next 25 years could run at over twice the level of the last 25 years. After two decades characterised by tight monetary and fiscal policies to bear down on inflation, the full effects of the major supply-side shocks of the 1990s – the demise of Communism, globalisation and the technological revolution – will be seen. Structural changes in emerging economies will contribute significantly to the higher global growth trend, whilst developed economy living standards will rise faster in part through the lower prices transparency of information and global competition provide.
Ushering in this new era of higher growth is an increased appetite for risk-taking. Growing acceptance that inflation is no longer a threat is being reflected in lower real interest rates – lower, in fact, than trend economic growth rates. This means that companies, entrepreneurs and investors are being paid to take risk, so it should come as no surprise that they are so doing. Capital investment, advertising, and employment are rising, along with patent applications, new company formation – and investor interest in the stock markets.
Yet stock market historians will know that periods of economic prosperity do not necessarily coincide with strong returns from financial assets. The past 20 years of more subdued growth has by contrast witnessed a sustained bull market in equities and bonds. We believe that we have entered the final great phase of that bull trend, coinciding with the dawn of this era of rising growth. Once the latter is firmly established – in the next three to five years – progress from financial assets may be much more muted.
For now, however, the outlook for financial assets remains extremely positive, since the greatest returns usually come in the final years of a bull market. Quite simply, the global investor is spoiled for choice. The US has led the way in establishing a higher trend growth rate and dominates the provision of enabling technology. Given the strength of its multinationals in this field, our US portfolio continues to deliver excellent earnings growth year in, year out so whilst we are modestly underweight nearly 40% of our global equity portfolios is in the US.
Change remains the keynote in Europe, but whilst restructuring of the corporate landscape and its attendant improvement in returns on equity continues to underpin our enthusiasm for European equities, a further positive surprise should emerge as the region participates in this higher trend growth rate, defying its historical legacy as a hidebound, slow growth area. We are overweight, with near 30% in continental Europe and a further 5% in the UK.
Even in Japan, where longer term fiscal concerns remain, the economy is beginning to resynchronise with the world after the lost decade of the 1990s. Corporate change is evident here too, but the pace of restructuring relative to other regions together with those longer-term concerns leaves us modestly underweight still, with 10% of global equity portfolios in Japan.
By contrast, other Asian and developing markets have emerged from their crises of the last few years in better shape at both the economic and corporate sector level. They should benefit from the rising global growth profile and, as high-beta markets, will perform well in an era of increased appetite for risk. Moreover, many Asian and emerging markets now offer the global equity investor the diversification benefits offered in previous decades by Japan or parts of Europe. Hence the remaining near 20% of our global equity portfolios is invested in Hong Kong, Singapore and other emerging markets across Asia, Latin America and Eastern Europe.
In a period of resynchronising global growth and of rising stock-specific risk, however, bonds have a very real role to play too. Last year’s decoupling of bonds from equities reflects the changing relationship between growth and inflation and should come as no surprise. But the changing correlations between bonds and equities means that bonds offer not only good value in terms of real yield but provide a diversification benefit they have not done for the past 20 years. There has never been a better time to have a balanced mix of assets and hence for global multi-asset portfolios we allocate 25% to bonds and 75% to equities.
The rising growth outlook and growing appetite for risk fully supports current financial market valuations, so we remain fully invested. Money-making opportunities abound in this transition phase, spurred on by technological change and globalisation. Be mindful, however, that the next few years may well be the final great phase of the 20-year bull market – and begin to structure portfolios and plan accordingly.
Richard Buxton is a director at Baring Asset Management in London