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Outlook: China set to win trade war as finance democratises

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Investors seeking to generate returns in the next five years, will need to shift a part of their allocations away from US to Chinese stocks, emerging markets and private equity, according to Pictet Asset Management.

Commenting on the firm’s secular outlook, Luca Paolini, chief strategist at Pictet AM, said that the US is likely to underperform and that “US equities trade at record premiums in an expensive currency – the US dollar should weaken over the coming years”.

“European and emerging Asian equities will do better in our view, with Chinese stocks set to be the star performer,” he said, pointing to the following sectors likely to outperform most: technology, staples and health care, as well as sectors with good balance sheets that generate cash.

While it is indeed in the interests of China and the US to find common ground, even under the most positive scenario, not everyone stands to benefit.

“China’s inevitable rise will bring an end to US tech hegemony and the exceptional profitability that American tech firms have enjoyed in the past decade,” the outlook stated.

At the same time, growing competition may give rise to an acceleration of technological development and diffusion, providing a much-needed boost to global productivity.

The asset manager recommends investors allocate away from increasingly expensive companies in Silicon Valley and allocate more of their capital to rapidly growing businesses in other hotspots, such as Asia.

Monetary policy and returns

Central bank policy will keep unleashing stimulus to support the recovery of economies from the impact of the virus.

“Having pumped liquidity equivalent to 14% of global GDP during 2020, central banks will aim to put a ceiling on bond yields, to reverse deflationary pressures by closing output gaps that opened up during the crisis, and then to keep growth on trend,” Paolini says.

“They have plenty of firepower to keep monetary policy loose for a long time yet.”

As a result, investment returns will be heavily impacted. Investors face returns well below long-term averages over the next five years, especially in the case of fixed income, as interest rates stay lower for even longer.

In times of great uncertainty, a real return of 5% per year will be a satisfying performance.

To increase returns, Paolini recommends investors move away from traditional balanced portfolios in the next five years.

“Investors will need to boost allocations to emerging markets, alternatives, treasury inflation-protected securities and absolute return strategies,” he said.

Given the poor outlook for traditional asset classes, Pictet AM favours alternatives with good diversification potential, such as gold and hedge or market-neutral funds.

It expects gold to rise to $2,500 (€2,118) as the dollar depreciates and policy rates stay near zero.

Greater sustainable capitalism

A potential game changer will be the drive to democratise finance, which will impact private equity, the asset manager believes.

Regulators are now looking to open up the market to individual investors, which has been dominated by institutions and the ultra-wealthy.

The US has led the way, but other countries, including the UK, are considering similar moves, the outlook said.

“Because private equity-owned companies are proliferating while the number of listed firms is falling, the arguments for opening up private equity to individual investors have become too loud to ignore,” the outlook states.

Crucially, private equity has plenty of dry powder, some $1.46trn (€1.23trn), which can be used to shore up balance sheets or to reinvest it, Pictet AM said.

Risks of passive investments

Meanwhile, investors and regulators are becoming increasingly concerned about the risks that come with the expansion of index trackers.

Research shows passive investing poses threats to market stability and sustainable investing, the outlook said.

“That’s not to say passive investment will go into reverse, just that the pace of expansion may slow as investors and regulators discover that passive strategies, while cheap and easy to access, are far from risk free,” the outlook notes.

The potential of investors to engage with companies and embrace responsible and sustainable business models is reduced in passive funds, it said.

Passive portfolios tend to invest in so many companies as to make direct engagement with them impractical, hindering the development of responsible capitalism.

“More generally, the rise of passive investing threatens efficient market pricing,” according to the outlook.

As the gap between winning and losing stocks widens, benefitting companies that embrace innovation and technology, passive investing would fail to correctly price this shift.

Index-tracking means that the shares of companies with large weightings attract more capital irrespective of their financial performance.

“So, if the system is dominated by passive investing, the price of a security ceases to function as a gauge of a firm’s underlying prospects, leading to capital mis-allocation,” the outlook said.

Elena Johansson

Senior Reporter

Part of the Mark Allen Group.