Notably, the eurozone is showing signs that it is through the worst of the crisis. Peripheral countries are implementing the necessary structural reforms and working through the pain that comes with such substantial change.
Global economic growth and loose monetary policies should continue to support the price of risky assets. The Fed is unlikely to begin reducing its monthly purchases until next year, while other central banks could increase their quantitative easing programmes.
Additionally, there is scope for the ECB to cut interest rates. Abundant cheap liquidity from central banks should drive markets higher.
Many of the risks that had concerned markets in 2012 have continued to fade throughout this year. However, there are signs that investors may have become complacent. We believe China’s credit bubble represents a key risk to the global economy and investment returns. The amount of debt in China has reached unsustainable levels, and we believe this bubble could burst at some point.
Areas we like
Real assets
Equities and real estate should offer some protection against inflation at a time when central bank policy is in uncharted territory. Prospective future returns still look reasonable especially from equities compared with bonds.
World’s best companies
Shares in leading global businesses are fairly valued and paying good dividends. Companies with dominant brands, healthy balance sheets and robust cash flows can flourish, even in a world of low growth.
Portfolio hedges
Leading government bonds cannot be relied on to defend capital in difficult markets. Instead, we are using specialist hedge funds and option strategies to defend our portfolios against some of the big risks we fear.
In detail: strong performance from hedge funds
September was a strong month for hedge funds with all styles except managed futures (CTAs) delivering a positive return. Event-driven and equity strategies performed particularly well.
Many managers benefited from maintaining their exposures despite a notable increase in risk aversion during August.
However, we expect funds to reduce risk as we head into the end of the year in order to preserve performance. These higher-beta strategies should continue to perform well if the global economic recovery remains on course.
Meanwhile, managed futures may continue to struggle. They have suffered from a lack of any sustained market trends since the 2007-08 crisis as well as sudden market reversals. Yet for the moment, we believe managed futures still play a useful role in portfolios as a hedge against any possible short-term market correction.
Emerging markets
There are many ways of gaining exposure to the strong growth and often healthy economies in the developing world. An active investment approach is the most appropriate as well as being highly selective from a regional perspective. Negative sentiment has challenged our long-term views. However, value seems to be reappearing following the recent correction, creating investment opportunities again.
Japanese equities
Valuations are generally neutral although the market looks cheap on some valuation measures, such as the price-to-book ratio. In our view, a weaker yen and negative real interest rates could trigger a further re-rating of Japanese equities over the next 12 to 18 months.
Large technology stocks
The large technology companies are generating lots of cash, and returns on invested capital are generally in the double digits. Debt levels are low, valuations are attractive and sales growth has also been strong, with revenues rising sharply.
Areas we are avoiding
High-quality government bonds
At current yields, US, UK and German government bonds are off their historical lows but still not high enough to compensate for the associated risks.
Dirk Wiedmann is head of investments at Rothschild Wealth Management
