James Klempster, portfolio manager at Momentum Global Investment Management, explains why diversification will continue to play an integral role this year.
Despite recent wobbles, global equities have provided high single digit returns year to date.
The consensus view has turned more bullish and there are a number of reasons to be positive. In spite of this, we must remember we are a long way from a full resolution to the financial crisis and the world is far from normality.
We are in a very different cycle to that which we are accustomed, but a disciplined focus on valuation should help investors ride out the bumps along the way.
Why portfolio diversification will be especially key this year
Deleveraging will keep overall growth subdued for several years to come and central banks will keep monetary policy loose to balance out tight fiscal policy. It is unlikely interest rates will be increased while strong deflationary forces remain. Central banks are now committed to a massive programme of monetary easing, providing seemingly endless liquidity when needed.
They have the tools to do this and can continue indefinitely. Asset prices do not usually go down a long way when liquidity is this freely available, but this is precisely what creates bubbles; economic fundamentals need to keep pace with the markets or, ultimately, the risks of dislocation escalate.
Emerging markets will not be immune from this slow growth environment as they are heavily dependent on exports and capital investment, and both are likely to slow down. However, the rebalancing towards domestic consumption will mitigate this effect.
Real incomes in much of the developed world could begin to stabilise or even improve modestly as inflation rates fall, providing a much needed boost to consumption.
The demand for companies with strong balance sheets, cashflows, margins and sustainable franchises is likely to persist; high quality stocks are rapidly becoming the de rigueur asset class. This could ultimately induce bubble-like features in this sector, but we are far from that at the moment.
The US is doing reasonably well. Growth has slowed but the private sector is in good shape. It is highly competitive, helped by good productivity, a weaker dollar and falling domestic energy prices. Important sectors of the US economy are on the mend which will help growth, improve consumer confidence and strengthen banks’ balance sheets.
The political will to preserve the euro project should not be underestimated. The union will likely muddle through and there might be casualties along the way, but Europe’s leaders are intent on the project.
Europe could surprise on the upside. Even Greece is likely to be running a primary fiscal surplus next year and the Troika is expected to extend the time they have to meet fiscal targets.
An extreme risk that remains is bank failure but central banks have provided the liquidity buffer and support to prevent a systemic failure.
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