Report on global investing, part III: Looking ahead

But while near-term events can be significant in relation to short-term movements in financial markets, enduring global trends in economies, markets and industries are what tend to influence long-term investment returns. A thematic investment framework identifying these key changes can help provide perspective and guide investment decisions in the years ahead. Here are five themes to consider.

Credit and consequences
The bursting of the credit bubble in many of the major developed economies in 2007 had important consequences in a wide range of areas. In the aftermath of the credit crisis, consumers and companies retain large amounts of debt, there are continuous strains in the global financial system, and regulation aimed at reducing the risk of future financial crises is becoming more onerous. These factors are likely to constrict both the supply of, and the demand for, credit in the developed world.

Although there have been recent improvements in economies and financial markets, credit scarcity is likely to significantly impact consumer-driven economies and all asset classes and investment strategies. This change touches on a broad range of investment-related areas, including the prospect of greater government involvement in economies and financial markets. It emphasizes, too, some of the investment opportunities in emerging markets. Take the banking sector: in an up-and-coming economy, balance sheets are generally healthier, and there are greater opportunities to expand lending because it is less burdened with debt.

Fire risks
The spectre of inflation, which can be captured in the concept of fire risks, is associated predominantly with the threat of monetary debasement over the longer term, chiefly as a result of the enormous monetary and fiscal stimulus being implemented at the moment by global authorities. In order to combat the deflationary effects of the global recession, governments and monetary authorities are taking unprecedented policy measures. However, the impairment of financial systems and the trend toward continued debt repayment by companies and consumers may continue to undermine the effectiveness of official stimulus. This may prompt authorities to redouble their efforts, risking higher inflation in the future, particularly if improvements in financial conditions lead to a higher “credit multiplier” (by which central bank policy flows to corporate and household borrowers).

While the timing of the risk is highly uncertain, it seems appropriate to account for it in portfolio construction, for example, through exposure to inflation hedges such as precious metals and inflation-linked bonds.

Global realignment
Western industrialized nations still dominate the world’s economic output, wealth, consumption and market capitalization—and they consume the lion’s share of natural resources. However, the rising economic influence of the developing world progressively challenges this position. How realignment takes place will be critical to the longer-term fate of global economies and markets. In particular, developing nations will need to address their previous overexporting by focusing on greater domestic activity.

Associated trends of realignment include strong growth in developing-world incomes, the westernization of consumers’ tastes and the increasing influence of developing economies on demand for resources. Related investment opportunities focus on domestic consumer goods and services companies, as well as companies in the financial, real estate, healthcare, travel and leisure sectors. However, there are also risks associated with realignment, including an escalation of protectionist (anti-trade) measures and the danger of asset price bubbles in emerging markets.