ASSET ALLOCATION

Trevor Greetham, Director of Asset Allocation

Growth among developed economies remains tepid, with availability of credit the limiting factor. Housing markets are weak and the tailwind from the rebuilding of depleted inventories is petering out. I expect other central banks, led by the Bank of England, to follow the example set by the Fed by printing more money.

In contrast, I expect emerging market authorities to continue to tighten their monetary policies. Their growth was not credit-constrained and spare capacity is scarce. Further US dollar weakness associated with QE2 will also provide stimulus to these economies, at a time when inflationary pressures are already mounting.

A decoupling from weak developed economies should also support further strength in emerging market currencies. Stocks in emerging markets are also likely to do well as long as authorities are not forced to tighten too much.

Commodities also seem likely to do well if weak US growth leads to further Fed liquidity injections. They are also likely to perform well if US growth recovers, as demand will remain strong for some time even if emerging market governments tighten policy aggressively. In the weak US economy scenario, gold will probably continue to do best as investors use the metal to hedge both inflation risks in the emerging markets and fears of currency debasement in the developed world. Industrial metals would probably do best if global growth picks up in a synchronised way.

I think developed market stocks could surprise positively once the industrial cycle picks up but it could take three to six months to work off excess inventories and ramp up production. I am relatively cautious on the eurozone as the European Central Bank appears unwilling to print money or engage in competitive devaluation. Spain will be the key to a more positive outcome, as its economy is too big to rescue with ease. However, it is a major manufacturer whose exporters would benefit from improved global demand and a recovery in growth would provide a boost to confidence for the entire region.

Until such time as growth in the developed world becomes more tangible, bond markets could continue to fare better than equities. However, once a strong global growth trajectory is established, yields are likely to rise from low levels, exposing investors to capital losses they are not accustomed to.

With the global economic cycle likely to remain short and asset prices volatile, it will be important to maintain a well-diversified portfolio in 2011 – and to be flexible in terms of asset allocation, taking advantage of the tactical opportunities that will undoubtedly arise as policy actions announced towards the end of 2010 begin to take effect, for good or for ill.

ASIAN EQUITIES

David Urquhart – portfolio manager Fidelity Asia Fund

Asia continues to grow healthily although the pace of growth in 2011 is likely to moderate from the strong rebound in growth seen from 2009 and into 2010. Driven by solid domestic demand, the region is expected to deliver GDP growth of around 8% in 2011 (versus 9% expected for 2010). Despite the slow growth of Asia’s traditional export destinations, North America, Europe, and Japan, trade within the region has rebounded remarkably strongly after a precipitous fall in 2008. A large part of this rebound has been intra-region exports of final products. Demand from within the Asian region, and in emerging markets globally, is playing a bigger role in this upswing. In addition Asian brands (ex Japan) are continuing to take market share from US, European and Japanese brands. The advantage of lower production costs continue, allowing Asian companies to deliver to customers better value-for-money. In addition the gap in product quality continues to narrow against the more established brands. This is most notable in the consumer electronics industry. Domestic demand in Asia remains resilient, supported by increasing affluence (real wage growth is typically faster than real GDP growth in Asia), low debt levels and high savings rates. All of which are likely to support multi-year growth.

Martha Wang – portfolio manager Fidelity China Fund

2011 is going to be an interesting year for China as it continues to pursue structural reform to ensure economic growth. The focus will continue to be quality of growth versus quantity.  As outlined in the preliminary twelfth five-year plan, Chinese government’s development plans are expected to centre around pro-consumption policy to continuously stimulate domestic consumption. In terms of pro consumption policies, the public spending on healthcare and social security are expected to rise. RMB appreciation and wage growth will continue to be growth catalysts, boosting domestic demand and household income.

Teera Chanpongsang – portfolio manager Fidelity India Fund

India is expected to continue to generate strong real GDP growth, driven by underlying structural growth trends such as a large labour force, growing domestic consumption and increased infrastructure spending.  These provide compelling investment opportunities and should lead to strong earnings growth in the coming years. Growing income levels in a fast growing population, together with high savings rate and low debt levels should continue to support consumption, which in turn would create more investment opportunities. Local manufacturing firms are also working close to their full capacity, which suggests that more greenfield and brownfield expansions will happen, once again creating investment opportunities.

Robert Rowland – portfolio manager Japanese equities

I maintain a cautious outlook for Japan. The country’s economy is set to slow as global growth momentum wanes, output gaps persist, capex growth remains weak and wage deflation continues. While downside risks to the economy have undoubtedly increased and deflation remains entrenched, Japan’s proximity to high-growth Asian economies such as China should provide a measure of support to exporting companies.  Furthermore, the government is in the process of formulating additional support measures and the Bank of Japan has eased monetary policy further by effectively cutting its policy rate to zero and increasing asset purchases. Meanwhile valuations of Japanese stocks remain supportive, with both asset- and earnings-based metrics at the lower end of historical ranges. I believe that the downside of the market is limited, but the market has few upside catalysts.

OVERSEAS EQUITIES

Adrian Brass – portfolio manager US equities

I expect the US economy to continue to recover from the depressed levels of last year, due to stabilisation of the major structural overhangs, such as the financial system, housing and unemployment. While, in the short-term, unprecedented levels of stimulus from quantitative easing programmes are driving asset prices higher over the longer term I remain concerned by the levels of government and consumer indebtedness and the possibility of rising taxes. However, the US is a broad market in which I am able to find plenty of attractively valued investment opportunities.

Alexander Scurlock – portfolio manager European equities

I continue to be positive on European equities, since I think market valuations are favourable, especially versus government bonds.  In particular, I continue to believe the core areas of Europe are most attractive.  In particular, Germany is the prime beneficiary of stronger growth in emerging markets and a ‘one-size-fits-all’ ECB policy. Fiscal austerity in southern and peripheral European states, however, reinforces my conviction that overall European economic growth will be sluggish, as rising taxes and cuts in spending curtail business activity. My focus is on finding sustainable growth opportunities within this challenging economic environment. The key to this is pricing power. Companies that have pricing power will attract a premium in an environment of low inflation and low economic growth.

Nick Price – portfolio manager emerging market equities

The secular drivers of emerging markets remains intact: attractive demographics, competitive advantages from low labour costs, an abundance of natural resources, increasing prosperity, productivity gains and sound fiscal management. At this stage, I do not yet subscribe to the idea of an emerging market bubble.  I continue to find attractive opportunities at reasonable valuations. Regardless of any near term volatility in equity markets, I remain extremely positive over the long term.

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