In our inaugural 12-month asset price outlook published on January 7, we rated Developed Equities a “7.” A rating of “5” suggests a return outlook close to its historical average (since 1926, the annualized total return of the S&P 500, with dividends reinvested, is just under 10%). i.e. We were relatively bullish on Developed Equities, as our rating of “7” in the beginning of this year suggests a higher-than-average return outlook. We were less bullish on Emerging Markets, however, as we believed countries like Brazil and India were: 1) experiencing inflationary pressures due to the lack of infrastructure and educational investments over the last decade, 2) the commodity bull cycle was maturing, and 3) China, the number one growth country in the world, was experiencing a structural growth slowdown (we projected a 5% to 8% growth rate over the next 5 years, versus a 8% to 11% growth rate over the last decade). As such, we rated Emerging Markets a “5” only.
Since January 7, the MSCI World Index (representative of Developed Equities) returned 11.8%, while the MSCI Emerging Markets Index declined by 10.4%. The return gap of over 20% between Developed and Emerging Market Equities (despite the ongoing troubles in the Euro Zone) over the last seven months is the largest running seven-month return gap between Developed and EM equities since month-end September 2000, and prior to that, the Brazilian/Russian crisis in fall 1998. Our constructive outlook on Developed Equities relative to Emerging Equities was thus prescient, although we did not expect Emerging Market equities to under perform so severely. Emerging Markets, in general, have been hurt by an overweight in the commodity and materials industries, as well as country-specific troubles such as the crash in the Indian Rupee, the slowdown in China (and domestic investors’ preference in Chinese real estate over Chinese stocks), and the near-recession in Brazil.
That said, Emerging Markets in general are in very good shape. Balance sheets at most EM governments and corporations are flushed with cash, while EM’s dependence on US$ funding has declined substantially. Domestic ownership of EM equities has grown substantially–thus minimizing any potential fallout from a mass exit by foreign investors. SE Asian countries, in particular, have pooled their resources to create a $240 billion multilateral currency swap agreement. Dubbed the “Chiang Mai Initiative,” it was designed to prevent a repeat of a systemic fallout in SE Asia similar to the Asian Crisis. We think growth in EM countries and EM equities are poised to re-accelerate; and are thus overweight EM relative to Developed Equities over the next 12 months. We are raising our return rating for EM equities to “6,” while downgrading our return rating for Developed equities to “4.”
Our true value-add, however, was our highly bearish outlook on gold. On January 7, we gave gold a return rating of just “2,” with a very high risk rating of “8.” Our risk-reward outlook for gold was timely, as gold prices subsequently declined from $1,645.25 an ounce to $1,314.50 an ounce today–representing a decline of 20.1% in just under seven months. Gold is now hugely oversold in the short-run. We are thus raising our rating on gold from “2” to “3” (with a corresponding risk rating revision from “8” to a more benign “7”) despite our recent 6- to 12-month gold price target revision from $1,100-$1,300 an ounce to $1,000-$1,200 an ounce. Our 12-month revised outlook on major asset classes is published below. Any feedback or comments are welcome.