Emerging markets may lose sheen

Given the deterioration in the technical picture of stock markets around the world, I would for now defer new equity purchases. My advice would be to eventually have at least 50 per cent of an international portfolio in emerging economies, because of the shift in the balance of economic power in the world. If indeed, emerging economies make up for more than 50 per cent of the world’s economic activity in a large number of sectors, and if emerging economies will continue to grow at a faster pace than the most advanced economies of Europe, the US, and Japan, this heavyweighting in emerging markets should be obvious. But for now, we could run into a period during which, as was the case in 2008, emerging markets underperform the S&P 500.

Paul Sheard
Global chief economist, Nomura Securities

Demand, not supply, is the constraint on global growth

Looking to 2010, the first point to note is that the global recession is over – the quarter-on-quarter contractions in global GDP having ended in Q2 2009 (for the G10 in Q3) – and we think will stay over. Apart from another major shock, which we do not expect, the global economy should continue on its recovery path. We forecast global growth of 4.2 per cent in 2010. But developed world growth stands to be much weaker (2 per cent) than growth in emerging economies (6.6 per cent). The recovery we forecast will not even make up the output lost in the recession. But demand, not supply, is the constraint on growth, and we expect demand growth in the crisis-hit developed economies, notably the US, Europe and (for somewhat different reasons) Japan, to be muted for some time. Of course, the external environment for emerging economies has changed, perhaps permanently. Emerging economies like China will need to rely more on domestic demand growth and less on export growth. Of the 4.2 per cent growth that we forecast for 2010, 3.1 pp is attributable to emerging markets and a full 2.0 pp to just China and India.

Marc Chandler
Global head of currency strategy, Brown Brothers Harriman

More green for the dollar

Even though the calendar may turn, the main drivers in the foreign exchange market are likely to remain intact in the early part of 2010. These main drivers, including the low US interest rates in absolute and relative terms, the ample liquidity being provided by officials, and their underwriting of the risk appetite will likely continue to take a toll on the dollar. In the first part of the year, the euro and Australian dollar for example could test their late 2009 highs. However, the combination of the continued trend or above trend growth in the US economy, coupled with what I expect to be rising inflation expectations, will prompt the Federal Reserve to begin hiking interest rates in Q3 of 2010. The first tightening by the Fed will likely take place before hikes by the ECB, BOE and BOJ. The dollar is likely to find better traction as the year progresses.

The dollar’s bottom is better conceived as a process rather than a specific moment. In late 2007, the dollar bottomed first against the British pound and the Canadian dollar several months before bottoming against the Swiss franc (March 2008) and the euro (July 2008). A reasonable case can be made that similarly, sterling’s cyclical high was recorded in early August above $1.70 and that the Canadian dollar’s cyclical high was recorded in mid-October near $0.98 (CAD1.02).

Mark Williams
chief Asia economist, Capital Economics

China is a problem of plenty

China is back on track but crucial choices lie ahead. After the lending boom in 2009, rapid growth is pretty much assured for 2010. This is because many of the recipients of loans have yet to spend them, so, even if lending was to dry up, there is enough juice in the system to keep spending flowing. As it happens though, the government appears set on maintaining its current stimulative stance, so lending, government spending and the weakness of the renminbi will all continue to support growth in the months ahead. The big question is about when the government will shift its focus from coping with global economic crisis to the longer-term issue of sustainably boosting domestic demand. The current investment-led approach is not sustainable if consumers overseas are not able or willing to buy up China’s excess production. But Chinese consumers will not take their place without far-reaching reforms to support much-needed growth in jobs and household income. The challenge is that the sort of reforms needed (interest rate hikes, financial sector liberalization, tax reform, the breaking up of state monopolies) might support consumption growth over the long term but could end up hurting investment – and powerful state-owned firms – straight away. The government avoided this hard choice before the crisis hit. It can’t do so much longer.

Jim Rogers
Commodity expert

Agri commodities to bloom

Commodities are a good space to be in, because if the world economy doesn’t do well then governments will be pumping money into economies, which will push up demand for commodities, and if economies are doing okay, then demand will be higher naturally. In basic metals, if there is a world recovery, shortages will develop, although prices have already gone up significantly. Currently, I am neither a buyer nor a seller in this segment. In precious metals also, I wouldn’t sell anything, although silver and palladium are cheaper than gold currently. The one space that I prefer over others is agricultural commodities; this is the space where the shortages are really sharp. Even the inventories of agricultural commodities are among the lowest in decades. We actually have a shortage of farmers now and the only way for governments to rectify this is to allow food prices to go up. In the energy space, oil is also in a multi-year bull market, but natural gas may be a better play than oil itself. Here also, I’m not selling anything.

Daragh Maher
Deputy head of global forex strategy, Calyon

Aussie, NZ currencies to rule

It will prove a mixed year for many major currencies given the fixation of currency markets is likely to drift away from simple considerations of risk appetite and risk aversion to the more traditional drivers of relative growth and interest rates. It looks set to be a testing year for the euro, a currency bid during 2009 not because of its own merits but largely because it was simply not the US dollar. If the USD enjoys a growth-related upswing, the euro will likely suffer considerable outflows, augmented by concerns over some governments’ fiscal vulnerability, weak growth and a possibly premature tightening by the European Central Bank. The Japanese yen also looks vulnerable as it is set to regain its role of funding currency of choice as interest rate expectations in other economies rise more swiftly than in Japan. The major winners will likely be the likes of Aussie dollar and New Zealand dollar where interest rate hikes and strong local economies will help drive further gains, the only real constraint being valuation concerns as they push higher.

Russell Napier
CLSA strategist

Advantage US banks

In 2010 the developed world banking systems will begin to work again and this will be the key driver for global financial markets. In 2009, a lot of money chased a limited number of growth stories in the emerging markets, commodities or select technology stocks. This search for growth focused on emerging markets because their banking systems were capable of turning very easy monetary policy into loan growth, GDP growth and rising assets prices. When developed world banking systems begin to work in 2010, these assets will not be quite so attractive on a relative basis. It is unlikely that all the developed world’s banking systems begin to work simultaneously. The US authorities have taken the most extreme measures to rejuvenate their banking system and this has hit the dollar hard. However, these extreme measures will end when the banking system starts to work. Thus the scenario for 2010 is that the US banking system, as recipient of the strongest medicine, is cured first and this will be very positive for the dollar. In 2010, US stocks, particularly bank stocks, will be the best performers, while most professional fund managers will find themselves over exposed to emerging markets and commodity stocks.