BRICs lose favour as money pours into Europe

Investment dollars are leaving emerging markets and heading back into developed countries, says Sentry executive vice-president and chief investment officer Dennis Mitchell.

“That money is flowing out because you are no longer being compensated for the risks that you’re taking,” he stated during a presentation in Toronto yesterday.

The growth premium in countries like the BRICs, Malaysia, Thailand and Korea has dropped from 500 basis points between 2005 and 2010 to less than 400. That’s not enough, he explains.

Returns aren’t likely to pick up, he adds, because the global population is aging. As people grow old they consume less, he notes.

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America and Europe are looking better, but Japan, China and emerging markets are in for a tough ride, say Sentry investment managers.

In the U.S., they see a sustained recovery, but it will be vulnerable to market shocks, says James Dutkiewicz, chief investment strategist and senior portfolio manager.

“The U.S. is slowly healing itself. […] It’s going to take a long time for all the past excesses to work their way out,” adds Mitchell. And high unemployment is still a concern.

While the jobless rate is 7.3%, many new jobs don’t pay as much as the ones erased in the downturn. That rate also doesn’t account for the record-high levels of people who have simply given up looking for work, he notes.

U.S. inflation won’t be a concern as consumers are still struggling to buy things again, say Dutkiewicz and Mitchell, so they predict the Fed will continue its stimulus policies and won’t raise rates until late 2015 or early 2016.

Whenever QE ends, emerging markets will feel the pinch, says Dutkiewicz. Central banks need to take into account the effect of withdrawing stimulus on developing countries, where much of the money has been invested.

“It’s a great ride while it’s going on, but you have to try and find who is going to pay the bill. The only place I can find right now is in emerging markets,” he explains.

Depending on how these markets react, a slowdown could ricochet back into established economies and cause deflation, he adds.

Challenges in Asia, improvement in Europe

China is moving its economy from an export and infrastructure model to one that relies on domestic consumption. The process is slowing growth, says Mitchell.

“Historically, emerging markets that have made the transition to developed market status have stumbled,” he says.

“The difference is, no other emerging market has had 1.3 billion people tightly controlled by seven guys who have an army. We will see how the Chinese experiment pans out. But going forward, you are going to see lower growth out of China: in the 6% to 8% range, as opposed to the 8% to 10% that they are accustomed to,” he adds.

Japan also faces economic challenges. Analysts are skeptical about the potential success of Prime Minister Shinzo Abe’s three-pronged stimulus plan, which includes monetary and fiscal stimulus, and restructuring the economy.

While QE and stimulus are sound ideas, restructuring is risky, says Mitchell. “This is the crucial one that if they don’t execute properly, the other two don’t matter.”

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The country wants to entice more women into the workforce, accept more immigrants, stimulate competition and increase trade. Its current debt-to-GDP ratio is more than 200%, says Dutkiewicz. “I wouldn’t be surprised in two to three years if it’s the number-one thing we’re talking about—a potentially systemic risk emanating from Japan.”

He also predicts losses on Japanese government bonds in the next two to five years. An aging population, shrinking labour force and slow productivity growth all pose a challenge to the country, he says.

As for the Eurozone, investment is picking up because the region’s financial fundamentals are improving, says Mitchell.

“Europe is now where the U.S. was three years ago in terms of repairing the banking system: in terms of the ECB becoming the lender of last resort; in terms of business confidence,” he explains. “All the Eurozone countries now have current account surpluses.”

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