HSBC economist Stephen King says "Goodbye to all that"

The world that we took for granted is gone. No more rapid global growth. No more easy investment opportunities. No more excess liquidity.

That was the starting point for "Goodbye to all that," a Feb. 25 presentation to the Boston Security Analysts Society by Stephen King, chief economist and global head of economics for HSBC Group.

King, who's based in the U.K., brought a global perspective to the current housing and credit crunch in the U.S. "The U.S. housing crisis has become a transatlantic lenders' problem," he said. Why? Because in their quest for higher yields, institutional investors in the U.K and the eurozone became heavy investors in U.S. corporate bonds. By corporate bonds, he meant asset-backed securities, especially mortgage-backed securities. U.K. banks that have gotten burned are tightening their lending standards just like their U.S. counterparts.

King predicted that 2008's biggest negative surprise for financial markets might come from outside the U.S.: the sudden loss of momentum in the U.K. and elsewhere. In fact, he suggested that the U.S. dollar may appreciate in 2008 because economic risks are priced into the U.S. market, but not in Europe.

On the emerging market front, King said that those economies have decoupled from the U.S. "Slower G7 domestic demand growth may not be an emerging market disaster," according to him. But while some strategists stress the upside of emerging market demand for the U.S., King emphasized the downside. A slowly growing U.S. that's cutting interest rates will boost capital flows into emerging markets, where too much domestic demand will fuel inflation in fuel and food costs. That inflation will deliver another blow to the economies of developed nations.

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Susan B. Weiner, CFA
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van Agtmael: Put 20% of your portfolio in emerging markets

Your neutral benchmark for stocks should include a 20% allocation to emerging market stocks, said Antoine van Agtmael in his April 23 speech on "The Emerging Markets Century" to the Boston Security Analysts Society. Twenty percent is roughly the percentage of global market capitalization accounted for by emerging market stocks.

Van Agtmael, the chairman and chief investment officer of Emerging Markets Management, wouldn't stop at 20%. He recommends raising your allocation by 1% annually. Your benchmark should be dynamic, he said. However, after a series of good years, you should skip a year of raising your allocation. Speaking of good years, emerging markets have enjoyed a strong run recently. Accordingly, van Agtmael would currently recommend underweighting emerging markets in your portfolio.


Consider companies outside the top 200

Van Agtmael recommended that investment professionals consider companies other than only the 1,000 included in the indexes. He noted that 90% of investments in emerging market companies are made into the top 200 stocks. That's a small percentage of the 15,000 stocks listed around the world.

Investment managers should look at what made the current leaders among emerging markets great. They should seek those same characteristics in what's likely to become the next generation of market leaders. For van Agtmael, those characteristics include:

• Unconventional thinking about how to solve problems
• A truly global mindset
• An obsession with quality and execution

America no longer at the center

From a broader perspective, van Agtmael said that Americans need to lose their perception that we're the center of the economic universe. This is less and less true. Moreover, we are now in the midst of the biggest and greatest shift in the global economy and power since the Industrial Revolution. In some sense, it's a return to the world before the Industrial Revolution, when China and India were the world's largest economies, he said.


Van Agtmael's new book


Van Agtmael recently published The Emerging Markets Century: How a New Breed of World-Class Company is Overtaking the World.

Outlook for emerging market bonds

“Emerging Market Bonds: Are You Being Paid for Risk?” was the subject of a Boston Security Analysts Society panel moderated by William L. Nemerever, partner and co-manager, global fixed income group, Grantham, Mayo, van Otterloo & Co. on January 23.

Their bottom line: Emerging market (EM) bonds are fairly valued and their near-term outlook is excellent. Years ago EM bonds used to be considered risky, even speculative. That has changed. Now they’re just another part of the global bond universe, said David W. Rolley, co-head of global fixed income, Loomis Sayles & Co.

During the past couple years, EM spreads have tightened and even become tighter than corporate bonds with similar ratings, said John Peta, portfolio manager, emerging market strategies, Standish Mellon Asset Management. Why? He cited factors including:

· Improved credit ratings

· Broader investor base due to strategic inflows and local investors

· Less vulnerability due to abandonment of fixed exchange rates

Rolley played up the role of 28 years of 10% GDP growth in reducing the volatility of the EMBI Global index. But low volatility can’t persist forever. “Volatility is too low. EM governments will provide it themselves by misbehaving,” he said.

Citigroup’s Don Hanna, managing director, head of emerging market economic and market analysis, identified three trends keeping EM bond spreads tight:

· Globalization

· Financial innovation

· Better government policies

Risks loom in each of these sectors over the longer term.

The downside to the greater stability of EM bonds is they don’t offer as much portfolio diversification as in their more volatile days. Perhaps the last stronghold of diversification lies in local currency EM bonds, suggested Rolley.

P.S. When I subsequently discussed this presentation with some BSAS members over lunch, they were concerned that it didn't spend much time on the risks from the carry trade or the fact that investors are not being well-compensated to take on risk. What do you think?