According to Barclays, developed market stocks, bonds and currencies will be stronger in comparison to emerging markets, once the US Federal Reserve possibly begins "tapering" the quantitative easing (QE), as signalled, by the end of 2013.
Kevin Gardiner, CIO Europe, Barclays, said this is likely primarily because a world where monetary policy is normalising could be one in which the decade-long flow of funds out of developed and into emerging markets slows and even reverses for a while.
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On 20 June, a Federal Open Markets Committee (FOMC) statement and the press conference by Chairman Bernanke more or less confirmed September as the most likely start date of the rollback of the US’s QE programme, given current economic conditions.
Gary Dugan, chief investment officer, Asia and Middle East at Coutts, agreed saying, "In the near term, investors are going to worry that higher US rates will encourage further flows of capital out of the emerging markets. Also those investors who believe the Fed is making a policy mistake will worry that emerging market growth will be hurt by any slowdown in the US."
After the US Fed signalled the QE "tapering" move as well as the reduction of its purchases of bonds, Barclays said bonds and stocks may continue to move downwards together for a while, as interest rate expectations rise.
According to Barclays, the UK market will also not be as attractive and other developed markets in the Far East such as Hong Kong and Australia look vulnerable.
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By GlobalDataMore generally, Barclays said commodities can be vulnerable to worsen emerging market sentiment, but if the US economy is indeed going to gather more momentum, and China is still unlikely to hard-land, underlying demand is not going to evaporate.
"Perhaps the clearest call is on gold, whose perceived status as a store of value in the face of (over-stated) dollar debasement fears could receive a brutal debunking as the prospect of higher rates and yields gets closer and the dollar stays firm. Gold should be a low single-digit percentage holding for most investors," said Gardiner.
Investment strategy
Gardiner advised long-term investors whose holdings of stocks are relatively low to use current weakness as an opportunity to enter the market as well, in the light of the Fed’s decision.
Salman Ahmed, global and emerging fixed income strategist at Lombard Odier Investment Managers, said, "We think bond managers now need to be nimble and equipped with the full range of tools to manage duration, credit and inflation risks. We think investors without this flexibility are dangerously exposed."
Fed up
Dugan said, in the recent Coutts Wealth Watch, that the FOMC statement has added "considerable near-term volatility" into the markets.
"Bernanke talked about a number of one offs that are keeping inflation low at the moment and that they expected to reverse. However if you look around the world at the moment there are many signs of falling inflation," said Dugan.
High yield bonds
According to Duncan Lawrie Private Bank, the increase of liquidity into global markets has created dangerous market valuations that will pose serious risks to investors when the QE is finally tapered.
With the US’ plans to cut back its QE programme and UK figures indicating a stronger economy with less QE stimulus, investors in search of high yield returns may see their investment plummet, as liquidity in some markets dries up and the high yield bubble bursts, reported Duncan Lawrie Private Bank.
Gardiner added, "Some commentators will suggest that higher bond yields and mortgage rates themselves will cause the economy to falter, and will undercut stock valuations. We think this will be to confuse cause and effect – as we see things, the economy will be driving interest rates, not the other way around – but we can’t rule out the possibility of having to make some tactical adjustment to our developed equity position too (though for the time being we stay overweight).
"But taking a strategic view, we expect the correlation between the two big investment markets to become negative, as more of the cumulative underperformance of stocks during the crisis is unwound in the years ahead."
