The year 2010 did not go according to plan.
Having prevented a depression in 2008 and with a strong rebound in 2009, policymakers expected the global economy to see sustained growth in 2010. That never happened. Recent data show a slowing global recovery. Output in the West is far below pre-2008 levels, with stubbornly high unemployment in the United States and debt crises in Europe blighting lives and souring politics.
While Asia has largely recovered from the recession, tensions in the Korean Peninsula and rising inflation in China are causing uncertainties in that region, prompting investors to move their cash to safety in the United States dollar. New opportunities exist in other emerging markets — Africa, the Middle East and South America — but poor access to capital is hampering growth. It’s no wonder the global capital markets are in a lurch. Investors simply are cautious.
That makes for a less optimistic outlook for global capital markets in 2011. Hedge fund managers and all kinds of investors are experiencing some of the toughest conditions in decades. Markets are already losing their nerves. Global stocks dropped in November, wiping out $2.3 trillion from market values worldwide amid fears that Ireland’s debt crisis will spread. European governments and the International Monetary Fund handed Ireland a $113 billion rescue package but failed to assuage investor concerns that Spain and Portugal won’t go the way of Greece and Ireland.
Growth yes, but lackluster
Despite all of that, many economists think the worst is over. The world economy isn’t likely to slip into another recession in 2011. What’s likely to be seen is lackluster growth and persistently high unemployment in the West. The U.S. growth rate is expected to be sluggish at 2.5 percent, well below the 3 percent long-term average rate and barely able to create enough jobs to offset the number of new workers entering the labor market. Chalk it up to low consumer spending, which accounts for two-thirds of the country’s gross domestic product (total output of goods and services), and a weak housing market.
To help spur growth, the U.S. Federal Reserve agreed to spend $600 billion buying long-term bonds, which would make it cheaper to borrow by driving down interest rates, so investors can have access to funding. However, most economists don’t think the influx of cash will attract investors to the credit market. Investors are cautious about taking on more debt.
That the central bank is buying debt means investors are afraid of risking their cash. With so many companies going out of business, investors with the money to lend have to be more careful about whom to give money to. Banks are wary about lending to all but the most creditworthy of investors.
There are a few bright spots, however, such as emerging markets, where returns are much better. Foreign money poured into emerging East Asia’s bond market in the third quarter of 2010, boosting local currency bonds on issue to $5.1 trillion despite government efforts to slow a tide of cash pushing their currencies too high, according to a new Asian Development Bank report. The report, which was released on Nov. 28, said the value of local currency bonds outstanding was up from $4.8 trillion at the end of the April-June quarter and 17.2 percent higher than a year earlier. The increase was driven by corporate bonds while growth in sales of government bonds slowed as economic stimulus spending was wound down, the ADB said. Corporate profits are also on pace to expand 45 percent this year, and could climb another 14 percent next year. That would get them back to pre-recession levels.
Chinese asset managers aren’t wasting time. They have embarked on a drive to attract investors from the United States, Europe and the rest of Asia, touting high returns because of their knowledge of the local market. “If you don’t have local research analysts, you miss the opportunities,” one of them said.
Asia is not moving ahead alone. The past few years have seen China and India joining the ranks of Africa’s leading trading partners, which reflects the ascendancy of the two countries as much as the collapse of the Western economies. Trade ties between South Africa and China, for example, have blossomed exponentially, with about $7 billion in natural resources being exported from South Africa to China and $9.5 billion worth of value-added manufactured goods moving the opposite direction.
Emerging market trends
This is part of a new trend, whereby emerging markets are boosting trades among themselves. Sovereign investment firms from the Middle East, for example, now own $2 billion worth of assets in Brazil. Speaking at the World Investment Forum in Xiamen, China, in September. Robert D. Hormats, U.S. undersecretary of state for economic, energy and agricultural affairs, noted the impact of emerging markets on what he termed “the contours of international investment.”
“Since World War II, the largest flows have occurred between developed economies, with the single largest bilateral investment relationship existing between the U.S. and Europe. Investment relationships between developed and developing economies had largely been characterized by outflows from developed economies to developing countries,” Hormats said. “This pattern has changed and will continue to change. A number of the large emerging economies — particularly Brazil, Russia, India, China and South Africa but others as well — are now increasingly important overseas investors. In 2009, [foreign direct investment] flows from emerging and developing economies into other markets approached one-quarter of a trillion dollars. These countries held overseas investment stock of nearly $2.7 trillion, more than three times their total a decade earlier.”
Intra-emerging-market investments provide opportunities for Western investors to tap into. Indeed, some Western investors are starting to take action. Société Générale of France is now targeting Chinese companies doing business in the mineral-rich continent as part of its African expansion. The move, which would see the French investment bank doubling its investments in Africa by 2015, would help it access part of the growth of Chinese commercial activity in the region. Small and institutional investors who hold SG shares stand to gain, as do those with the courage to go for other types of investment.
One such institutional investor is BNY Mellon Asset Management, which is launching a long-only equity Latin America Infrastructure Fund. The fund will be a buyer of securities that mature in three to four years, with lower volatility. Janus Capital Group also has rolled out the Perkins Global Value Fund to invest in undervalued global equities. And Van Eck Global of New York has launched Market Vectors Rare Earth / Strategic Metals exchange-traded fund, or ETF, which would be the first-ever listed ETF exposing investors to companies that produce, refine or recycle the industrial metals.
Others may want to invest in bonds or in equities. Concerns about the economy have driven down bond yields, as investors look to the safety of fixed-income assets. With Europe going through a serious debt crisis, bonds may not be for the fainthearted, though it may all come down to timely rebalancing by individual investors.
Entering emerging markets
For Western investors, probably the easiest way to get involved in emerging markets is through big multinational companies such as Société Générale, or exchange-traded funds that offer exposure to those markets. Emerging markets are on track to surpass the U.S. over the next couple of years because of their strong growth. Investing in those markets doesn’t have to strictly follow the traditional path of buying stocks and bonds. Agriculture and natural resource commodities like energy and metals have elbowed their way into becoming an important and profitable asset class. Not only are investors now able to trade these assets as securities, but they also can invest in the underlying sectors allied with them.
For example, the industrial sector consumes 50 percent the world’s total energy delivered. The fact that industrial consumption of energy is growing as living standards rise is contributing to the transformation of the energy system, with new technologies and new companies cropping up every day to limit carbon emission while raising power supply. These include smart-grid technologies that enable the use of renewable energy and help increase energy efficiency in countries without a reliable supply of electricity, such as South Africa.
An investor who understands that South Africa needs a huge increase in Green investments may start looking to invest in independent companies that have the potential to produce renewable energy. At the same time, Western companies that have increasingly set high energy efficiency targets, such as such as Wal-Mart stores and FedEx, can be attractive to individual or institutional investors. (Note that Wal-Mart acquired a South African supermarket chain this year for $4 billion.)
To be sure, there aren’t a lot of actively managed international portfolio investments focused on Africa, and most of what’s available have a bias for South Africa. Yet new markets are opening up in Angola, Botswana, Ghana, Kenya, Nigeria and Uganda. Also, many of the new funds are located in London or New York, with less local research expertise. But a growing number of market-savvy Africans, many of them armed with MBAs from North America and Europe, are establishing their own investment portfolios to provide credible infrastructure for interested American investors to access the African market. They have already attracted the attention of British rock star Bob Geldof, who is now trying to raise $1 billion from institutional investors for a private-equity venture in Africa. Should he launch the fund, it would be among the largest in a wave of new private-equity ventures seeking to capitalize on economic growth on the continent.
Certainly, investing in emerging and frontier markets carries risks. For starters, some of those markets in Africa, South America and the Middle East are still illiquid and there’s no reliable data or information to help make decisions. Yet money has continued to flow into those markets. The Emerging Markets Private Equity Association reported recently that private-equity investment in emerging markets rose $13 billion in the first half of 2010, up from $8 billion for the previous year.
Year-to-date returns are also juicy. The S&P 40 Index, which includes stocks from frontier markets such as Botswana, Ghana and Kenya, is up about 9.0 percent year-to-date. The MSCI Emerging/Frontier Index is up 9.4 percent year-to-date, compared to a 7.0 percent gain for the MSCI North America Index and a 13 percent decline for the European Union Index.
The bond choice
Despite declines in November, the S&P 500 Index, the key index for midsize U.S. stocks, is up 8 percent year-to-date after a roller-coaster ride, with another gain of 7 percent expected next year. Markets plunged 16 percent from April to July before rebounding 9 percent in September. These extreme swings have scared off investors, who have been moving their cash to the bond and commodity markets.
Investors prefer bonds sold by the U.S. and Germany over any other type of bond because these two governments are less likely to default. The dollar is safe because it is still the world’s reserve currency and the U.S. central bank can print more money, while Germany’s economy is relatively strong, having recovered from the recession much faster than the rest of Europe.
Meanwhile, bonds sold by euro zone countries that have barely emerged from the recession — such as Ireland, Greece, Spain and Portugal — as well as bank bonds, are much more risky because these countries are carrying a heavy debt load after the financial crash of 2008. They provide high yields precisely because of their high risk.
The current volatility in the stock and bond markets reflects nervousness among investors, who are becoming more risk-averse as the rate of defaults increase. With risk of default rising for banks and smaller EU countries, many investors are turning to emerging market bonds. The capital flight has left European stock markets about 35 percent off their 2007 highs. Yet there’s money to be made even in the EU and U.S. bonds. Yields or total return for the riskiest corporate bonds are double for the safest triple A-rated companies.