In this month's market commentary, Mike Bell, discusses why investors looking to diversify away from the US after its phenomenal 15-year run may need to look beyond Europe – and why emerging markets, both selectively in equities and in debt, may offer a more compelling path to true diversification.
Investors are understandably looking to diversify away from the US after the phenomenal run it's had over the last 15 years, but many investors are looking to turn to Europe. I think, however, that Europe is structurally challenged for two key reasons. First of all is the rising competition from China, particularly within cars. If you look across Germany, France, Italy, and Spain, there are currently 20 factories which are operating at below 60% capacity. That suggests to me that there's risks of further job cuts coming in Europe because they struggle to compete with China. The other key structural challenge facing Europe is demographics. The working age population in Germany, Italy, and Spain is set to shrink quite meaningfully over the coming years. If you're a European bank in one of those countries, then the simple question I have is, who are you going to lend to? So, when looking to diversify away from the US, I think it makes sense to broaden one's horizons and look perhaps to the emerging markets. If China's rise is part of the problem for Europe, then investing in China allows investors to take advantage of those companies which are winning and outcompeting Europe on the global stage. That said, even within China, it's important to be selective. They, too, have their demographic challenges, with working age populations that are likewise set to shrink strongly. A passive exposure to China might give one more exposure than makes sense to contracting working age populations. Whereas an active exposure allows you to focus on the stocks which can win on the global stage. Looking more broadly within emerging markets, particularly for investors who are looking to diversify away from the US because of its tech exposure, it's important to understand that there is a substantial tech exposure within the broad MSCI EM Index. When you look at the performance of, for example, the South Korean KOSPI Index over the last year, having gone up extremely strongly and then performed very badly in July, I would want to be looking within emerging market strategies for strategies that have been able to be selective and active. Anyone that had been able to outperform in both July and over the last year must be doing something right. I also think it makes sense for investors to consider investing in the emerging markets outside of equities. If, for example, you go back to 2000 and look at the period when the dot-com bubble burst, emerging market debt performed much better than equities. Both US equities, but also global equities. So for investors looking to diversify away from US risk, I think it makes sense to broaden one's horizons beyond Europe, look to the emerging markets, both within China, but selectively, within the broader emerging market equity indices, but again, being very active, and also extending one's horizons into emerging market debt that has historically been able to outperform in periods where equities and particularly tech stocks have struggled. To discuss this in more depth, please reach out to your RBC BlueBay sales contact. I look forward to discussing it with you more in the near future.
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