There Is No Alternative to Taking Risk 

Andreas Utermann 

Global View 

10/1/2013 

Global CIO Andreas Utermann presents the key takeaways from our fall 2013 Investment Forum: because financial repression is continuing and central banks are willingly staying “behind the curve,” risk assets are the only real choice for investors.
Coming into our second Investment Forum of 2013, which took place in New York in mid-September, our over-arching secular view from previous Forums – that we are living in an era of financial repression, and that for investors there is no alternative to taking risk – still held firm. As a result, our discussion in New York focused on major developments of the past year, assessing their impact against our secular view.

Andreas at the Investment Forum

Understand.

After debating the effectiveness of Japan’s Prime Minister Shinzo Abe’s new policies, we agreed that “Abenomics” was unlikely to succeed, despite the determination of the administration to tackle disinflation. Without aggressive supply-side reforms and an opening of the country to net immigration to address demographic challenges, we believe it is an unsustainable state of affairs and could trigger an eventual crisis in the yen and consequent reallocation of savings in Japan – with significant global implications.

In addressing the sell-off in US Treasuries caused by the Fed’s1 tapering comments, there was little doubt that this was the turning point in the global interest-rate cycle and the death knell for the threedecade- long bull market in bonds. Nevertheless, with high levels of indebtedness globally, our prediction continues to be for looser monetary policy that lasts longer than the market currently anticipates.

We also discussed a range of region- and asset-class-specific topics, emphasizing the attractiveness of emerging markets (EM). Developing economies with current-account deficits are likely to be hurt by future monetary policy tightening in developed markets. We view EM equities as somewhat expensive in historical comparison and not a unique means of gaining equity exposure to economic growth in the region. Conversely, local-currency EM bonds offer investors unique access to economies with healthy demographics and relatively low debt-to-GDP2 ratios. Consequently, the recent sell-off in both EM bond prices and some EM local currencies meant that the yield pick-up relative to developing-market debt represented a significant buffer against further currency depreciation over medium maturities.


Act.

In a world where deleveraging has only just begun and low refinancing costs are important, central-bank stimulus in the form of QE¹ remains critical. Central banks will therefore remain willingly “behind the curve.” Ample liquidity will keep short-term yields near zero and long-term yields below their equilibrium level, with inflation risks on the upside. With many of the world’s financial assets invested in very short-term liquid instruments, financial repression remains a danger to investors. We are convinced that there is no alternative to investing in risk assets:

Benchmark developed-market government bonds are yielding below their equilibrium level and continue to be expensive. Longer maturities should be avoided.
Given the unique features of local-currency emerging-market bonds, we maintain our positive stance on local-currency emerging-market bonds while broadening it to include some of the more fragile economies recently hit by tapering comments.
 
Equity valuations are supported by a number of factors: the significant yield gap between bonds and equities; the fact that most large investors are underweight equities; and the attractive dividend yields in many sectors. Within the dividend segment, perhaps a cyclical orientation toward companies with dividend growth potential is warranted.
 
Japanese assets are a special case. One might play a tactical reflation trade on Japanese equities, but as long as significant structural reforms are not underway, sustained outperformance should not be expected. JGBs² should be avoided.

More than ever, the only way to achieve returns is by taking risk.

4Q13 Global Strategic Outlook

Global Strategic Outlook

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Equities Outlook - Asia-Pacific
North Asia Rebounds, South East Asia Still Lags
Economic Forecast and Valuation Review





1. Quantitative easing
2. Japanese government bonds

Equities have tended to be volatile, and do not offer a fixed rate of return. Foreign markets may be more volatile, less liquid, less transparent and subject to less oversight, and values may fluctuate with currency exchange rates; these risks may be greater in emerging markets. Dividend-paying stocks are not guaranteed to continue to pay dividends. U.S. Government bonds and Treasury bills are guaranteed by the U.S. Government and, if held to maturity, offer a fixed rate of return and fixed principal value.

The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.

 

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