Liam Halligan of Prosperity Capital Management -
Our "Big Picture" thesis is this: when future historians review the current period, an extremely important trend they will identify is that the "sub-prime debacle" - and the related damage to faith in Western markets and institutions - will have caused an acceleration and accentuation of the on-going shift in global portfolio flows away from the "advanced" nations and towards emerging market asset classes.
In a very brief summary: we see five main reasons why flows to emerging market portfolios will rise, benefiting emerging market assets disproportionately, over the next three to five years as a result of the sub-prime crisis.
1) West-to-East growth
As a result of the credit crunch, the IMF forecasts the Western economies will contract by 2% this year. The emerging markets, meanwhile, will grow by 3.3%. In other words, the relative growth gap between ast and west is now wider than it has been for several years. This pattern continues into 2010 and beyond, with the emerging markets continuing to outpace the rest of the world, as the West only slowly recovers.
2) Deficit-to-surplus countries
As well as "going where the growth is," portfolio investors will, in our view, increasingly warm to "surplus" countries (mainly emerging markets) over the next few years, at the expense of nations running large and growing deficits (mainly in the West). The BRIC countries between them now account for 45% of total global forex reserves.
For several years hence, the debilitating effect of "sub-prime" means the world will be haunted by systemic risk. But with their large reserves, major emerging market economies will be able to stabilize their banking systems, defend their currencies and stimulate their economies without taking on more leverage - factors making them attractive to global investors...
3) "Leveraged to unimpaired"
... which brings us to the gap between western and eastern indebtedness and the level of state expenditure. In many large western economies, combined household, corporate and state debts exceed 200% of GDP. Servicing this debt burden now the era of "easy credit" is over will prove very burdensome, hindering growth. In addition, ageing population will further increase already high state expenditures. emerging markets, in contrast, generally have both less leverage and less state expenditures. Emerging markets will therefore be able to spend more on promoting economic growth in the coming years, driving further divergence in relative west/east growth rates.
4) "Intangibles to tangibles"
The fourth "big picture" trend is the shift in investor sentiment away from intangible assets and towards tangible goods - which will also benefit emerging markets, not least Russia.
Many Western governments, in a bid to tackle "sub-prime," are now printing money and issuing swathes of sovereign debt. This is making global money managers extremely nervous, not only because some of the world's major currencies are being debased - making the related sovereign instruments less attractive - but also due to the inflationary implications of this ultimately misguided policy response.
5) On-going search for yield
Our fifth, and final, "big picture" thought is that emerging markets could benefit over the next few years as western markets falter, given that the "search for yield" among mainstream asset managers, far from abating as a result of the credit crunch, could easily intensify due to a combination of tighter regulation and Western demography. In many cases, given that demographic pressures faced by pension funds and life companies intensify significantly over the next few years, they will require higher returns.
So the "search for yield" will continue, and perhaps become even more concerted - even though, post sub-prime, Western markets are likely to endure a serious regulatory crack-down, rendering impossible many previous strategies that (for some) have generated high returns.
ED: A fuller account of this argument is available in PCM's "Big Picture" article in the fund's April Prosperity Newsletter available at www.prosperitycapital.com END
Liam Halligan is chief economist at Prosperity Capital Management
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