Go East for Growth
For advanced economies, growth-supporting trends are diminishing
Link between slower growth and subpar returns apparent in Europe
EM Asia equities remain strong
Over the last 30 years, investors have enjoyed a long run of exceptional returns. Supported by extraordinarily healthy business conditions and profit growth, real total returns for global equities in the United States and Western Europe have averaged 1.5 and 2.2 percentage points, respectively, above each region’s historical averages since the mid-1980s. But the global economic landscape is likely to look quite different over the next decade, and those counting on continuation of this golden age of equity investing may be in for an unpleasant surprise.
For advanced economies, the major trends supporting economic growth the last 30 years are diminishing or even declining. Labor forces are rapidly aging, and productivity gains have stalled. At the same time, government debt loads are fast approaching levels that significantly curb potential growth. In fact, for many regions and countries, long-term GDP forecasts are at record lows.
The implications of this for equity investors is significant. Many factors have an impact on equity prices, but, over the long run, stock returns tend to reflect the cash flows (earnings and dividends) supplied by companies. And corporate cash flows are ultimately driven by economic growth. Research has shown that equity returns have been higher in periods with high GDP growth and lowest in the periods with slow growth (see chart).
Indeed, the link between slower secular growth and subpar equity returns is already apparent in the economies of Europe, which have been particularly symptomatic of the negative structural developments out at play. Over the past five years, City National Rochdale clients have significantly benefited from our bias to domestic equities and long-term strategic underweight to other international developed markets. But as we look forward, even the U.S. is not immune from global trends. The Fed now has 1.8% long-term trend growth estimate for the U.S. That’s down from more than 3% in 2000.
After asset allocation, the most important decision in portfolio construction is where to invest regionally and, at a time when the outlook for growth is muted in the U.S. and elsewhere, we find our heads increasingly turning east. Emerging Asian equities represent some of the best long-term value that we see across the global capital markets. Asia boasts superior demographics, higher savings and investment rates, and rapid pace of urbanization and per capita income levels. It has a consumer economy that will be accelerating as a result of the growing middle class. All of this should lead to higher earnings growth, which is ultimately what drives markets.
A key element of investment success is a long-term perspective. With it, investors can assess the impact on their portfolios of fundamental, economic and demographic changes. They can then allocate their portfolios more effectively, focusing on attaining the returns necessary over an extended time horizon to meet their investment objectives.
The past year has served as a painful reminder that emerging markets can be very volatile. However, from a long-term perspective, the reasons for owning EM Asia equities remain just as strong as they were before this year’s declines. The gloomy atmosphere today has deflected attention from emerging markets’ growing resilience to external threats, a result of structural improvements over the past two decades and their growing independence from the industrialized world’s business cycle. While there are risks associated with our positive outlook, our view is that the long-term growth profile of Emerging Asia equities is compelling enough to overcome short-term gyrations and to warrant an increasing place in your portfolio when the dust settles.