Buy equities, EMs on a five-year view: BMO

On a five-year view, economic growth in China, India and Japan will contribute significantly to steadily improving performance in international stock markets, despite a big rise in global debt since 2008, according to BMO Global Asset Management.

The Canadian firm will today release its third annual five-year outlook, which examines long-term trends expected to dominate the global economy and markets over the medium term.

BMO GAM’s base-case scenario – which it dubs “firing on more than one cylinder” and assigns a 60% likelihood of occurring – forecasts continued low energy prices, inflation and interest rates. It assumes that the US will continue to continue to drive the global economic recovery, but that a more balanced recovery is on the cards, as Europe and Asia show signs of improvement. China, India and Japan in particular are expected to contribute to this.

This suggests investors should overweight equities relative to fixed income and also overweight emerging markets, especially India and other commodity-importing countries.

While medium-term growth will not be as strong in India as in China, once the former reaches a tipping point in the shift from agrarian to industrial production, the scope for growth will be enormous, said Steven Bell, London-based director for global macro at BMO GAM.

There’s a strong appetite for reform, he added, and though the elder politicians, led by prime minister Narendra Modi, will respond to this, a new generation will emerge over the next five to 10 years to drive India forward.

China’s policymakers have a difficult road ahead as the country undergoes a dramatic shift from an industrialised economy to a consumer-driven one. Key to BMO’s base-case view is that adjustments will be moderate and will not interrupt China’s growth trajectory and that Beijing has ample flexibility and firepower to contain a potential crisis.

A massive debt overhang is a headwind for several countries, such as the US, Japan, Korea and Thailand, where high sovereign debt-to-GDP ratios are an impediment to growth, have a deflationary effect, suppress interest rates and limit both fiscal and monetary policy options, said Bell.

Against the backdrop of 35 years of falling interest rates, global debt has risen by $63 trillion to $199 trillion since the 2008 financial crisis, according to McKinsey Global Institute, creating continued concerns about global growth and financial system vulnerability.

But BMO’s view is that the global economy won’t collapse. Bell said: “The dramas of debt, deflation and economic collapse may have been over-stated, and expectations have diminished to the point where it’s going to be easy for markets to outperform in the medium term."

Looking back on the outlook it presented for 2015, BMO said: “Our assumption last year that the US economy would take its first steps back from quantitative easing without a crisis has been on target. Our recommendation to overweight US stocks and the cyclical sectors in particular was a good call, for the most part."

However, BMO admitted that it had overestimated the progress the European Union would make, as it has remained on the cusp of recession.

Moreover, the firm added: “On the fixed income side, our defensive tilt detracted somewhat from our performance, although the barbell strategy we advocated did capture both some credit and duration/maturity rewards.”