Mercer Investment Consulting has reverted to a ‘buy’ rating for emerging markets assets but remains bearish on the Australian dollar ($A) in its latest dynamic asset allocation (DAA) report. The consultant rated the major asset classes at fair value for Australian investors and took a neutral position in the overall split between growth and defensive assets. According to David Stuart, who heads the Mercer DAA service in Australia, Mercer has liked the structural case for emerging markets for some time but shied away from recommending more tilting in that direction last year because of strong inflows and high asset valuations.

Since then, most markets have subsequently come back considerably, particularly the important growth market of China. “China has been particularly weak,” Stuart said. “It’s clearly in a slowdown phase, but that doesn’t detract from the long-term story.” He said the $A could still rise again to become close to parity with the US dollar, “but we think that in the long-term, in the 80s (80c to $US1) it’s overvalued”. He says that some Mercer clients have been trading the $A, selling in the 90-cent range and buying it in the 80-cent range. “The $A is a risk asset,” he said. “We think you should have an underweight position over time…

The end game for the $A is a year or two away when we’re faced with the prospect of normalising interest rates in the rest of the world.” Mercer currently believes global government bonds are overvalued. The Mercer DAA service offers asset allocation advice over a one-to-three-year time horizon, sitting between tactical asset allocation advice at the shorter end and strategic asset allocation at the longer end. The service, as with similar discrete services offered by the major consulting firms, has become increasingly popular since the onset of the global financial crisis. Stuart pointed out that noone knows how quickly markets will revert back from a level of disequilibrium. The tech bubble of the late 1990s, for instance, took several years to burst. “DAA is a service, not a product,” he said.

“We’re advising clients to help them make their own decisions. Most of them moved back into equities by early last year and benefitted from the market recovery.” On the big picture decision of the mix between growth and defensive assets, the Mercer report states: “In the absence of a doubledip recession or deflationary environment, valuation parameters for global equities arguably have improved as markets have weakened, with earnings forecasts maintained or even increased despite the macroeconomic issues. If these forecasts are met, equities would appear cheap relative to history on either a simple P/E measure or relative to bonds.

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