Rising political risk in the United States and Europe means Australian superannuation funds will probably direct more capital into emerging markets.
The scale of Australia’s $2.3 trillion superannuation system requires funds to invest an increasing proportion of their assets offshore, having outgrown the local sharemarket. But the unpredictability of President Trump’s administration in the US and the rise of nationalist politics in a post-Brexit Europe have risk on the rise in the two biggest, and historically safest, offshore markets.
US equity markets have breached record highs since Trump’s win in November, but senior strategists have warned that this trend could be about to reverse as the world’s biggest economy endures a period of political upheaval.
A panel of experts discussed these and related issues at the Conference of Major Superannuation Funds, taking place on the Gold Coast, March 22-24.
JP Morgan chief economist and head of fixed income and foreign exchange strategy for Australia and New Zealand, Dr Sally Auld, said investors should keep a close eye on currency markets for clues as to what’s likely to happen in equity markets next.
“The US dollar is not performing as well as people thought it would be given the recent, more positive, economic news. I think that reflects that some people think a premium needs to be priced in for political risk,” she said. “The view at JP Morgan is that US equities probably look vulnerable to a correction and that is starting to play out. Long term, the outlook for the US is still good, but in the shorter term the dollar is telling a story there.”
Auld said one serious medium-term risk in US markets was the future membership of the Federal Reserve board.
She reflected on the market gyrations a few years ago in the lead up to Janet Yellen being named US Federal Reserve chair, amid speculation as to whether she or fellow board member Lawrence Summers would win the role.
“Yellen and Summers are both extremely accomplished, well-respected economists, and the market moved a lot on the question of which one of them would lead the Fed. Well imagine if the competition was not between a dovish or hawkish candidate but a race where there are serious questions about whether one of the candidates is competent.”
Yellen’s four-year term ends in January 2018, with Trump having flagged he will ask senators to block her being appointed for a second term. A number of the other seven members of the Federal Reserve board will see their terms expire in the next two years also.
Turning to emerging markets
Auld said she expected the best opportunities for institutional investors over the coming decade to be found in “emerging markets ex-China”.
Franklin Templeton Investments senior vice-president, portfolio manager and director of research, Dr Sonal Desai, tipped that Latin American markets would be the strongest returning markets in the decade ahead.
“Latin America has already had its decade of populist politics,” she said.
Desai said that if Trump enables a combination of corporate tax cuts and infrastructure projects, it would lift business confidence and boost the outlook for the US economy and markets.
She said investors should be careful not to be too distracted by the bombastic politicking style of the new US president.
“We all need to spend less time looking at Trump’s 140-character tweets,” she said.
Schroders global head of multi-asset investments, Johanna Kyrklund, also tipped emerging markets “particularly [emerging market] debt” to be the best source of returns for institutional investors over the coming decade.
While Kyrklund was wary of rising political risk in the US under Trump, she was far more concerned about political risk in Europe.
The next four years will probably be marked by unconventional politics in the US, but this does not equate to sovereign risk, Kyrklund said. “I don’t think there is a sovereign risk problem investing in the US at the moment, but I do see more sovereign risk in Europe – the structures in place at the moment are not sustainable on a five-year view.”
Next up…President Le Pen?
Kyrklund said more European nations would probably elect nationalist governments and follow the lead of Britain in choosing to leave the European Union and euro currency bloc.
Investors needed to be prepared for the real chance that right-wing nationalist Marine Le Pen would win the upcoming French presidential election, she said.
“She could definitely win,” Kyrklund said.
Desai saw less chance of a Le Pen win but agreed it was a political risk that could not be discounted.
“It’s not our base case, but then again neither was Trump or Brexit.”
To read all our coverage from Day Two of CMSF 2017, click here.