Global Research

Record low government bond yields slower global growth and weak

demographic outlook point to disappointing 10-year equity returns

This leaves Emerging Markets a structurally favoured asset class

In a growth-starved world with historically low bond yields equity markets that can

benefit from faster growth higher bond yields and improving demographics should

command an even greater premium in the coming years This report looks at how 10

Emerging and 10 Developed Markets stack up on a 10-year horizon according to these

three key drivers of long-run returns

Emerging Markets have enjoyed the best demographic trends over the past 25 years and

this trend should continue in the coming decades according to United Nations projections

On this basis the standouts are South Africa India and Mexico which are projected to

see the biggest reduction in old-age dependency and increase in prime savers as well as

the fastest growth in urbanisation until 2035 The Philippines is also expected to join this

list after previously experiencing some of the world‟s worst demographic changes

The US Canada Japan Hong Kong Korea and Switzerland are now expected to see

some of the worst trends in the coming decades Canada may potentially be one of the

biggest losers from this shift as it had seen some of the best long-run equity returns

accompany some of the best demographics trends

However better demographics are no guarantee of stronger economic growth or equity

performance For instance South Africa‟s high unemployment and political woes prevent

the country from enjoying much of its ldquodemocratic dividendrdquo This puts an even greater

emphasis on identifying markets that have delivered on this potential through better

earnings and equity performance as well as the ability to benefit from rising bond yields

Putting all of these factors together produces the following ldquoTop 5rdquo list of countries with

the best long-run outlook for equity returns India Mexico Taiwan Thailand and the

Philippines In contrast the ldquoBottom 5rdquo for the next decade are the US Canada Japan

South Korea and Switzerland

European markets are the wild card Demographics trends which had been among the

worst at the cost of weaker equity performance are not expected to deteriorate at such a

rate in future IMF growth forecasts reflect an entrenched pessimism that might only be

shaken by the success of the current unconventional policy measures aimed at stimulating

growth or from reforms that manage to lead to an improvement in potential growth Given

the failure to achieve either of these objectives in the past decade and the recent political

turmoil there remains little cause for optimism in the region over the long run

Wesley Fogel

Investment Strategist

+44 7860 264 902

fogelhotmailcom

25 August 2016 Asset Allocation

Global

Navigator

Taking a long view

Asset Allocation

Disappointing global growth post the 20089 financial

crisis combined with a string of political and

economic shocks has left financial market sentiment

increasingly policy-driven This environment -

dubbed the ldquonew normalrdquo - clouds the long-term

outlook for equities and government bonds

However there is nothing really bdquonew‟ about the

support to risk assets that softer monetary policy has

been providing to both the Emerging and Developed

world ever since US bond yields peaked in

September 1981 Chart 1 shows how three phases of

halving US yields have been associated with some of

the strongest US equity returns over this period

Despite the support from lower rates conventional

economic wisdom (still) has it that market prices

reflect underlying fundamentals and ultimately move

towards equilibrium while near-term shocks are

random ldquonoiserdquo that will eventually be corrected

Chart 1 US equities have enjoyed 3 phases of halving yields

Source Bloomberg Authorrsquos calculations 3 periods of falling US 10-year yield

3091981-431986 431986-592002 542010-1082016

While the structural decline in bond yields can partly

be explained by the taming of inflationary pressures

the debate has shifted towards whether the scale of

monetary easing has in many instances gone too far

The ever-larger scale of quantitative easing and the

move to negative-yielding government (amp corporate)

bonds amid torpid global economic growth have also

raised doubts about the effectiveness of such

unconventional policies As a result the concept of

reflexivity has moved to the heart of the debate about

what drives financial markets

Reflexivity asserts that market prices influence

fundamentals which in turn can change expectations

the pattern repeats itself pushing prices ever further

away from their long-run equilibrium until a point

where ldquoboomrdquo turns to ldquobustrdquo

The increasingly episodic and global nature of the

economic cycle combined with a rising correlation

within financial markets does help to explain why

reflexivity has been able to mount a credible

challenge to long-held market beliefs the pressure on

the Chinese yuan following speculation around a

further US interest rate hike is a recent case in point

Growing macro uncertainty has also led to a

heightened level of myopia among long-term

investors as ldquoshock fatiguerdquo effectively caps their

ability to lock up capital for extended periods This

manifests itself in a seemingly irrational demand for

negative-yielding bonds and record levels of cash

holdings among global fund managers

60

560

1060

1560

2060

2560

81 84 87 90 93 96 99 02 05 08 11 14

0

2

4

6

8

10

12

14

16

SampP 50 0

annualised

ret urn 16

SampP 50 0

annualised

ret urn 10

1 19 8 1- 19 8 6 3 2 0 10 - 2 0 162 19 8 6 - 2 0 0 2

SampP 50 0

annualised

ret urn 8 6

SampP 50 0

(Left HS) U S 10 yr

( R ig ht HS)

1

2

3

Taking a long view

Negative yields and slower growth mean equities will disappoint

Demographic trends can help determine the winners and losers

Emerging Markets stand to benefit the most from expected trends

Chart 2 US equities have been the most consistent long-term performers

Source Bloomberg Authorrsquos calculations Daily data starts in January 1990 in US$

Chart 2 shows how this volatile backdrop has seen

leadership among equities shift dramatically over the

past decade (red bars) compared with the trend since

1990 (blue bars) Emerging Markets have seen some

of the biggest changes with returns in Saudi Arabia

(collapse in oil) Poland and the Czech Republic

(slower growth lower yields waning demographics)

falling fastest Other EMs including the Philippines

(faster growth) Taiwan and Thailand (faster growth

better demographics) have seen among the biggest

improvements in equity performance

It is also remarkable to observe that US equities have

managed to deliver the identical annualised return

(included reinvested dividends) of 78 over the past

10 and 25 years Only Japan has managed to deliver

as stable a return profile over this period although it

has struggled to move above a 1 return per year

A persistent decline in yields is about the only thing

that Japan and the US have had in common in recent

decades which should be enough to raise red flags

about the need to revise down long-term return

expectations perhaps more so in the US given how

supportive a trend of lower rates has proven to be

Precisely estimating 10-year equity returns is

infinitely more difficult than with government bonds

However it is possible to identify the key drivers of

equities over the past 25 years and then try to

understand the implications of how these trends

might evolve in the coming decade

In a growth-starved world with historically low bond

yields equity markets that can benefit from faster

growth higher interest rates and improving

demographics should command an even greater

premium in the coming years

This report attempts to address these issues for 20

countries (10 Emerging and 10 Developed) which

have the best quality and longest history available

going as far back as 1990 wherever possible

Taking each of the three factors above in turn it is

possible to get a better understanding of long-term

drivers of equity returns and start to form a view on

the outlook for the next 10 years

Demographics

Demographic trends help define long-run potential

economic growth and the associated investment

opportunities that certain trends are expected to bring

Trends in the following key metrics from an equity

investment perspective are addressed in turn

1 Prime savers - population aged 40-64

divided by the rest of the population)

2 Old-age dependency ndash population aged 65+

divided by the population aged 15-64

3 Urbanisation - percentage of the population

residing in urban areas

Since 1990 all three measures have seen improving

trends - increase in prime savers falling old-age

dependency and growing urbanisation - helping to

underpin equity returns over the same period with

some countries benefiting much more than others

However the coming decades are likely see much of

this positive catalyst fade thus reinforcing the

message implied from historically low bond yields

expected returns will need to be revised lower

However it should still be possible to differentiate

between markets based on future demographic trends

according to United Nations (UN) projections

15

4

13

2

13

0

12

9

11

9

10

5

10

2

98

97

95

74

73

70

67

67

62

55

37

04

49

-11

-24

50

71

-22

77

62

35

58

78

49

08 12

46

16

17

4

13

5

75

14

-5

0

5

10

15

20

Me

xico

Cze

ch R

ep

Sa

ud

i Ara

bia

So

uth

Afr

ica

Au

stra

lia

Po

lan

d

Ind

ia

Ho

ng

Ko

ng

Ca

na

da

Sw

itze

rlan

d

US

Ge

rma

ny

Eu

rozo

ne

Fra

nce

Ko

rea

UK

Ph

ilipp

ine

s

Th

aila

nd

Ta

iwa

n

Jap

an

Average 10-year annualised

equity return

Latest 10-year annualised

equity return

Fed put

Prime savers risks of asset shedding

When the share of the population aged between 40

and 64 years old is falling then a country suffers from

asset shedding The International Monetary Fund

(IMF) has previously identified US equity weakness

in the 1970s and early 1980s coinciding with a low

share of prime savers The strength of equities during

the 1990s was then associated with a sharp increase

in the prime saving population1

When compared with the increase in prime savers in

the US since 1990 UN data shows the Emerging Asia

economies have enjoyed a much stronger tailwind

over the same period Thailand Korea Taiwan and

Hong Kong all saw a faster increase in the share of

prime savers Amid a broadly deteriorating outlook

for the share of prime savers the most positive trends

are projected to be in Saudi Arabia Mexico India

and South Africa while Korea and Hong Kong

should see the biggest reversal of fortunes

Chart 3 The share of prime savers is expected to fall in many countries in the coming decades

Source Bloomberg United Nations World Population Prospects The 2015 Revision

Authorrsquos calculations Prime savers population aged 40-64 divided by the rest of the

population

Old-age dependency a potential drag on growth

The world is expected to see the share of the

population older than 65 years increase from 12 to

38 by 2100 according to UN projections After

remaining high across the globe for a lengthy period

of time a widespread fall in fertility rates will help to

1 International Monetary Fund Regional Economic

Outlook Asia- Pacific November 2008 (link)

encourage a more sustainable pattern of development

and also reduce pressures on the environment

The IMF sees these developments placing public

finances of countries under pressure via two

channels spending on age-related programs

(pensions and health) and slower economic growth2

It sees the fiscal consequences as potentially dire as

increases in spending potentially lead to

unsustainable public debts that require sharp cuts in

other spending or mean large tax increases that could

become a drag on economic growth

Looking forward over the coming decades chart 4

shows both the extent to which the pace of ageing

will both deteriorate and differentiate among a

number of major economies

The most favoured on this basis are South Africa

the Philippines India Saudi Arabia and Mexico

which are expected to see the biggest improvement in

prime saver ratios The most challenged economies

will be Hong Kong Taiwan Korea Germany and

Thailand most of which are also likely to see a

falling in the share of prime savers

Chart 4 Old-age dependency ratios are projected to rise even faster around the world in future years

Source Bloomberg United Nations World Population Prospects The 2015 Revision

Authorrsquos calculations Old-age dependency ratio population aged 65+ divided by

population aged between 15 and 64

2 IMF Staff Discussion Note The Fiscal

Consequences of Shrinking Populations October

2015 (link)

-20

-10

0

10

20

30

40

50

Sa

ud

i Ara

bia

Me

xico

Ind

ia

So

uth

Afr

ica

Po

lan

d

Ph

ilipp

ine

s

Cze

ch R

ep

Th

aila

nd

Ta

iwa

n

Jap

an

Au

stra

lia

Eu

rop

e

UK

US

Ca

na

da

Ko

rea

Sw

itze

rlan

d

Fra

nce

Ge

rma

ny

Ho

ng

Ko

ng

1990-2015 change

in prime savers pp

2015-2035 projected change

in prime savers pp

-5

0

5

10

15

20

25

30

35

So

uth

Afr

ica

Ph

ilipp

ine

s

Ind

ia

Sa

ud

i Ara

bia

Me

xico

Au

stra

lia UK

Cze

ch R

ep

Fra

nce US

Jap

an

Eu

rop

e

Po

lan

d

Sw

itze

rlan

d

Ca

na

da

Th

aila

nd

Ge

rma

ny

Ko

rea

Ta

iwa

n

Ho

ng

Ko

ng

1990-2015 change

in old age dependency ratio

2015-2035 projected change

in old age dependency

Disappointing global growth post the 20089 financial

crisis combined with a string of political and

economic shocks has left financial market sentiment

increasingly policy-driven This environment -

dubbed the ldquonew normalrdquo - clouds the long-term

outlook for equities and government bonds

However there is nothing really bdquonew‟ about the

support to risk assets that softer monetary policy has

been providing to both the Emerging and Developed

world ever since US bond yields peaked in

September 1981 Chart 1 shows how three phases of

halving US yields have been associated with some of

the strongest US equity returns over this period

Despite the support from lower rates conventional

economic wisdom (still) has it that market prices

reflect underlying fundamentals and ultimately move

towards equilibrium while near-term shocks are

random ldquonoiserdquo that will eventually be corrected

Chart 1 US equities have enjoyed 3 phases of halving yields

Source Bloomberg Authorrsquos calculations 3 periods of falling US 10-year yield

3091981-431986 431986-592002 542010-1082016

While the structural decline in bond yields can partly

be explained by the taming of inflationary pressures

the debate has shifted towards whether the scale of

monetary easing has in many instances gone too far

The ever-larger scale of quantitative easing and the

move to negative-yielding government (amp corporate)

bonds amid torpid global economic growth have also

raised doubts about the effectiveness of such

unconventional policies As a result the concept of

reflexivity has moved to the heart of the debate about

what drives financial markets

Reflexivity asserts that market prices influence

fundamentals which in turn can change expectations

the pattern repeats itself pushing prices ever further

away from their long-run equilibrium until a point

where ldquoboomrdquo turns to ldquobustrdquo

The increasingly episodic and global nature of the

economic cycle combined with a rising correlation

within financial markets does help to explain why

reflexivity has been able to mount a credible

challenge to long-held market beliefs the pressure on

the Chinese yuan following speculation around a

further US interest rate hike is a recent case in point

Growing macro uncertainty has also led to a

heightened level of myopia among long-term

investors as ldquoshock fatiguerdquo effectively caps their

ability to lock up capital for extended periods This

manifests itself in a seemingly irrational demand for

negative-yielding bonds and record levels of cash

holdings among global fund managers

60

560

1060

1560

2060

2560

81 84 87 90 93 96 99 02 05 08 11 14

0

2

4

6

8

10

12

14

16

SampP 50 0

annualised

ret urn 16

SampP 50 0

annualised

ret urn 10

1 19 8 1- 19 8 6 3 2 0 10 - 2 0 162 19 8 6 - 2 0 0 2

SampP 50 0

annualised

ret urn 8 6

SampP 50 0

(Left HS) U S 10 yr

( R ig ht HS)

1

2

3

Taking a long view

Negative yields and slower growth mean equities will disappoint

Demographic trends can help determine the winners and losers

Emerging Markets stand to benefit the most from expected trends

Chart 2 US equities have been the most consistent long-term performers

Source Bloomberg Authorrsquos calculations Daily data starts in January 1990 in US$

Chart 2 shows how this volatile backdrop has seen

leadership among equities shift dramatically over the

past decade (red bars) compared with the trend since

1990 (blue bars) Emerging Markets have seen some

of the biggest changes with returns in Saudi Arabia

(collapse in oil) Poland and the Czech Republic

(slower growth lower yields waning demographics)

falling fastest Other EMs including the Philippines

(faster growth) Taiwan and Thailand (faster growth

better demographics) have seen among the biggest

improvements in equity performance

It is also remarkable to observe that US equities have

managed to deliver the identical annualised return

(included reinvested dividends) of 78 over the past

10 and 25 years Only Japan has managed to deliver

as stable a return profile over this period although it

has struggled to move above a 1 return per year

A persistent decline in yields is about the only thing

that Japan and the US have had in common in recent

decades which should be enough to raise red flags

about the need to revise down long-term return

expectations perhaps more so in the US given how

supportive a trend of lower rates has proven to be

Precisely estimating 10-year equity returns is

infinitely more difficult than with government bonds

However it is possible to identify the key drivers of

equities over the past 25 years and then try to

understand the implications of how these trends

might evolve in the coming decade

In a growth-starved world with historically low bond

yields equity markets that can benefit from faster

growth higher interest rates and improving

demographics should command an even greater

premium in the coming years

This report attempts to address these issues for 20

countries (10 Emerging and 10 Developed) which

have the best quality and longest history available

going as far back as 1990 wherever possible

Taking each of the three factors above in turn it is

possible to get a better understanding of long-term

drivers of equity returns and start to form a view on

the outlook for the next 10 years

Demographics

Demographic trends help define long-run potential

economic growth and the associated investment

opportunities that certain trends are expected to bring

Trends in the following key metrics from an equity

investment perspective are addressed in turn

1 Prime savers - population aged 40-64

divided by the rest of the population)

2 Old-age dependency ndash population aged 65+

divided by the population aged 15-64

3 Urbanisation - percentage of the population

residing in urban areas

Since 1990 all three measures have seen improving

trends - increase in prime savers falling old-age

dependency and growing urbanisation - helping to

underpin equity returns over the same period with

some countries benefiting much more than others

However the coming decades are likely see much of

this positive catalyst fade thus reinforcing the

message implied from historically low bond yields

expected returns will need to be revised lower

However it should still be possible to differentiate

between markets based on future demographic trends

according to United Nations (UN) projections

15

4

13

2

13

0

12

9

11

9

10

5

10

2

98

97

95

74

73

70

67

67

62

55

37

04

49

-11

-24

50

71

-22

77

62

35

58

78

49

08 12

46

16

17

4

13

5

75

14

-5

0

5

10

15

20

Me

xico

Cze

ch R

ep

Sa

ud

i Ara

bia

So

uth

Afr

ica

Au

stra

lia

Po

lan

d

Ind

ia

Ho

ng

Ko

ng

Ca

na

da

Sw

itze

rlan

d

US

Ge

rma

ny

Eu

rozo

ne

Fra

nce

Ko

rea

UK

Ph

ilipp

ine

s

Th

aila

nd

Ta

iwa

n

Jap

an

Average 10-year annualised

equity return

Latest 10-year annualised

equity return

Fed put

Prime savers risks of asset shedding

When the share of the population aged between 40

and 64 years old is falling then a country suffers from

asset shedding The International Monetary Fund

(IMF) has previously identified US equity weakness

in the 1970s and early 1980s coinciding with a low

share of prime savers The strength of equities during

the 1990s was then associated with a sharp increase

in the prime saving population1

When compared with the increase in prime savers in

the US since 1990 UN data shows the Emerging Asia

economies have enjoyed a much stronger tailwind

over the same period Thailand Korea Taiwan and

Hong Kong all saw a faster increase in the share of

prime savers Amid a broadly deteriorating outlook

for the share of prime savers the most positive trends

are projected to be in Saudi Arabia Mexico India

and South Africa while Korea and Hong Kong

should see the biggest reversal of fortunes

Chart 3 The share of prime savers is expected to fall in many countries in the coming decades

Source Bloomberg United Nations World Population Prospects The 2015 Revision

Authorrsquos calculations Prime savers population aged 40-64 divided by the rest of the

population

Old-age dependency a potential drag on growth

The world is expected to see the share of the

population older than 65 years increase from 12 to

38 by 2100 according to UN projections After

remaining high across the globe for a lengthy period

of time a widespread fall in fertility rates will help to

1 International Monetary Fund Regional Economic

Outlook Asia- Pacific November 2008 (link)

encourage a more sustainable pattern of development

and also reduce pressures on the environment

The IMF sees these developments placing public

finances of countries under pressure via two

channels spending on age-related programs

(pensions and health) and slower economic growth2

It sees the fiscal consequences as potentially dire as

increases in spending potentially lead to

unsustainable public debts that require sharp cuts in

other spending or mean large tax increases that could

become a drag on economic growth

Looking forward over the coming decades chart 4

shows both the extent to which the pace of ageing

will both deteriorate and differentiate among a

number of major economies

The most favoured on this basis are South Africa

the Philippines India Saudi Arabia and Mexico

which are expected to see the biggest improvement in

prime saver ratios The most challenged economies

will be Hong Kong Taiwan Korea Germany and

Thailand most of which are also likely to see a

falling in the share of prime savers

Chart 4 Old-age dependency ratios are projected to rise even faster around the world in future years

Source Bloomberg United Nations World Population Prospects The 2015 Revision

Authorrsquos calculations Old-age dependency ratio population aged 65+ divided by

population aged between 15 and 64

2 IMF Staff Discussion Note The Fiscal

Consequences of Shrinking Populations October

2015 (link)

-20

-10

0

10

20

30

40

50

Sa

ud

i Ara

bia

Me

xico

Ind

ia

So

uth

Afr

ica

Po

lan

d

Ph

ilipp

ine

s

Cze

ch R

ep

Th

aila

nd

Ta

iwa

n

Jap

an

Au

stra

lia

Eu

rop

e

UK

US

Ca

na

da

Ko

rea

Sw

itze

rlan

d

Fra

nce

Ge

rma

ny

Ho

ng

Ko

ng

1990-2015 change

in prime savers pp

2015-2035 projected change

in prime savers pp

-5

0

5

10

15

20

25

30

35

So

uth

Afr

ica

Ph

ilipp

ine

s

Ind

ia

Sa

ud

i Ara

bia

Me

xico

Au

stra

lia UK

Cze

ch R

ep

Fra

nce US

Jap

an

Eu

rop

e

Po

lan

d

Sw

itze

rlan

d

Ca

na

da

Th

aila

nd

Ge

rma

ny

Ko

rea

Ta

iwa

n

Ho

ng

Ko

ng

1990-2015 change

in old age dependency ratio

2015-2035 projected change

in old age dependency

Chart 2 US equities have been the most consistent long-term performers

Source Bloomberg Authorrsquos calculations Daily data starts in January 1990 in US$

Chart 2 shows how this volatile backdrop has seen

leadership among equities shift dramatically over the

past decade (red bars) compared with the trend since

1990 (blue bars) Emerging Markets have seen some

of the biggest changes with returns in Saudi Arabia

(collapse in oil) Poland and the Czech Republic

(slower growth lower yields waning demographics)

falling fastest Other EMs including the Philippines

(faster growth) Taiwan and Thailand (faster growth

better demographics) have seen among the biggest

improvements in equity performance

It is also remarkable to observe that US equities have

managed to deliver the identical annualised return

(included reinvested dividends) of 78 over the past

10 and 25 years Only Japan has managed to deliver

as stable a return profile over this period although it

has struggled to move above a 1 return per year

A persistent decline in yields is about the only thing

that Japan and the US have had in common in recent

decades which should be enough to raise red flags

about the need to revise down long-term return

expectations perhaps more so in the US given how

supportive a trend of lower rates has proven to be

Precisely estimating 10-year equity returns is

infinitely more difficult than with government bonds

However it is possible to identify the key drivers of

equities over the past 25 years and then try to

understand the implications of how these trends

might evolve in the coming decade

In a growth-starved world with historically low bond

yields equity markets that can benefit from faster

growth higher interest rates and improving

demographics should command an even greater

premium in the coming years

This report attempts to address these issues for 20

countries (10 Emerging and 10 Developed) which

have the best quality and longest history available

going as far back as 1990 wherever possible

Taking each of the three factors above in turn it is

possible to get a better understanding of long-term

drivers of equity returns and start to form a view on

the outlook for the next 10 years

Demographics

Demographic trends help define long-run potential

economic growth and the associated investment

opportunities that certain trends are expected to bring

Trends in the following key metrics from an equity

investment perspective are addressed in turn

1 Prime savers - population aged 40-64

divided by the rest of the population)

2 Old-age dependency ndash population aged 65+

divided by the population aged 15-64

3 Urbanisation - percentage of the population

residing in urban areas

Since 1990 all three measures have seen improving

trends - increase in prime savers falling old-age

dependency and growing urbanisation - helping to

underpin equity returns over the same period with

some countries benefiting much more than others

However the coming decades are likely see much of

this positive catalyst fade thus reinforcing the

message implied from historically low bond yields

expected returns will need to be revised lower

However it should still be possible to differentiate

between markets based on future demographic trends

according to United Nations (UN) projections

15

4

13

2

13

0

12

9

11

9

10

5

10

2

98

97

95

74

73

70

67

67

62

55

37

04

49

-11

-24

50

71

-22

77

62

35

58

78

49

08 12

46

16

17

4

13

5

75

14

-5

0

5

10

15

20

Me

xico

Cze

ch R

ep

Sa

ud

i Ara

bia

So

uth

Afr

ica

Au

stra

lia

Po

lan

d

Ind

ia

Ho

ng

Ko

ng

Ca

na

da

Sw

itze

rlan

d

US

Ge

rma

ny

Eu

rozo

ne

Fra

nce

Ko

rea

UK

Ph

ilipp

ine

s

Th

aila

nd

Ta

iwa

n

Jap

an

Average 10-year annualised

equity return

Latest 10-year annualised

equity return

Fed put

Prime savers risks of asset shedding

When the share of the population aged between 40

and 64 years old is falling then a country suffers from

asset shedding The International Monetary Fund

(IMF) has previously identified US equity weakness

in the 1970s and early 1980s coinciding with a low

share of prime savers The strength of equities during

the 1990s was then associated with a sharp increase

in the prime saving population1

When compared with the increase in prime savers in

the US since 1990 UN data shows the Emerging Asia

economies have enjoyed a much stronger tailwind

over the same period Thailand Korea Taiwan and

Hong Kong all saw a faster increase in the share of

prime savers Amid a broadly deteriorating outlook

for the share of prime savers the most positive trends

are projected to be in Saudi Arabia Mexico India

and South Africa while Korea and Hong Kong

should see the biggest reversal of fortunes

Chart 3 The share of prime savers is expected to fall in many countries in the coming decades

Source Bloomberg United Nations World Population Prospects The 2015 Revision

Authorrsquos calculations Prime savers population aged 40-64 divided by the rest of the

population

Old-age dependency a potential drag on growth

The world is expected to see the share of the

population older than 65 years increase from 12 to

38 by 2100 according to UN projections After

remaining high across the globe for a lengthy period

of time a widespread fall in fertility rates will help to

1 International Monetary Fund Regional Economic

Outlook Asia- Pacific November 2008 (link)

encourage a more sustainable pattern of development

and also reduce pressures on the environment

The IMF sees these developments placing public

finances of countries under pressure via two

channels spending on age-related programs

(pensions and health) and slower economic growth2

It sees the fiscal consequences as potentially dire as

increases in spending potentially lead to

unsustainable public debts that require sharp cuts in

other spending or mean large tax increases that could

become a drag on economic growth

Looking forward over the coming decades chart 4

shows both the extent to which the pace of ageing

will both deteriorate and differentiate among a

number of major economies

The most favoured on this basis are South Africa

the Philippines India Saudi Arabia and Mexico

which are expected to see the biggest improvement in

prime saver ratios The most challenged economies

will be Hong Kong Taiwan Korea Germany and

Thailand most of which are also likely to see a

falling in the share of prime savers

Chart 4 Old-age dependency ratios are projected to rise even faster around the world in future years

Source Bloomberg United Nations World Population Prospects The 2015 Revision

Authorrsquos calculations Old-age dependency ratio population aged 65+ divided by

population aged between 15 and 64

2 IMF Staff Discussion Note The Fiscal

Consequences of Shrinking Populations October

2015 (link)

-20

-10

0

10

20

30

40

50

Sa

ud

i Ara

bia

Me

xico

Ind

ia

So

uth

Afr

ica

Po

lan

d

Ph

ilipp

ine

s

Cze

ch R

ep

Th

aila

nd

Ta

iwa

n

Jap

an

Au

stra

lia

Eu

rop

e

UK

US

Ca

na

da

Ko

rea

Sw

itze

rlan

d

Fra

nce

Ge

rma

ny

Ho

ng

Ko

ng

1990-2015 change

in prime savers pp

2015-2035 projected change

in prime savers pp

-5

0

5

10

15

20

25

30

35

So

uth

Afr

ica

Ph

ilipp

ine

s

Ind

ia

Sa

ud

i Ara

bia

Me

xico

Au

stra

lia UK

Cze

ch R

ep

Fra

nce US

Jap

an

Eu

rop

e

Po

lan

d

Sw

itze

rlan

d

Ca

na

da

Th

aila

nd

Ge

rma

ny

Ko

rea

Ta

iwa

n

Ho

ng

Ko

ng

1990-2015 change

in old age dependency ratio

2015-2035 projected change

in old age dependency

Prime savers risks of asset shedding

When the share of the population aged between 40

and 64 years old is falling then a country suffers from

asset shedding The International Monetary Fund

(IMF) has previously identified US equity weakness

in the 1970s and early 1980s coinciding with a low

share of prime savers The strength of equities during

the 1990s was then associated with a sharp increase

in the prime saving population1

When compared with the increase in prime savers in

the US since 1990 UN data shows the Emerging Asia

economies have enjoyed a much stronger tailwind

over the same period Thailand Korea Taiwan and

Hong Kong all saw a faster increase in the share of

prime savers Amid a broadly deteriorating outlook

for the share of prime savers the most positive trends

are projected to be in Saudi Arabia Mexico India

and South Africa while Korea and Hong Kong

should see the biggest reversal of fortunes

Chart 3 The share of prime savers is expected to fall in many countries in the coming decades

Source Bloomberg United Nations World Population Prospects The 2015 Revision

Authorrsquos calculations Prime savers population aged 40-64 divided by the rest of the

population

Old-age dependency a potential drag on growth

The world is expected to see the share of the

population older than 65 years increase from 12 to

38 by 2100 according to UN projections After

remaining high across the globe for a lengthy period

of time a widespread fall in fertility rates will help to

1 International Monetary Fund Regional Economic

Outlook Asia- Pacific November 2008 (link)

encourage a more sustainable pattern of development

and also reduce pressures on the environment

The IMF sees these developments placing public

finances of countries under pressure via two

channels spending on age-related programs

(pensions and health) and slower economic growth2

It sees the fiscal consequences as potentially dire as

increases in spending potentially lead to

unsustainable public debts that require sharp cuts in

other spending or mean large tax increases that could

become a drag on economic growth

Looking forward over the coming decades chart 4

shows both the extent to which the pace of ageing

will both deteriorate and differentiate among a

number of major economies

The most favoured on this basis are South Africa

the Philippines India Saudi Arabia and Mexico

which are expected to see the biggest improvement in

prime saver ratios The most challenged economies

will be Hong Kong Taiwan Korea Germany and

Thailand most of which are also likely to see a

falling in the share of prime savers

Chart 4 Old-age dependency ratios are projected to rise even faster around the world in future years

Source Bloomberg United Nations World Population Prospects The 2015 Revision

Authorrsquos calculations Old-age dependency ratio population aged 65+ divided by

population aged between 15 and 64

2 IMF Staff Discussion Note The Fiscal

Consequences of Shrinking Populations October

2015 (link)

-20

-10

0

10

20

30

40

50

Sa

ud

i Ara

bia

Me

xico

Ind

ia

So

uth

Afr

ica

Po

lan

d

Ph

ilipp

ine

s

Cze

ch R

ep

Th

aila

nd

Ta

iwa

n

Jap

an

Au

stra

lia

Eu

rop

e

UK

US

Ca

na

da

Ko

rea

Sw

itze

rlan

d

Fra

nce

Ge

rma

ny

Ho

ng

Ko

ng

1990-2015 change

in prime savers pp

2015-2035 projected change

in prime savers pp

-5

0

5

10

15

20

25

30

35

So

uth

Afr

ica

Ph

ilipp

ine

s

Ind

ia

Sa

ud

i Ara

bia

Me

xico

Au

stra

lia UK

Cze

ch R

ep

Fra

nce US

Jap

an

Eu

rop

e

Po

lan

d

Sw

itze

rlan

d

Ca

na

da

Th

aila

nd

Ge

rma

ny

Ko

rea

Ta

iwa

n

Ho

ng

Ko

ng

1990-2015 change

in old age dependency ratio

2015-2035 projected change

in old age dependency

Urbanisation growth catalyst

The world has become increasingly urban with cities

currently home to just over half of the global

population compared with 30 in 19503 This trend

is expected to continue with 66 expected to live in

cities by 2050 according to the UN There will be an

increasing focus on this trend as nearly all of the 11

billion increase in global population projected over

the next 15 years is expected to occur in urban areas4

While it may not be certain if urbanisation causes

countries to grow faster or if faster growth causes

greater urbanisation it is clear is that no country has

either achieved high incomes or rapid growth without

substantial often quite rapid urbanisation5

Chart 5 EM should continue to benefit from urbanisation

Source Bloomberg United Nations World Population Prospects The 2015 Revision

Authorrsquos calculations Percentage of Population at Mid-Year Residing in Urban Areas

by Major Area

In the coming decades Thailand India South

Africa and Taiwan are expected to see the fastest

pace of growth in urbanisation Korea will see a sharp

slowdown in this trend along with Hong Kong as well

as Australia (see chart 5)

Demographics and equities

In order to see how each of these major demographic

trends have been associated with equity returns the

3 United Nations 2014 Revision of World

Urbanization Prospects (link)

4 Urbanization City Growth and the New United

Nations Development Agenda Cornerstone (link)

5 Ibid

average ranking of all three trends are compared with

a ranking of equity market performance since 1990

Long-term equity performance is expressed as the

daily average 10-year annualised total return in US

dollar terms which is illustrated in chart 6

Chart 6 Methodology for calculating long-run equity returns

Source Authorrsquos calculations Daily data

Chart 7 breaks into quadrants where the overall best

or worst demographic trends have accompanied the

strongest or weakest equity returns The best

demographics and long-term equity returns have

mainly come in Emerging Markets Mexico Saudi

Arabia South Africa and India Canada is the only

Developed Market economy to have seen among the

strongest equity returns accompany some of the best

demographic trends Developed Europe as well as

Japan and the Philippines have seen some of the

worst equity returns accompany poor demographics

Chart 7 Demographics have had the biggest positive impact on EM equities while this has been a drag on DM

Source Bloomberg United Nations World Population Prospects The 2015 Revision

Authorrsquos calculations Compares ranking of overall trends in old-age dependency

prime-savers and urbanisation with the average 10-year annualised equity return in

US$ terms between January 1990-July 2016

-5

0

5

10

15

20

25

Th

aila

nd

Ind

ia

So

uth

Afr

ica

Ta

iwa

n

Eu

rop

e

Me

xico

Ge

rma

ny

Fra

nce

Ph

ilipp

ine

s

UK

Jap

an

Po

lan

d

Sa

ud

i Ara

bia

Ca

na

da

US

Sw

itze

rlan

d

Ko

rea

Cze

ch R

ep

Au

stra

lia

Ho

ng

Ko

ng

1990-2015 change

in urbanisation rate

2015-2035 change

in urbanisation rate

Past10-year annualised equity market return Average

2000 2016

IMPROVING DEMOGRAPHICS

amp WEAKER EQUITY PERFORMANCE

USKorea

Thailand

Taiwan

IMPROVING DEMOGRAPHICS

amp STRONGER EQUITY PERFORMANCE

MexicoSaudi ArabiaSouth Africa

IndiaCanada

DETERIORATING DEMOGRAPHICS

amp WEAKER EQUITY PERFORMANCE

Germany France

UK

JapanPhilippines

DETERIORATING DEMOGRAPHICS

amp STRONGER EQUITY PERFORMANCE

Poland Czech RepHong KongAustralia

Switzerland

Oveall demographics amp equity performance 1990-2016

Conclusions

Many of the Emerging Markets that have enjoyed the

best demographic trends over the past 25 years are

expected to continue to be the biggest winners in the

coming decades The standouts are South Africa

India and Mexico which are projected to see the

biggest reduction in old-age dependency and the

biggest increase in prime savers and urbanisation

Chart 7 highlighted how all three counties had seen

their equity markets deliver some of the best long-run

returns at the same time as enjoying the best overall

demographic trends This can help provide a key

support for future returns over the coming decade

The Philippines is also expected to join this list after

having previously seeing some of the world‟s worst

demographics this turnaround can potentially

provide a positive catalyst for risk assets as weaker

long-run equity performance had come with some of

worst demographic trends This improving structural

trend can already bee seen in a stronger equity

performance in the Philippines over the past decade

Chart 8 Emerging Markets will continue to enjoy the biggest demographic benefits over the coming decades

Source Bloomberg United Nations World Population Prospects The 2015 Revision

Authorrsquos calculations

Thailand and Taiwan are seen benefiting among the

most from growing urbanisation as well as a trend of

rising prime savers continuing to move in a positive

direction Both equity markets have delivered some

of the weakest equity returns since 1990 despite a

positive demographic backdrop Any further

improvement in demographic trends can help to

underpin better long-run equity returns which can

already been seen in an improved performance over

the past 10 years

Saudi Arabia which has seen economic growth slow

sharply following the collapse in oil prices is still

expected to benefit from the biggest decline in old-

age dependency and rise in prime savers continuing a

positive trend The Czech Republic another major

equity underperformer over the past decade is also

projected to see among the best trends in both

metrics in contrast to having seen some of the worst

changes over the past two decades

The US Canada and Korea are now expected to see

some of the worst trends over the next 20 years after

having enjoyed some of the best demographic

changes in the past Canada may potentially be one of

the biggest losers from this shift as it has seen some

of the best equity returns accompany the best

demographics The US and Korea which had seen

among the weakest equity returns despite some the

best demographic changes also look vulnerable

Chart 9 Developed Markets are expected to see the worst demographic trends over the next 20 years

Source Bloomberg United Nations World Population Prospects The 2015 Revision

Authorrsquos calculations

Hong Kong Japan and Switzerland are also expected

to continue to see some of the worst demographic

trends Hong Kong and Switzerland may struggle the

most with this change after having managed to

deliver some of the best equity returns despite the

worst demographic changes since 1990

Old-age

dependencyUrbanisation

Prime savers

Poland

GermanyFranceUK

Australia

Saudi Arabia

Czech Rep

South Africa

IndiaMexico

Philippines Thailand

Taiwan

Best demographic trends 2015-2035

Old-age

dependencyUrbanisation

Prime savers

France

Saudi Arabia

Czech RepPoland

Thailand

Taiwan

Germany

US Canada

Hong KongJapan KoreaSwitzerland UK

Australia

Worst demographic trends 2015-2035

Economic growth

In the long-run corporate earnings should be

expected to grow broadly in-line with aggregate

domestic economic activity However the increasing

internationalisation of trade combined with the

ongoing structural changes in the global economy

may lead the relationship between earnings and GDP

growth to change over time

In addition a demographic backdrop that is generally

expected to become less favourable combined with an

uneven and disappointing global recovery since the

20089 financial crisis means that growth delivery is

expected to become a major differentiating factor

behind equity performance in the coming years

Wherersquos the growth

Chart 10 shows how since 2006 Emerging Asia has

been the best at delivering both a faster economic

expansion as well as better growth in earnings-per-

share (EPS) India and the Philippines have been the

standouts with Hong Kong Taiwan Korea Thailand

as well as Poland also among the strongest

Chart 10 Emerging Asia economies have delivered the best earnings and GDP growth over the past decade

Source Bloomberg IMF Authorrsquos calculations Year-on-year change in 12-month

forward EPS and annual GDP growth

Europe has seen some of the weakest EPS and

economic growth with the UK France and the Czech

Republic among the worst in addition to Mexico

South Africa and Australia

The US Japan and Germany are among the markets

to have seen earnings grow faster than their

respective domestic economies A sizeable export-

dependency in both Japan and Germany can partly

explain this disparity while a surge in stock buybacks

may help to explain a relatively stronger EPS trend in

the US It is important to note that neither of these

forces can be expected to remain as a strong a

compensating factor in the coming years

Chart 11 shows how the IMF‟s latest long-term GDP

growth estimates merely reflect many of the major

trends observed over the past decade This leaves

open the possibility for some predictable revisions to

follow in future

Among the potential for upgrades are the Emerging

Asian markets including Thailand and Taiwan which

are expected to see slower growth despite the

continued demographic improvements highlighted in

the previous section

The Philippines and India are among the few

economies forecast to see the growth trend

accelerating from already very strong levels Given

the global decoupling that would be needed to

achieve such a growth outcome there is some scope

for downward revisions in future especially if the

pace of political reforms were to falter

Chart 11 Long-run global growth expectations are always subject to change

Source Authorrsquos calculations IMF

The growth forecasts for most of Europe and Japan

reflect an entrenched pessimism that might only be

shaken by the success of the current unconventional

Hong Kong

Taiwan

FranceJapan

Europe

Germany

US

Korea

Canada

Poland

Czech Rep

South Africa Switzerland

Thailand

Mexico

UK

Philippines

Australia

Saudi Arabia

India

0

1

2

3

4

5

6

7

-2 0 2 4 6 8 10 12 14 16

Strong GDPStrong EPS

Weak GDPWeak EPS

Weak GDPStrong EPS

StrongGDPWeak EPS

Average annual EPS growth since 2006

Ave

rag

e a

nn

ua

l GD

P g

row

th s

ince

20

06

Australia

Canada CzechFrance

Germany

Hong Kong

India

Japan

KoreaMexico

Philippines

Poland

Saudi ArabiaS Africa

SwitzerlandTaiwan

Thailand

UK

US

Europe

0

1

2

3

4

5

6

7

8

0 1 2 3 4 5 6 7Average annual GDP growth 1990-2016

Ave

rag

e a

nn

ua

l GD

P g

row

th2

016

-202

1 e

st

policy measures aimed at stimulating growth or from

reforms that manage to lead to an improvement in

potential growth Given the failure to achieve either

of these objectives for more than two decades in

Japan and for the past decade in Europe there

remains little cause for optimism especially given the

demographic headwinds already highlighted

Growth and equities

The comprehensive historical study of Dimson

Marsh amp Staunton finds little if any long-term

relationship between real equity returns and economic

growth6 Just as important is the price investors must

pay for this growth

As Chart 12 shows many of the Emerging Asia

economies that are expected to achieve some of the

fastest GDP growth in the coming years currently

trade at premiums to their respective 10-year average

Chart 12 European and US equity valuations look rich compared with EM Asia

Source Bloomberg Authorrsquos calculations IMF Daily 12-month forward PE data

However the US Canada Australia and developed

European markets also trade at similar premiums

despite a much weaker growth outlook leaving these

markets vulnerable to future derating Japan South

Africa and the Czech Republic which are expected to

see growth remain sluggish in the coming years

already show the biggest discounts

6 Triumph of the Optimists 101 Years of Global

Investment Returns Elroy Dimson Paul Marsh amp

Mike Staunton 2002

Contrary to the findings of Dimson et al slowing

global growth over the past decade has helped foster

an environment whereby faster earnings growth has

been rewarded with better equity returns Chart 13

shows how EM Asia has been the biggest beneficiary

of this trend while Europe Canada and South Africa

have been punished the most

Japan has been one of the biggest outliers as faster

earnings growth has failed to translate into better

equity performance The extent to which currency

weakness has provided support to earnings in the past

highlights the limited extent to which this approach

translates into sustained equity market performance

Chart 13 EM Asia has seen stronger earnings and equity performance over the past decade vs Europe

Source Authorrsquos calculations IMF

Conclusions

Equities remain vulnerable both in the medium-term

given the current late cycle stage of the global

economic cycle as well as over the long-term as

structural growth drivers become a headwind As a

result the equity investor will increasingly need to

focus on markets where growth and earnings delivery

are likely to be the strongest

While there isn‟t a proven relationship between

economic growth and earnings it is important to

observe that over the past decade equity markets in

countries with both faster GDP and EPS growth have

seen some of the best equity returns and currently

trade at some of the biggest valuation premiums

Mexico

South Africa

Saudi Arabia

India

Thailand

Poland

Australia

Taiwan

US

Philippines

Canada

Czech Rep

Switzerland

Eurozone

Korea

UK

Hong Kong

France

Germany

Japan

-35

-25

-15

-5

5

15

25

35

45

0 1 2 3 4 5 6 7

12

m

Fw

dP

E d

isco

un

tp

rem

ium

vs

10

-ye

ar

ave

rag

e)

Average annual GDP growth 2016-2021 est

Weak GDPexpensive equities Strong GDPexpensive equities

Weak GDPcheap equities

Mexico

South Africa

Saudi Arabia

India

Thailand

Poland

Australia

Taiwan

US

Philippines

Canada

Czech Rep

Switzerland

Eurozone

Korea

UK

Hong Kong

France

GermanyJapan

-2

0

2

4

6

8

10

12

14

-5 0 5 10 15 20

Strong EPSStrong equity performance

Weak EPS

Weak equity performance

Annualised equity total return 2006-2016

Ave

rag

e a

nn

ua

l EP

S g

row

th

200

6-2

01

6

Equity markets returns in 2016 have so far been

mostly driven by multiple expansion (see chart 14)

although positive earnings momentum has also

contributed towards this performance across most

major EMs (excluding Saudi Arabia and the Czech

Republic) The coming decade can be expected to see

the trend of rewarding earnings momentum with

stronger equity returns and higher premium continue

Chart 14 Multiple expansion has driven most of the gains in equity markets during 2016

Source Bloomberg Authorrsquos calculations Data until August 21th 2016

Government bond yields

Persistent doubts about the future path of benchmark

bond yields from record low levels presents a further

medium-term challenge for equity investors and helps

to explain much of the recent myopic shift in the

investment strategy process

Any upward or worse sudden normalisation would

put a higher discount rate underneath currently lofty

valuations highlighted in chart 12 on the previous

page while a decline from historically low levels

implies the further need to revise down growth

expectations threatening the equity market outlook

How long is a piece of string

It is almost exactly 35 years since US bond yields

peaked and the following structural decline was

initially accompanied by a number of benign trends

across many other Developed and Emerging Markets

as inflation slowed from double-digit levels

The turn of the century saw the biggest decline in EM

as a step-change in political and economic stability

heralded a period of stronger China-led growth and

slower inflation

The past decade has seen DM bond yields fall faster

as slower inflation has been accompanied by sluggish

global economic growth recently bringing negative

rates to an increasing number of countries

As a result the average 10-year yield among the 10

EMs studied in this report is now 36 less than 100

basis points from the average historical low DMs

now have an average yield of 06 only 16bp above

their multi-decade lows (see chart 15)

Chart 15 Global bond yields are close to record lows

Source Bloomberg Authorrsquos calculations Data from January 1990 where possible as

of August 21st 2016

The open desire of the US Federal Reserve to hike

rates over the coming quarters still goes against the

grain as the rest of the world moves towards even

looser monetary policy in 2016 and potentially

beyond So far this year 17 major central banks have

cut interest rates after 19 moved lower in 2015

Some EM central banks have been tightening policy

although this has usually been to defend its currency

and fend off faster inflation (eg South Africa and

Mexico) which further complicates the Fed‟s

objective given that it now explicitly acknowledges

global factors in its decision-making process

Indeed expanding QE and negative interest rates

failing to generate 2 inflation has brought the entire

inflation-targeting framework into question An

-10

-5

0

5

10

15

20

25

30

Th

aila

nd

Ca

na

da

Ph

ilipp

ine

s

So

uth

Afr

ica

Ta

iwa

n

Ko

rea

Au

stra

lia

Me

xico

Po

lan

d

US

Ind

ia

Ho

ng

Ko

ng

Ge

rma

ny

Jap

an

Fra

nce UK

Sw

itze

rlan

d

Eu

rozo

ne

Cze

ch R

ep

Sa

ud

i Ara

bia

Conttributon toyear-to-date equity performance US$)

12m fwd PE change12m fwd EPS change12m fwd dividend yield

-2

0

2

4

6

8

10

12

14

16

18

20

22

So

uth

Afr

ica

Ind

ia

Me

xico

Sa

ud

i Ara

bia

Ph

ilipp

ine

s

Po

lan

d

Th

aila

nd

Au

stra

lia US

Ko

rea

Ca

na

da

Ho

ng

Ko

ng

Ta

iwa

n

UK

Cze

ch R

ep

Fra

nce

Ge

rma

ny

Eu

rozo

ne

Jap

an

Sw

itze

rlan

d

Historical

range

Latest 10-year yield

important factor behind the failure to generate faster

inflation has been the collapse in oil prices following

a shift in strategy by Saudi-led OPEC two years ago

As the Saudi‟s continue balance market share with a

transition to less oil dependence a low oil price

environment can be expected to continue for the

foreseeable future

As chart 16 shows much of the trend in US inflation

can be explained by the year-on-year change oil

prices Assuming oil prices remain at $45 or even

$50bbl for the next 12 months it would still be

difficult for inflation to exceed 2 for very long

Chart 16 US inflation set to accelerate even with little change in oil prices

Source Bloomberg Authorrsquos calculations

With monetary policy increasingly seen ldquopushing on

a stringrdquo and given the slower growth and weaker

demographic backdrop that is likely over the coming

years the threat of higher bond yields remains

unlikely to create the major headwind for equity

investors in the medium-term Indeed EM equity

markets stand to benefit the most from the hunt for

yield given an attractive EMDM bond yield spread

Bond yields and equities

Still from such a historically low level there is a

limit to how much further these rates can or will

move lower It is therefore important to understand

which markets have benefited the most from a falling

rate environment and hence will enjoy less benefit

from this trend in the future

Chart 17 compares the correlation between daily

rolling 10-year bond yields changes and 10-year

equity returns during 1990-2016 and since 2012 This

shows EM Asia Australia and the Czech Republic

in the top-right quadrant as the most consistent

beneficiaries from a rising rate environment In

contrast Mexico and Saudi Arabia have seen equities

benefit the most from a falling rate environment

The past few years has seen the biggest change in the

US and Developed European markets where growth

has become more disappointing As a result these

equity markets have benefited more from a rising rate

environment than was the case in past decades

Canada Hong Kong Poland South Africa and the

Philippines have been benefiting less from rising

rates than in the past A mixture of political risk and

sluggish growth now leaves these equity markets

especially vulnerable to a rising rate environment

Chart 17 Asia-Pacific and Developed Europe equities the biggest beneficiaries of higher bond yields

Source Bloomberg Authorrsquos calculations Correlation between 10-year change in

bond yields and 10-year annualised equity returns in US$ using daily data over the

period January 1990 (where possible) and July 2016

Conclusions

The Fed‟s ldquodovish tighteningrdquo approach to raising

rates is expected to continue over the coming

quarters which will give rise to some inevitable bouts

of volatility in both equities and fixed income

markets While spikes in yields can be expected the

overall move upwards will be gradual and hence

should not become a major headwind for risk assets

-3

-2

-1

0

1

2

3

4

5

6

-150

-100

-50

0

50

100

150

00 02 04 06 08 10 12 14 16

US inflation YoY change

(Right HS)

Brent oil YoY change

(Left HS)

Brent oil YoY change

if oil price next 12m $45bbl$50bbl

India

Japan

Hong Kong

Taiwan

Thailand

Czech Rep

Australia

Korea

PolandPhilippines

Canada

US

Saudi Arabia

SwitzerlandEurozone

Mexico

France

UK Germany

-50

-30

-10

10

30

50

70

90

110

-60 -40 -20 0 20 40 60 80 100

Equities consistently benefit

from rising yields

20

12

-20

16

co

rre

latio

n b

etw

ee

n e

qui

ties

an

d b

ond

yie

lds

1990-2016 correlation between equities and bond yields

Equities consistently benefit

from falling yields

Equities benefiting less

from rising yields since 2012

Equities benefiting more

from rising yields since 2012

S Africa

Conclusions

Improving demographics don‟t always result in faster

economic growth and improving economic growth

won‟t always lead to faster earnings growth This

makes forecasting 10-year equity returns especially

challenging given the ongoing structural changes

taking place in the global economy

What is increasingly clear is that markets will

continue to be driven by the hunt for yield and

growth Concerns over an ongoing sluggish recovery

post the 20089 financial crisis the limits to what

monetary and fiscal policy can achieve (on their own)

as well as a deteriorating demographic outlook all

stand to weigh on equity returns over the next decade

A direct consequence of this fragile macro backdrop

will be an even greater focus on markets that can

deliver growth and where rising bond yields are

supportive to equities

On the basis of these criteria India Mexico

Taiwan Thailand and the Philippines look the

strongest for the next decade

In contrast the US Canada Japan South Korea

and Switzerland look to be the weakest over a 10-

year horizon

A cornerstone of this debate is whether near-record low bond yields have become a symptom (aka ldquoJapanificationrdquo) or a cure (conventional monetary stimulus) of the uneven and disappointing global economic growth that has followed the 20089 financial crisis

Chart 18 Bond yield spread between top 5 and bottom 5 markets the highest in over a decade

Source Bloomberg Authorrsquos calculations Top 5 US Canada Japan South Korea and

Switzerland Bottom 5 India Mexico Taiwan Thailand and the Philippines Equal-

weighted baskets

Creating an equal-weighted basket of each group

highlights the potential for these markets to diverge in

the coming years Chart 18 shows how the move in

local currency bond yields over the past few years

reflects the disparity in 10-year outlook the spread

between the average yield of the top 5 and the bottom

5 is now close to the highest in a decade

While bond yields have diverged long-term equity

returns (as per the methodology shown in chart 6 on

p 5) for both groups have modestly converged

However chart 19 shows how the additional equity

return generated by the top 5 has stayed roughly

constant at an annualised 5 since 2013 even as the

bond yield differential has risen over the same period

Chart 19 Top 5 vs bottom 5 equity performance differential has stayed roughly unchanged since 2013

Source Bloomberg Authorrsquos calculations Equity return is average annualised 10-year

return in US$ using daily data since 1990 Top 5 US Canada Japan South Korea and

Switzerland Bottom 5 India Mexico Taiwan Thailand and the Philippines Equal-

weighted baskets

A continued hunt for yield that should ensure bonds

are well bid among the top 5 as well as the potential

growth disparity are both key long-term ingredients

that can help ensure equity performance differentials

between the top and bottom 5 widens further in

coming years

This relatively more constructive view on the top 5 is

reinforced by the scale of the decline in long-run

returns in excess of 10-year bond yields as shown in

chart 20

This highlights that equities returns have fallen faster

than the decline in bond yields since 2013 in both

groups but more so among the top 5 This leaves the

ldquoequity risk premiumrdquo (ERP) of the top 5 relative to

the bottom 5 at the lowest since 2008 Given the

potential for spread compression in bond yields there

0

1

2

3

4

5

6

7

8

9

01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

50

100

150

200

250

300

350

400Top 5 bond yields

(Left HS )

B ot t o m 5 bo nd yield s

(Left HS )

Top 5 bo t t om 5 d if erent ial

(Right HS bp)

-10

-5

0

5

10

15

20

25

30

01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

-15

-10

-5

0

5

10

15

To p 5 equit y ret urns

(Left HS )

B ot t om 5 equit y ret urns

(Left HS )

To p 5 bo t t om 5 d if erent ial

(Right HS bp)

is significant scope for this ERP differential to widen

much further in the coming years Until we reach the

levels last seen in 2010 the case for being structurally

overweight Emerging Markets and underweight

Developed Markets will remain in tact for both

equities and fixed income

Chart 20 Equity risk premium of the top 5 has fallen sharply relative to the bottom 5

Source Bloomberg Authorrsquos calculations Top 5 US Canada Japan South Korea and

Switzerland Bottom 5 India Mexico Taiwan Thailand and the Philippines Equal-

weighted baskets

Wesley Fogel

-10

-5

0

5

10

15

20

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

-15

-10

-5

0

5

10

15T o p 5 eq uit y ret urn

vs lo cal 10 yr b o nd yield

(Left HS )

T o p 5 equit y ret urn

vs lo cal 10 - yrbond yield

(Left HS )

Top 5 bo t t om 5 d if erent ial

(Right HS bp)

Wesley Fogel

Investment Strategist

Tel +44 7860 264 902

Email fogelhotmailcom

Economic growth

In the long-run corporate earnings should be

expected to grow broadly in-line with aggregate

domestic economic activity However the increasing

internationalisation of trade combined with the

ongoing structural changes in the global economy

may lead the relationship between earnings and GDP

growth to change over time

In addition a demographic backdrop that is generally

expected to become less favourable combined with an

uneven and disappointing global recovery since the

20089 financial crisis means that growth delivery is

expected to become a major differentiating factor

behind equity performance in the coming years

Wherersquos the growth

Chart 10 shows how since 2006 Emerging Asia has

been the best at delivering both a faster economic

expansion as well as better growth in earnings-per-

share (EPS) India and the Philippines have been the

standouts with Hong Kong Taiwan Korea Thailand

as well as Poland also among the strongest

Chart 10 Emerging Asia economies have delivered the best earnings and GDP growth over the past decade

Source Bloomberg IMF Authorrsquos calculations Year-on-year change in 12-month

forward EPS and annual GDP growth

Europe has seen some of the weakest EPS and

economic growth with the UK France and the Czech

Republic among the worst in addition to Mexico

South Africa and Australia

The US Japan and Germany are among the markets

to have seen earnings grow faster than their

respective domestic economies A sizeable export-

dependency in both Japan and Germany can partly

explain this disparity while a surge in stock buybacks

may help to explain a relatively stronger EPS trend in

the US It is important to note that neither of these

forces can be expected to remain as a strong a

compensating factor in the coming years

Chart 11 shows how the IMF‟s latest long-term GDP

growth estimates merely reflect many of the major

trends observed over the past decade This leaves

open the possibility for some predictable revisions to

follow in future

Among the potential for upgrades are the Emerging

Asian markets including Thailand and Taiwan which

are expected to see slower growth despite the

continued demographic improvements highlighted in

the previous section

The Philippines and India are among the few

economies forecast to see the growth trend

accelerating from already very strong levels Given

the global decoupling that would be needed to

achieve such a growth outcome there is some scope

for downward revisions in future especially if the

pace of political reforms were to falter

Chart 11 Long-run global growth expectations are always subject to change

Source Authorrsquos calculations IMF

The growth forecasts for most of Europe and Japan

reflect an entrenched pessimism that might only be

shaken by the success of the current unconventional

Hong Kong

Taiwan

FranceJapan

Europe

Germany

US

Korea

Canada

Poland

Czech Rep

South Africa Switzerland

Thailand

Mexico

UK

Philippines

Australia

Saudi Arabia

India

0

1

2

3

4

5

6

7

-2 0 2 4 6 8 10 12 14 16

Strong GDPStrong EPS

Weak GDPWeak EPS

Weak GDPStrong EPS

StrongGDPWeak EPS

Average annual EPS growth since 2006

Ave

rag

e a

nn

ua

l GD

P g

row

th s

ince

20

06

Australia

Canada CzechFrance

Germany

Hong Kong

India

Japan

KoreaMexico

Philippines

Poland

Saudi ArabiaS Africa

SwitzerlandTaiwan

Thailand

UK

US

Europe

0

1

2

3

4

5

6

7

8

0 1 2 3 4 5 6 7Average annual GDP growth 1990-2016

Ave

rag

e a

nn

ua

l GD

P g

row

th2

016

-202

1 e

st

policy measures aimed at stimulating growth or from

reforms that manage to lead to an improvement in

potential growth Given the failure to achieve either

of these objectives for more than two decades in

Japan and for the past decade in Europe there

remains little cause for optimism especially given the

demographic headwinds already highlighted

Growth and equities

The comprehensive historical study of Dimson

Marsh amp Staunton finds little if any long-term

relationship between real equity returns and economic

growth6 Just as important is the price investors must

pay for this growth

As Chart 12 shows many of the Emerging Asia

economies that are expected to achieve some of the

fastest GDP growth in the coming years currently

trade at premiums to their respective 10-year average

Chart 12 European and US equity valuations look rich compared with EM Asia

Source Bloomberg Authorrsquos calculations IMF Daily 12-month forward PE data

However the US Canada Australia and developed

European markets also trade at similar premiums

despite a much weaker growth outlook leaving these

markets vulnerable to future derating Japan South

Africa and the Czech Republic which are expected to

see growth remain sluggish in the coming years

already show the biggest discounts

6 Triumph of the Optimists 101 Years of Global

Investment Returns Elroy Dimson Paul Marsh amp

Mike Staunton 2002

Contrary to the findings of Dimson et al slowing

global growth over the past decade has helped foster

an environment whereby faster earnings growth has

been rewarded with better equity returns Chart 13

shows how EM Asia has been the biggest beneficiary

of this trend while Europe Canada and South Africa

have been punished the most

Japan has been one of the biggest outliers as faster

earnings growth has failed to translate into better

equity performance The extent to which currency

weakness has provided support to earnings in the past

highlights the limited extent to which this approach

translates into sustained equity market performance

Chart 13 EM Asia has seen stronger earnings and equity performance over the past decade vs Europe

Source Authorrsquos calculations IMF

Conclusions

Equities remain vulnerable both in the medium-term

given the current late cycle stage of the global

economic cycle as well as over the long-term as

structural growth drivers become a headwind As a

result the equity investor will increasingly need to

focus on markets where growth and earnings delivery

are likely to be the strongest

While there isn‟t a proven relationship between

economic growth and earnings it is important to

observe that over the past decade equity markets in

countries with both faster GDP and EPS growth have

seen some of the best equity returns and currently

trade at some of the biggest valuation premiums

Mexico

South Africa

Saudi Arabia

India

Thailand

Poland

Australia

Taiwan

US

Philippines

Canada

Czech Rep

Switzerland

Eurozone

Korea

UK

Hong Kong

France

Germany

Japan

-35

-25

-15

-5

5

15

25

35

45

0 1 2 3 4 5 6 7

12

m

Fw

dP

E d

isco

un

tp

rem

ium

vs

10

-ye

ar

ave

rag

e)

Average annual GDP growth 2016-2021 est

Weak GDPexpensive equities Strong GDPexpensive equities

Weak GDPcheap equities

Mexico

South Africa

Saudi Arabia

India

Thailand

Poland

Australia

Taiwan

US

Philippines

Canada

Czech Rep

Switzerland

Eurozone

Korea

UK

Hong Kong

France

GermanyJapan

-2

0

2

4

6

8

10

12

14

-5 0 5 10 15 20

Strong EPSStrong equity performance

Weak EPS

Weak equity performance

Annualised equity total return 2006-2016

Ave

rag

e a

nn

ua

l EP

S g

row

th

200

6-2

01

6

Equity markets returns in 2016 have so far been

mostly driven by multiple expansion (see chart 14)

although positive earnings momentum has also

contributed towards this performance across most

major EMs (excluding Saudi Arabia and the Czech

Republic) The coming decade can be expected to see

the trend of rewarding earnings momentum with

stronger equity returns and higher premium continue

Chart 14 Multiple expansion has driven most of the gains in equity markets during 2016

Source Bloomberg Authorrsquos calculations Data until August 21th 2016

Government bond yields

Persistent doubts about the future path of benchmark

bond yields from record low levels presents a further

medium-term challenge for equity investors and helps

to explain much of the recent myopic shift in the

investment strategy process

Any upward or worse sudden normalisation would

put a higher discount rate underneath currently lofty

valuations highlighted in chart 12 on the previous

page while a decline from historically low levels

implies the further need to revise down growth

expectations threatening the equity market outlook

How long is a piece of string

It is almost exactly 35 years since US bond yields

peaked and the following structural decline was

initially accompanied by a number of benign trends

across many other Developed and Emerging Markets

as inflation slowed from double-digit levels

The turn of the century saw the biggest decline in EM

as a step-change in political and economic stability

heralded a period of stronger China-led growth and

slower inflation

The past decade has seen DM bond yields fall faster

as slower inflation has been accompanied by sluggish

global economic growth recently bringing negative

rates to an increasing number of countries

As a result the average 10-year yield among the 10

EMs studied in this report is now 36 less than 100

basis points from the average historical low DMs

now have an average yield of 06 only 16bp above

their multi-decade lows (see chart 15)

Chart 15 Global bond yields are close to record lows

Source Bloomberg Authorrsquos calculations Data from January 1990 where possible as

of August 21st 2016

The open desire of the US Federal Reserve to hike

rates over the coming quarters still goes against the

grain as the rest of the world moves towards even

looser monetary policy in 2016 and potentially

beyond So far this year 17 major central banks have

cut interest rates after 19 moved lower in 2015

Some EM central banks have been tightening policy

although this has usually been to defend its currency

and fend off faster inflation (eg South Africa and

Mexico) which further complicates the Fed‟s

objective given that it now explicitly acknowledges

global factors in its decision-making process

Indeed expanding QE and negative interest rates

failing to generate 2 inflation has brought the entire

inflation-targeting framework into question An

-10

-5

0

5

10

15

20

25

30

Th

aila

nd

Ca

na

da

Ph

ilipp

ine

s

So

uth

Afr

ica

Ta

iwa

n

Ko

rea

Au

stra

lia

Me

xico

Po

lan

d

US

Ind

ia

Ho

ng

Ko

ng

Ge

rma

ny

Jap

an

Fra

nce UK

Sw

itze

rlan

d

Eu

rozo

ne

Cze

ch R

ep

Sa

ud

i Ara

bia

Conttributon toyear-to-date equity performance US$)

12m fwd PE change12m fwd EPS change12m fwd dividend yield

-2

0

2

4

6

8

10

12

14

16

18

20

22

So

uth

Afr

ica

Ind

ia

Me

xico

Sa

ud

i Ara

bia

Ph

ilipp

ine

s

Po

lan

d

Th

aila

nd

Au

stra

lia US

Ko

rea

Ca

na

da

Ho

ng

Ko

ng

Ta

iwa

n

UK

Cze

ch R

ep

Fra

nce

Ge

rma

ny

Eu

rozo

ne

Jap

an

Sw

itze

rlan

d

Historical

range

Latest 10-year yield

important factor behind the failure to generate faster

inflation has been the collapse in oil prices following

a shift in strategy by Saudi-led OPEC two years ago

As the Saudi‟s continue balance market share with a

transition to less oil dependence a low oil price

environment can be expected to continue for the

foreseeable future

As chart 16 shows much of the trend in US inflation

can be explained by the year-on-year change oil

prices Assuming oil prices remain at $45 or even

$50bbl for the next 12 months it would still be

difficult for inflation to exceed 2 for very long

Chart 16 US inflation set to accelerate even with little change in oil prices

Source Bloomberg Authorrsquos calculations

With monetary policy increasingly seen ldquopushing on

a stringrdquo and given the slower growth and weaker

demographic backdrop that is likely over the coming

years the threat of higher bond yields remains

unlikely to create the major headwind for equity

investors in the medium-term Indeed EM equity

markets stand to benefit the most from the hunt for

yield given an attractive EMDM bond yield spread

Bond yields and equities

Still from such a historically low level there is a

limit to how much further these rates can or will

move lower It is therefore important to understand

which markets have benefited the most from a falling

rate environment and hence will enjoy less benefit

from this trend in the future

Chart 17 compares the correlation between daily

rolling 10-year bond yields changes and 10-year

equity returns during 1990-2016 and since 2012 This

shows EM Asia Australia and the Czech Republic

in the top-right quadrant as the most consistent

beneficiaries from a rising rate environment In

contrast Mexico and Saudi Arabia have seen equities

benefit the most from a falling rate environment

The past few years has seen the biggest change in the

US and Developed European markets where growth

has become more disappointing As a result these

equity markets have benefited more from a rising rate

environment than was the case in past decades

Canada Hong Kong Poland South Africa and the

Philippines have been benefiting less from rising

rates than in the past A mixture of political risk and

sluggish growth now leaves these equity markets

especially vulnerable to a rising rate environment

Chart 17 Asia-Pacific and Developed Europe equities the biggest beneficiaries of higher bond yields

Source Bloomberg Authorrsquos calculations Correlation between 10-year change in

bond yields and 10-year annualised equity returns in US$ using daily data over the

period January 1990 (where possible) and July 2016

Conclusions

The Fed‟s ldquodovish tighteningrdquo approach to raising

rates is expected to continue over the coming

quarters which will give rise to some inevitable bouts

of volatility in both equities and fixed income

markets While spikes in yields can be expected the

overall move upwards will be gradual and hence

should not become a major headwind for risk assets

-3

-2

-1

0

1

2

3

4

5

6

-150

-100

-50

0

50

100

150

00 02 04 06 08 10 12 14 16

US inflation YoY change

(Right HS)

Brent oil YoY change

(Left HS)

Brent oil YoY change

if oil price next 12m $45bbl$50bbl

India

Japan

Hong Kong

Taiwan

Thailand

Czech Rep

Australia

Korea

PolandPhilippines

Canada

US

Saudi Arabia

SwitzerlandEurozone

Mexico

France

UK Germany

-50

-30

-10

10

30

50

70

90

110

-60 -40 -20 0 20 40 60 80 100

Equities consistently benefit

from rising yields

20

12

-20

16

co

rre

latio

n b

etw

ee

n e

qui

ties

an

d b

ond

yie

lds

1990-2016 correlation between equities and bond yields

Equities consistently benefit

from falling yields

Equities benefiting less

from rising yields since 2012

Equities benefiting more

from rising yields since 2012

S Africa

Conclusions

Improving demographics don‟t always result in faster

economic growth and improving economic growth

won‟t always lead to faster earnings growth This

makes forecasting 10-year equity returns especially

challenging given the ongoing structural changes

taking place in the global economy

What is increasingly clear is that markets will

continue to be driven by the hunt for yield and

growth Concerns over an ongoing sluggish recovery

post the 20089 financial crisis the limits to what

monetary and fiscal policy can achieve (on their own)

as well as a deteriorating demographic outlook all

stand to weigh on equity returns over the next decade

A direct consequence of this fragile macro backdrop

will be an even greater focus on markets that can

deliver growth and where rising bond yields are

supportive to equities

On the basis of these criteria India Mexico

Taiwan Thailand and the Philippines look the

strongest for the next decade

In contrast the US Canada Japan South Korea

and Switzerland look to be the weakest over a 10-

year horizon

A cornerstone of this debate is whether near-record low bond yields have become a symptom (aka ldquoJapanificationrdquo) or a cure (conventional monetary stimulus) of the uneven and disappointing global economic growth that has followed the 20089 financial crisis

Chart 18 Bond yield spread between top 5 and bottom 5 markets the highest in over a decade

Source Bloomberg Authorrsquos calculations Top 5 US Canada Japan South Korea and

Switzerland Bottom 5 India Mexico Taiwan Thailand and the Philippines Equal-

weighted baskets

Creating an equal-weighted basket of each group

highlights the potential for these markets to diverge in

the coming years Chart 18 shows how the move in

local currency bond yields over the past few years

reflects the disparity in 10-year outlook the spread

between the average yield of the top 5 and the bottom

5 is now close to the highest in a decade

While bond yields have diverged long-term equity

returns (as per the methodology shown in chart 6 on

p 5) for both groups have modestly converged

However chart 19 shows how the additional equity

return generated by the top 5 has stayed roughly

constant at an annualised 5 since 2013 even as the

bond yield differential has risen over the same period

Chart 19 Top 5 vs bottom 5 equity performance differential has stayed roughly unchanged since 2013

Source Bloomberg Authorrsquos calculations Equity return is average annualised 10-year

return in US$ using daily data since 1990 Top 5 US Canada Japan South Korea and

Switzerland Bottom 5 India Mexico Taiwan Thailand and the Philippines Equal-

weighted baskets

A continued hunt for yield that should ensure bonds

are well bid among the top 5 as well as the potential

growth disparity are both key long-term ingredients

that can help ensure equity performance differentials

between the top and bottom 5 widens further in

coming years

This relatively more constructive view on the top 5 is

reinforced by the scale of the decline in long-run

returns in excess of 10-year bond yields as shown in

chart 20

This highlights that equities returns have fallen faster

than the decline in bond yields since 2013 in both

groups but more so among the top 5 This leaves the

ldquoequity risk premiumrdquo (ERP) of the top 5 relative to

the bottom 5 at the lowest since 2008 Given the

potential for spread compression in bond yields there

0

1

2

3

4

5

6

7

8

9

01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

50

100

150

200

250

300

350

400Top 5 bond yields

(Left HS )

B ot t o m 5 bo nd yield s

(Left HS )

Top 5 bo t t om 5 d if erent ial

(Right HS bp)

-10

-5

0

5

10

15

20

25

30

01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

-15

-10

-5

0

5

10

15

To p 5 equit y ret urns

(Left HS )

B ot t om 5 equit y ret urns

(Left HS )

To p 5 bo t t om 5 d if erent ial

(Right HS bp)

is significant scope for this ERP differential to widen

much further in the coming years Until we reach the

levels last seen in 2010 the case for being structurally

overweight Emerging Markets and underweight

Developed Markets will remain in tact for both

equities and fixed income

Chart 20 Equity risk premium of the top 5 has fallen sharply relative to the bottom 5

Source Bloomberg Authorrsquos calculations Top 5 US Canada Japan South Korea and

Switzerland Bottom 5 India Mexico Taiwan Thailand and the Philippines Equal-

weighted baskets

Wesley Fogel

-10

-5

0

5

10

15

20

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

-15

-10

-5

0

5

10

15T o p 5 eq uit y ret urn

vs lo cal 10 yr b o nd yield

(Left HS )

T o p 5 equit y ret urn

vs lo cal 10 - yrbond yield

(Left HS )

Top 5 bo t t om 5 d if erent ial

(Right HS bp)

Wesley Fogel

Investment Strategist

Tel +44 7860 264 902

Email fogelhotmailcom

policy measures aimed at stimulating growth or from

reforms that manage to lead to an improvement in

potential growth Given the failure to achieve either

of these objectives for more than two decades in

Japan and for the past decade in Europe there

remains little cause for optimism especially given the

demographic headwinds already highlighted

Growth and equities

The comprehensive historical study of Dimson

Marsh amp Staunton finds little if any long-term

relationship between real equity returns and economic

growth6 Just as important is the price investors must

pay for this growth

As Chart 12 shows many of the Emerging Asia

economies that are expected to achieve some of the

fastest GDP growth in the coming years currently

trade at premiums to their respective 10-year average

Chart 12 European and US equity valuations look rich compared with EM Asia

Source Bloomberg Authorrsquos calculations IMF Daily 12-month forward PE data

However the US Canada Australia and developed

European markets also trade at similar premiums

despite a much weaker growth outlook leaving these

markets vulnerable to future derating Japan South

Africa and the Czech Republic which are expected to

see growth remain sluggish in the coming years

already show the biggest discounts

6 Triumph of the Optimists 101 Years of Global

Investment Returns Elroy Dimson Paul Marsh amp

Mike Staunton 2002

Contrary to the findings of Dimson et al slowing

global growth over the past decade has helped foster

an environment whereby faster earnings growth has

been rewarded with better equity returns Chart 13

shows how EM Asia has been the biggest beneficiary

of this trend while Europe Canada and South Africa

have been punished the most

Japan has been one of the biggest outliers as faster

earnings growth has failed to translate into better

equity performance The extent to which currency

weakness has provided support to earnings in the past

highlights the limited extent to which this approach

translates into sustained equity market performance

Chart 13 EM Asia has seen stronger earnings and equity performance over the past decade vs Europe

Source Authorrsquos calculations IMF

Conclusions

Equities remain vulnerable both in the medium-term

given the current late cycle stage of the global

economic cycle as well as over the long-term as

structural growth drivers become a headwind As a

result the equity investor will increasingly need to

focus on markets where growth and earnings delivery

are likely to be the strongest

While there isn‟t a proven relationship between

economic growth and earnings it is important to

observe that over the past decade equity markets in

countries with both faster GDP and EPS growth have

seen some of the best equity returns and currently

trade at some of the biggest valuation premiums

Mexico

South Africa

Saudi Arabia

India

Thailand

Poland

Australia

Taiwan

US

Philippines

Canada

Czech Rep

Switzerland

Eurozone

Korea

UK

Hong Kong

France

Germany

Japan

-35

-25

-15

-5

5

15

25

35

45

0 1 2 3 4 5 6 7

12

m

Fw

dP

E d

isco

un

tp

rem

ium

vs

10

-ye

ar

ave

rag

e)

Average annual GDP growth 2016-2021 est

Weak GDPexpensive equities Strong GDPexpensive equities

Weak GDPcheap equities

Mexico

South Africa

Saudi Arabia

India

Thailand

Poland

Australia

Taiwan

US

Philippines

Canada

Czech Rep

Switzerland

Eurozone

Korea

UK

Hong Kong

France

GermanyJapan

-2

0

2

4

6

8

10

12

14

-5 0 5 10 15 20

Strong EPSStrong equity performance

Weak EPS

Weak equity performance

Annualised equity total return 2006-2016

Ave

rag

e a

nn

ua

l EP

S g

row

th

200

6-2

01

6

Equity markets returns in 2016 have so far been

mostly driven by multiple expansion (see chart 14)

although positive earnings momentum has also

contributed towards this performance across most

major EMs (excluding Saudi Arabia and the Czech

Republic) The coming decade can be expected to see

the trend of rewarding earnings momentum with

stronger equity returns and higher premium continue

Chart 14 Multiple expansion has driven most of the gains in equity markets during 2016

Source Bloomberg Authorrsquos calculations Data until August 21th 2016

Government bond yields

Persistent doubts about the future path of benchmark

bond yields from record low levels presents a further

medium-term challenge for equity investors and helps

to explain much of the recent myopic shift in the

investment strategy process

Any upward or worse sudden normalisation would

put a higher discount rate underneath currently lofty

valuations highlighted in chart 12 on the previous

page while a decline from historically low levels

implies the further need to revise down growth

expectations threatening the equity market outlook

How long is a piece of string

It is almost exactly 35 years since US bond yields

peaked and the following structural decline was

initially accompanied by a number of benign trends

across many other Developed and Emerging Markets

as inflation slowed from double-digit levels

The turn of the century saw the biggest decline in EM

as a step-change in political and economic stability

heralded a period of stronger China-led growth and

slower inflation

The past decade has seen DM bond yields fall faster

as slower inflation has been accompanied by sluggish

global economic growth recently bringing negative

rates to an increasing number of countries

As a result the average 10-year yield among the 10

EMs studied in this report is now 36 less than 100

basis points from the average historical low DMs

now have an average yield of 06 only 16bp above

their multi-decade lows (see chart 15)

Chart 15 Global bond yields are close to record lows

Source Bloomberg Authorrsquos calculations Data from January 1990 where possible as

of August 21st 2016

The open desire of the US Federal Reserve to hike

rates over the coming quarters still goes against the

grain as the rest of the world moves towards even

looser monetary policy in 2016 and potentially

beyond So far this year 17 major central banks have

cut interest rates after 19 moved lower in 2015

Some EM central banks have been tightening policy

although this has usually been to defend its currency

and fend off faster inflation (eg South Africa and

Mexico) which further complicates the Fed‟s

objective given that it now explicitly acknowledges

global factors in its decision-making process

Indeed expanding QE and negative interest rates

failing to generate 2 inflation has brought the entire

inflation-targeting framework into question An

-10

-5

0

5

10

15

20

25

30

Th

aila

nd

Ca

na

da

Ph

ilipp

ine

s

So

uth

Afr

ica

Ta

iwa

n

Ko

rea

Au

stra

lia

Me

xico

Po

lan

d

US

Ind

ia

Ho

ng

Ko

ng

Ge

rma

ny

Jap

an

Fra

nce UK

Sw

itze

rlan

d

Eu

rozo

ne

Cze

ch R

ep

Sa

ud

i Ara

bia

Conttributon toyear-to-date equity performance US$)

12m fwd PE change12m fwd EPS change12m fwd dividend yield

-2

0

2

4

6

8

10

12

14

16

18

20

22

So

uth

Afr

ica

Ind

ia

Me

xico

Sa

ud

i Ara

bia

Ph

ilipp

ine

s

Po

lan

d

Th

aila

nd

Au

stra

lia US

Ko

rea

Ca

na

da

Ho

ng

Ko

ng

Ta

iwa

n

UK

Cze

ch R

ep

Fra

nce

Ge

rma

ny

Eu

rozo

ne

Jap

an

Sw

itze

rlan

d

Historical

range

Latest 10-year yield

important factor behind the failure to generate faster

inflation has been the collapse in oil prices following

a shift in strategy by Saudi-led OPEC two years ago

As the Saudi‟s continue balance market share with a

transition to less oil dependence a low oil price

environment can be expected to continue for the

foreseeable future

As chart 16 shows much of the trend in US inflation

can be explained by the year-on-year change oil

prices Assuming oil prices remain at $45 or even

$50bbl for the next 12 months it would still be

difficult for inflation to exceed 2 for very long

Chart 16 US inflation set to accelerate even with little change in oil prices

Source Bloomberg Authorrsquos calculations

With monetary policy increasingly seen ldquopushing on

a stringrdquo and given the slower growth and weaker

demographic backdrop that is likely over the coming

years the threat of higher bond yields remains

unlikely to create the major headwind for equity

investors in the medium-term Indeed EM equity

markets stand to benefit the most from the hunt for

yield given an attractive EMDM bond yield spread

Bond yields and equities

Still from such a historically low level there is a

limit to how much further these rates can or will

move lower It is therefore important to understand

which markets have benefited the most from a falling

rate environment and hence will enjoy less benefit

from this trend in the future

Chart 17 compares the correlation between daily

rolling 10-year bond yields changes and 10-year

equity returns during 1990-2016 and since 2012 This

shows EM Asia Australia and the Czech Republic

in the top-right quadrant as the most consistent

beneficiaries from a rising rate environment In

contrast Mexico and Saudi Arabia have seen equities

benefit the most from a falling rate environment

The past few years has seen the biggest change in the

US and Developed European markets where growth

has become more disappointing As a result these

equity markets have benefited more from a rising rate

environment than was the case in past decades

Canada Hong Kong Poland South Africa and the

Philippines have been benefiting less from rising

rates than in the past A mixture of political risk and

sluggish growth now leaves these equity markets

especially vulnerable to a rising rate environment

Chart 17 Asia-Pacific and Developed Europe equities the biggest beneficiaries of higher bond yields

Source Bloomberg Authorrsquos calculations Correlation between 10-year change in

bond yields and 10-year annualised equity returns in US$ using daily data over the

period January 1990 (where possible) and July 2016

Conclusions

The Fed‟s ldquodovish tighteningrdquo approach to raising

rates is expected to continue over the coming

quarters which will give rise to some inevitable bouts

of volatility in both equities and fixed income

markets While spikes in yields can be expected the

overall move upwards will be gradual and hence

should not become a major headwind for risk assets

-3

-2

-1

0

1

2

3

4

5

6

-150

-100

-50

0

50

100

150

00 02 04 06 08 10 12 14 16

US inflation YoY change

(Right HS)

Brent oil YoY change

(Left HS)

Brent oil YoY change

if oil price next 12m $45bbl$50bbl

India

Japan

Hong Kong

Taiwan

Thailand

Czech Rep

Australia

Korea

PolandPhilippines

Canada

US

Saudi Arabia

SwitzerlandEurozone

Mexico

France

UK Germany

-50

-30

-10

10

30

50

70

90

110

-60 -40 -20 0 20 40 60 80 100

Equities consistently benefit

from rising yields

20

12

-20

16

co

rre

latio

n b

etw

ee

n e

qui

ties

an

d b

ond

yie

lds

1990-2016 correlation between equities and bond yields

Equities consistently benefit

from falling yields

Equities benefiting less

from rising yields since 2012

Equities benefiting more

from rising yields since 2012

S Africa

Conclusions

Improving demographics don‟t always result in faster

economic growth and improving economic growth

won‟t always lead to faster earnings growth This

makes forecasting 10-year equity returns especially

challenging given the ongoing structural changes

taking place in the global economy

What is increasingly clear is that markets will

continue to be driven by the hunt for yield and

growth Concerns over an ongoing sluggish recovery

post the 20089 financial crisis the limits to what

monetary and fiscal policy can achieve (on their own)

as well as a deteriorating demographic outlook all

stand to weigh on equity returns over the next decade

A direct consequence of this fragile macro backdrop

will be an even greater focus on markets that can

deliver growth and where rising bond yields are

supportive to equities

On the basis of these criteria India Mexico

Taiwan Thailand and the Philippines look the

strongest for the next decade

In contrast the US Canada Japan South Korea

and Switzerland look to be the weakest over a 10-

year horizon

A cornerstone of this debate is whether near-record low bond yields have become a symptom (aka ldquoJapanificationrdquo) or a cure (conventional monetary stimulus) of the uneven and disappointing global economic growth that has followed the 20089 financial crisis

Chart 18 Bond yield spread between top 5 and bottom 5 markets the highest in over a decade

Source Bloomberg Authorrsquos calculations Top 5 US Canada Japan South Korea and

Switzerland Bottom 5 India Mexico Taiwan Thailand and the Philippines Equal-

weighted baskets

Creating an equal-weighted basket of each group

highlights the potential for these markets to diverge in

the coming years Chart 18 shows how the move in

local currency bond yields over the past few years

reflects the disparity in 10-year outlook the spread

between the average yield of the top 5 and the bottom

5 is now close to the highest in a decade

While bond yields have diverged long-term equity

returns (as per the methodology shown in chart 6 on

p 5) for both groups have modestly converged

However chart 19 shows how the additional equity

return generated by the top 5 has stayed roughly

constant at an annualised 5 since 2013 even as the

bond yield differential has risen over the same period

Chart 19 Top 5 vs bottom 5 equity performance differential has stayed roughly unchanged since 2013

Source Bloomberg Authorrsquos calculations Equity return is average annualised 10-year

return in US$ using daily data since 1990 Top 5 US Canada Japan South Korea and

Switzerland Bottom 5 India Mexico Taiwan Thailand and the Philippines Equal-

weighted baskets

A continued hunt for yield that should ensure bonds

are well bid among the top 5 as well as the potential

growth disparity are both key long-term ingredients

that can help ensure equity performance differentials

between the top and bottom 5 widens further in

coming years

This relatively more constructive view on the top 5 is

reinforced by the scale of the decline in long-run

returns in excess of 10-year bond yields as shown in

chart 20

This highlights that equities returns have fallen faster

than the decline in bond yields since 2013 in both

groups but more so among the top 5 This leaves the

ldquoequity risk premiumrdquo (ERP) of the top 5 relative to

the bottom 5 at the lowest since 2008 Given the

potential for spread compression in bond yields there

0

1

2

3

4

5

6

7

8

9

01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

50

100

150

200

250

300

350

400Top 5 bond yields

(Left HS )

B ot t o m 5 bo nd yield s

(Left HS )

Top 5 bo t t om 5 d if erent ial

(Right HS bp)

-10

-5

0

5

10

15

20

25

30

01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

-15

-10

-5

0

5

10

15

To p 5 equit y ret urns

(Left HS )

B ot t om 5 equit y ret urns

(Left HS )

To p 5 bo t t om 5 d if erent ial

(Right HS bp)

is significant scope for this ERP differential to widen

much further in the coming years Until we reach the

levels last seen in 2010 the case for being structurally

overweight Emerging Markets and underweight

Developed Markets will remain in tact for both

equities and fixed income

Chart 20 Equity risk premium of the top 5 has fallen sharply relative to the bottom 5

Source Bloomberg Authorrsquos calculations Top 5 US Canada Japan South Korea and

Switzerland Bottom 5 India Mexico Taiwan Thailand and the Philippines Equal-

weighted baskets

Wesley Fogel

-10

-5

0

5

10

15

20

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

-15

-10

-5

0

5

10

15T o p 5 eq uit y ret urn

vs lo cal 10 yr b o nd yield

(Left HS )

T o p 5 equit y ret urn

vs lo cal 10 - yrbond yield

(Left HS )

Top 5 bo t t om 5 d if erent ial

(Right HS bp)

Wesley Fogel

Investment Strategist

Tel +44 7860 264 902

Email fogelhotmailcom

Equity markets returns in 2016 have so far been

mostly driven by multiple expansion (see chart 14)

although positive earnings momentum has also

contributed towards this performance across most

major EMs (excluding Saudi Arabia and the Czech

Republic) The coming decade can be expected to see

the trend of rewarding earnings momentum with

stronger equity returns and higher premium continue

Chart 14 Multiple expansion has driven most of the gains in equity markets during 2016

Source Bloomberg Authorrsquos calculations Data until August 21th 2016

Government bond yields

Persistent doubts about the future path of benchmark

bond yields from record low levels presents a further

medium-term challenge for equity investors and helps

to explain much of the recent myopic shift in the

investment strategy process

Any upward or worse sudden normalisation would

put a higher discount rate underneath currently lofty

valuations highlighted in chart 12 on the previous

page while a decline from historically low levels

implies the further need to revise down growth

expectations threatening the equity market outlook

How long is a piece of string

It is almost exactly 35 years since US bond yields

peaked and the following structural decline was

initially accompanied by a number of benign trends

across many other Developed and Emerging Markets

as inflation slowed from double-digit levels

The turn of the century saw the biggest decline in EM

as a step-change in political and economic stability

heralded a period of stronger China-led growth and

slower inflation

The past decade has seen DM bond yields fall faster

as slower inflation has been accompanied by sluggish

global economic growth recently bringing negative

rates to an increasing number of countries

As a result the average 10-year yield among the 10

EMs studied in this report is now 36 less than 100

basis points from the average historical low DMs

now have an average yield of 06 only 16bp above

their multi-decade lows (see chart 15)

Chart 15 Global bond yields are close to record lows

Source Bloomberg Authorrsquos calculations Data from January 1990 where possible as

of August 21st 2016

The open desire of the US Federal Reserve to hike

rates over the coming quarters still goes against the

grain as the rest of the world moves towards even

looser monetary policy in 2016 and potentially

beyond So far this year 17 major central banks have

cut interest rates after 19 moved lower in 2015

Some EM central banks have been tightening policy

although this has usually been to defend its currency

and fend off faster inflation (eg South Africa and

Mexico) which further complicates the Fed‟s

objective given that it now explicitly acknowledges

global factors in its decision-making process

Indeed expanding QE and negative interest rates

failing to generate 2 inflation has brought the entire

inflation-targeting framework into question An

-10

-5

0

5

10

15

20

25

30

Th

aila

nd

Ca

na

da

Ph

ilipp

ine

s

So

uth

Afr

ica

Ta

iwa

n

Ko

rea

Au

stra

lia

Me

xico

Po

lan

d

US

Ind

ia

Ho

ng

Ko

ng

Ge

rma

ny

Jap

an

Fra

nce UK

Sw

itze

rlan

d

Eu

rozo

ne

Cze

ch R

ep

Sa

ud

i Ara

bia

Conttributon toyear-to-date equity performance US$)

12m fwd PE change12m fwd EPS change12m fwd dividend yield

-2

0

2

4

6

8

10

12

14

16

18

20

22

So

uth

Afr

ica

Ind

ia

Me

xico

Sa

ud

i Ara

bia

Ph

ilipp

ine

s

Po

lan

d

Th

aila

nd

Au

stra

lia US

Ko

rea

Ca

na

da

Ho

ng

Ko

ng

Ta

iwa

n

UK

Cze

ch R

ep

Fra

nce

Ge

rma

ny

Eu

rozo

ne

Jap

an

Sw

itze

rlan

d

Historical

range

Latest 10-year yield

important factor behind the failure to generate faster

inflation has been the collapse in oil prices following

a shift in strategy by Saudi-led OPEC two years ago

As the Saudi‟s continue balance market share with a

transition to less oil dependence a low oil price

environment can be expected to continue for the

foreseeable future

As chart 16 shows much of the trend in US inflation

can be explained by the year-on-year change oil

prices Assuming oil prices remain at $45 or even

$50bbl for the next 12 months it would still be

difficult for inflation to exceed 2 for very long

Chart 16 US inflation set to accelerate even with little change in oil prices

Source Bloomberg Authorrsquos calculations

With monetary policy increasingly seen ldquopushing on

a stringrdquo and given the slower growth and weaker

demographic backdrop that is likely over the coming

years the threat of higher bond yields remains

unlikely to create the major headwind for equity

investors in the medium-term Indeed EM equity

markets stand to benefit the most from the hunt for

yield given an attractive EMDM bond yield spread

Bond yields and equities

Still from such a historically low level there is a

limit to how much further these rates can or will

move lower It is therefore important to understand

which markets have benefited the most from a falling

rate environment and hence will enjoy less benefit

from this trend in the future

Chart 17 compares the correlation between daily

rolling 10-year bond yields changes and 10-year

equity returns during 1990-2016 and since 2012 This

shows EM Asia Australia and the Czech Republic

in the top-right quadrant as the most consistent

beneficiaries from a rising rate environment In

contrast Mexico and Saudi Arabia have seen equities

benefit the most from a falling rate environment

The past few years has seen the biggest change in the

US and Developed European markets where growth

has become more disappointing As a result these

equity markets have benefited more from a rising rate

environment than was the case in past decades

Canada Hong Kong Poland South Africa and the

Philippines have been benefiting less from rising

rates than in the past A mixture of political risk and

sluggish growth now leaves these equity markets

especially vulnerable to a rising rate environment

Chart 17 Asia-Pacific and Developed Europe equities the biggest beneficiaries of higher bond yields

Source Bloomberg Authorrsquos calculations Correlation between 10-year change in

bond yields and 10-year annualised equity returns in US$ using daily data over the

period January 1990 (where possible) and July 2016

Conclusions

The Fed‟s ldquodovish tighteningrdquo approach to raising

rates is expected to continue over the coming

quarters which will give rise to some inevitable bouts

of volatility in both equities and fixed income

markets While spikes in yields can be expected the

overall move upwards will be gradual and hence

should not become a major headwind for risk assets

-3

-2

-1

0

1

2

3

4

5

6

-150

-100

-50

0

50

100

150

00 02 04 06 08 10 12 14 16

US inflation YoY change

(Right HS)

Brent oil YoY change

(Left HS)

Brent oil YoY change

if oil price next 12m $45bbl$50bbl

India

Japan

Hong Kong

Taiwan

Thailand

Czech Rep

Australia

Korea

PolandPhilippines

Canada

US

Saudi Arabia

SwitzerlandEurozone

Mexico

France

UK Germany

-50

-30

-10

10

30

50

70

90

110

-60 -40 -20 0 20 40 60 80 100

Equities consistently benefit

from rising yields

20

12

-20

16

co

rre

latio

n b

etw

ee

n e

qui

ties

an

d b

ond

yie

lds

1990-2016 correlation between equities and bond yields

Equities consistently benefit

from falling yields

Equities benefiting less

from rising yields since 2012

Equities benefiting more

from rising yields since 2012

S Africa

Conclusions

Improving demographics don‟t always result in faster

economic growth and improving economic growth

won‟t always lead to faster earnings growth This

makes forecasting 10-year equity returns especially

challenging given the ongoing structural changes

taking place in the global economy

What is increasingly clear is that markets will

continue to be driven by the hunt for yield and

growth Concerns over an ongoing sluggish recovery

post the 20089 financial crisis the limits to what

monetary and fiscal policy can achieve (on their own)

as well as a deteriorating demographic outlook all

stand to weigh on equity returns over the next decade

A direct consequence of this fragile macro backdrop

will be an even greater focus on markets that can

deliver growth and where rising bond yields are

supportive to equities

On the basis of these criteria India Mexico

Taiwan Thailand and the Philippines look the

strongest for the next decade

In contrast the US Canada Japan South Korea

and Switzerland look to be the weakest over a 10-

year horizon

A cornerstone of this debate is whether near-record low bond yields have become a symptom (aka ldquoJapanificationrdquo) or a cure (conventional monetary stimulus) of the uneven and disappointing global economic growth that has followed the 20089 financial crisis

Chart 18 Bond yield spread between top 5 and bottom 5 markets the highest in over a decade

Source Bloomberg Authorrsquos calculations Top 5 US Canada Japan South Korea and

Switzerland Bottom 5 India Mexico Taiwan Thailand and the Philippines Equal-

weighted baskets

Creating an equal-weighted basket of each group

highlights the potential for these markets to diverge in

the coming years Chart 18 shows how the move in

local currency bond yields over the past few years

reflects the disparity in 10-year outlook the spread

between the average yield of the top 5 and the bottom

5 is now close to the highest in a decade

While bond yields have diverged long-term equity

returns (as per the methodology shown in chart 6 on

p 5) for both groups have modestly converged

However chart 19 shows how the additional equity

return generated by the top 5 has stayed roughly

constant at an annualised 5 since 2013 even as the

bond yield differential has risen over the same period

Chart 19 Top 5 vs bottom 5 equity performance differential has stayed roughly unchanged since 2013

Source Bloomberg Authorrsquos calculations Equity return is average annualised 10-year

return in US$ using daily data since 1990 Top 5 US Canada Japan South Korea and

Switzerland Bottom 5 India Mexico Taiwan Thailand and the Philippines Equal-

weighted baskets

A continued hunt for yield that should ensure bonds

are well bid among the top 5 as well as the potential

growth disparity are both key long-term ingredients

that can help ensure equity performance differentials

between the top and bottom 5 widens further in

coming years

This relatively more constructive view on the top 5 is

reinforced by the scale of the decline in long-run

returns in excess of 10-year bond yields as shown in

chart 20

This highlights that equities returns have fallen faster

than the decline in bond yields since 2013 in both

groups but more so among the top 5 This leaves the

ldquoequity risk premiumrdquo (ERP) of the top 5 relative to

the bottom 5 at the lowest since 2008 Given the

potential for spread compression in bond yields there

0

1

2

3

4

5

6

7

8

9

01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

50

100

150

200

250

300

350

400Top 5 bond yields

(Left HS )

B ot t o m 5 bo nd yield s

(Left HS )

Top 5 bo t t om 5 d if erent ial

(Right HS bp)

-10

-5

0

5

10

15

20

25

30

01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

-15

-10

-5

0

5

10

15

To p 5 equit y ret urns

(Left HS )

B ot t om 5 equit y ret urns

(Left HS )

To p 5 bo t t om 5 d if erent ial

(Right HS bp)

is significant scope for this ERP differential to widen

much further in the coming years Until we reach the

levels last seen in 2010 the case for being structurally

overweight Emerging Markets and underweight

Developed Markets will remain in tact for both

equities and fixed income

Chart 20 Equity risk premium of the top 5 has fallen sharply relative to the bottom 5

Source Bloomberg Authorrsquos calculations Top 5 US Canada Japan South Korea and

Switzerland Bottom 5 India Mexico Taiwan Thailand and the Philippines Equal-

weighted baskets

Wesley Fogel

-10

-5

0

5

10

15

20

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

-15

-10

-5

0

5

10

15T o p 5 eq uit y ret urn

vs lo cal 10 yr b o nd yield

(Left HS )

T o p 5 equit y ret urn

vs lo cal 10 - yrbond yield

(Left HS )

Top 5 bo t t om 5 d if erent ial

(Right HS bp)

Wesley Fogel

Investment Strategist

Tel +44 7860 264 902

Email fogelhotmailcom

important factor behind the failure to generate faster

inflation has been the collapse in oil prices following

a shift in strategy by Saudi-led OPEC two years ago

As the Saudi‟s continue balance market share with a

transition to less oil dependence a low oil price

environment can be expected to continue for the

foreseeable future

As chart 16 shows much of the trend in US inflation

can be explained by the year-on-year change oil

prices Assuming oil prices remain at $45 or even

$50bbl for the next 12 months it would still be

difficult for inflation to exceed 2 for very long

Chart 16 US inflation set to accelerate even with little change in oil prices

Source Bloomberg Authorrsquos calculations

With monetary policy increasingly seen ldquopushing on

a stringrdquo and given the slower growth and weaker

demographic backdrop that is likely over the coming

years the threat of higher bond yields remains

unlikely to create the major headwind for equity

investors in the medium-term Indeed EM equity

markets stand to benefit the most from the hunt for

yield given an attractive EMDM bond yield spread

Bond yields and equities

Still from such a historically low level there is a

limit to how much further these rates can or will

move lower It is therefore important to understand

which markets have benefited the most from a falling

rate environment and hence will enjoy less benefit

from this trend in the future

Chart 17 compares the correlation between daily

rolling 10-year bond yields changes and 10-year

equity returns during 1990-2016 and since 2012 This

shows EM Asia Australia and the Czech Republic

in the top-right quadrant as the most consistent

beneficiaries from a rising rate environment In

contrast Mexico and Saudi Arabia have seen equities

benefit the most from a falling rate environment

The past few years has seen the biggest change in the

US and Developed European markets where growth

has become more disappointing As a result these

equity markets have benefited more from a rising rate

environment than was the case in past decades

Canada Hong Kong Poland South Africa and the

Philippines have been benefiting less from rising

rates than in the past A mixture of political risk and

sluggish growth now leaves these equity markets

especially vulnerable to a rising rate environment

Chart 17 Asia-Pacific and Developed Europe equities the biggest beneficiaries of higher bond yields

Source Bloomberg Authorrsquos calculations Correlation between 10-year change in

bond yields and 10-year annualised equity returns in US$ using daily data over the

period January 1990 (where possible) and July 2016

Conclusions

The Fed‟s ldquodovish tighteningrdquo approach to raising

rates is expected to continue over the coming

quarters which will give rise to some inevitable bouts

of volatility in both equities and fixed income

markets While spikes in yields can be expected the

overall move upwards will be gradual and hence

should not become a major headwind for risk assets

-3

-2

-1

0

1

2

3

4

5

6

-150

-100

-50

0

50

100

150

00 02 04 06 08 10 12 14 16

US inflation YoY change

(Right HS)

Brent oil YoY change

(Left HS)

Brent oil YoY change

if oil price next 12m $45bbl$50bbl

India

Japan

Hong Kong

Taiwan

Thailand

Czech Rep

Australia

Korea

PolandPhilippines

Canada

US

Saudi Arabia

SwitzerlandEurozone

Mexico

France

UK Germany

-50

-30

-10

10

30

50

70

90

110

-60 -40 -20 0 20 40 60 80 100

Equities consistently benefit

from rising yields

20

12

-20

16

co

rre

latio

n b

etw

ee

n e

qui

ties

an

d b

ond

yie

lds

1990-2016 correlation between equities and bond yields

Equities consistently benefit

from falling yields

Equities benefiting less

from rising yields since 2012

Equities benefiting more

from rising yields since 2012

S Africa

Conclusions

Improving demographics don‟t always result in faster

economic growth and improving economic growth

won‟t always lead to faster earnings growth This

makes forecasting 10-year equity returns especially

challenging given the ongoing structural changes

taking place in the global economy

What is increasingly clear is that markets will

continue to be driven by the hunt for yield and

growth Concerns over an ongoing sluggish recovery

post the 20089 financial crisis the limits to what

monetary and fiscal policy can achieve (on their own)

as well as a deteriorating demographic outlook all

stand to weigh on equity returns over the next decade

A direct consequence of this fragile macro backdrop

will be an even greater focus on markets that can

deliver growth and where rising bond yields are

supportive to equities

On the basis of these criteria India Mexico

Taiwan Thailand and the Philippines look the

strongest for the next decade

In contrast the US Canada Japan South Korea

and Switzerland look to be the weakest over a 10-

year horizon

A cornerstone of this debate is whether near-record low bond yields have become a symptom (aka ldquoJapanificationrdquo) or a cure (conventional monetary stimulus) of the uneven and disappointing global economic growth that has followed the 20089 financial crisis

Chart 18 Bond yield spread between top 5 and bottom 5 markets the highest in over a decade

Source Bloomberg Authorrsquos calculations Top 5 US Canada Japan South Korea and

Switzerland Bottom 5 India Mexico Taiwan Thailand and the Philippines Equal-

weighted baskets

Creating an equal-weighted basket of each group

highlights the potential for these markets to diverge in

the coming years Chart 18 shows how the move in

local currency bond yields over the past few years

reflects the disparity in 10-year outlook the spread

between the average yield of the top 5 and the bottom

5 is now close to the highest in a decade

While bond yields have diverged long-term equity

returns (as per the methodology shown in chart 6 on

p 5) for both groups have modestly converged

However chart 19 shows how the additional equity

return generated by the top 5 has stayed roughly

constant at an annualised 5 since 2013 even as the

bond yield differential has risen over the same period

Chart 19 Top 5 vs bottom 5 equity performance differential has stayed roughly unchanged since 2013

Source Bloomberg Authorrsquos calculations Equity return is average annualised 10-year

return in US$ using daily data since 1990 Top 5 US Canada Japan South Korea and

Switzerland Bottom 5 India Mexico Taiwan Thailand and the Philippines Equal-

weighted baskets

A continued hunt for yield that should ensure bonds

are well bid among the top 5 as well as the potential

growth disparity are both key long-term ingredients

that can help ensure equity performance differentials

between the top and bottom 5 widens further in

coming years

This relatively more constructive view on the top 5 is

reinforced by the scale of the decline in long-run

returns in excess of 10-year bond yields as shown in

chart 20

This highlights that equities returns have fallen faster

than the decline in bond yields since 2013 in both

groups but more so among the top 5 This leaves the

ldquoequity risk premiumrdquo (ERP) of the top 5 relative to

the bottom 5 at the lowest since 2008 Given the

potential for spread compression in bond yields there

0

1

2

3

4

5

6

7

8

9

01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

50

100

150

200

250

300

350

400Top 5 bond yields

(Left HS )

B ot t o m 5 bo nd yield s

(Left HS )

Top 5 bo t t om 5 d if erent ial

(Right HS bp)

-10

-5

0

5

10

15

20

25

30

01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

-15

-10

-5

0

5

10

15

To p 5 equit y ret urns

(Left HS )

B ot t om 5 equit y ret urns

(Left HS )

To p 5 bo t t om 5 d if erent ial

(Right HS bp)

is significant scope for this ERP differential to widen

much further in the coming years Until we reach the

levels last seen in 2010 the case for being structurally

overweight Emerging Markets and underweight

Developed Markets will remain in tact for both

equities and fixed income

Chart 20 Equity risk premium of the top 5 has fallen sharply relative to the bottom 5

Source Bloomberg Authorrsquos calculations Top 5 US Canada Japan South Korea and

Switzerland Bottom 5 India Mexico Taiwan Thailand and the Philippines Equal-

weighted baskets

Wesley Fogel

-10

-5

0

5

10

15

20

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

-15

-10

-5

0

5

10

15T o p 5 eq uit y ret urn

vs lo cal 10 yr b o nd yield

(Left HS )

T o p 5 equit y ret urn

vs lo cal 10 - yrbond yield

(Left HS )

Top 5 bo t t om 5 d if erent ial

(Right HS bp)

Wesley Fogel

Investment Strategist

Tel +44 7860 264 902

Email fogelhotmailcom

Conclusions

Improving demographics don‟t always result in faster

economic growth and improving economic growth

won‟t always lead to faster earnings growth This

makes forecasting 10-year equity returns especially

challenging given the ongoing structural changes

taking place in the global economy

What is increasingly clear is that markets will

continue to be driven by the hunt for yield and

growth Concerns over an ongoing sluggish recovery

post the 20089 financial crisis the limits to what

monetary and fiscal policy can achieve (on their own)

as well as a deteriorating demographic outlook all

stand to weigh on equity returns over the next decade

A direct consequence of this fragile macro backdrop

will be an even greater focus on markets that can

deliver growth and where rising bond yields are

supportive to equities

On the basis of these criteria India Mexico

Taiwan Thailand and the Philippines look the

strongest for the next decade

In contrast the US Canada Japan South Korea

and Switzerland look to be the weakest over a 10-

year horizon

A cornerstone of this debate is whether near-record low bond yields have become a symptom (aka ldquoJapanificationrdquo) or a cure (conventional monetary stimulus) of the uneven and disappointing global economic growth that has followed the 20089 financial crisis

Chart 18 Bond yield spread between top 5 and bottom 5 markets the highest in over a decade

Source Bloomberg Authorrsquos calculations Top 5 US Canada Japan South Korea and

Switzerland Bottom 5 India Mexico Taiwan Thailand and the Philippines Equal-

weighted baskets

Creating an equal-weighted basket of each group

highlights the potential for these markets to diverge in

the coming years Chart 18 shows how the move in

local currency bond yields over the past few years

reflects the disparity in 10-year outlook the spread

between the average yield of the top 5 and the bottom

5 is now close to the highest in a decade

While bond yields have diverged long-term equity

returns (as per the methodology shown in chart 6 on

p 5) for both groups have modestly converged

However chart 19 shows how the additional equity

return generated by the top 5 has stayed roughly

constant at an annualised 5 since 2013 even as the

bond yield differential has risen over the same period

Chart 19 Top 5 vs bottom 5 equity performance differential has stayed roughly unchanged since 2013

Source Bloomberg Authorrsquos calculations Equity return is average annualised 10-year

return in US$ using daily data since 1990 Top 5 US Canada Japan South Korea and

Switzerland Bottom 5 India Mexico Taiwan Thailand and the Philippines Equal-

weighted baskets

A continued hunt for yield that should ensure bonds

are well bid among the top 5 as well as the potential

growth disparity are both key long-term ingredients

that can help ensure equity performance differentials

between the top and bottom 5 widens further in

coming years

This relatively more constructive view on the top 5 is

reinforced by the scale of the decline in long-run

returns in excess of 10-year bond yields as shown in

chart 20

This highlights that equities returns have fallen faster

than the decline in bond yields since 2013 in both

groups but more so among the top 5 This leaves the

ldquoequity risk premiumrdquo (ERP) of the top 5 relative to

the bottom 5 at the lowest since 2008 Given the

potential for spread compression in bond yields there

0

1

2

3

4

5

6

7

8

9

01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16

50

100

150

200

250

300

350

400Top 5 bond yields

(Left HS )

B ot t o m 5 bo nd yield s

(Left HS )

Top 5 bo t t om 5 d if erent ial

(Right HS bp)

-10

-5

0

5

10

15

20

25

30

01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

-15

-10

-5

0

5

10

15

To p 5 equit y ret urns

(Left HS )

B ot t om 5 equit y ret urns

(Left HS )

To p 5 bo t t om 5 d if erent ial

(Right HS bp)

is significant scope for this ERP differential to widen

much further in the coming years Until we reach the

levels last seen in 2010 the case for being structurally

overweight Emerging Markets and underweight

Developed Markets will remain in tact for both

equities and fixed income

Chart 20 Equity risk premium of the top 5 has fallen sharply relative to the bottom 5

Source Bloomberg Authorrsquos calculations Top 5 US Canada Japan South Korea and

Switzerland Bottom 5 India Mexico Taiwan Thailand and the Philippines Equal-

weighted baskets

Wesley Fogel

-10

-5

0

5

10

15

20

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

-15

-10

-5

0

5

10

15T o p 5 eq uit y ret urn

vs lo cal 10 yr b o nd yield

(Left HS )

T o p 5 equit y ret urn

vs lo cal 10 - yrbond yield

(Left HS )

Top 5 bo t t om 5 d if erent ial

(Right HS bp)

Wesley Fogel

Investment Strategist

Tel +44 7860 264 902

Email fogelhotmailcom

is significant scope for this ERP differential to widen

much further in the coming years Until we reach the

levels last seen in 2010 the case for being structurally

overweight Emerging Markets and underweight

Developed Markets will remain in tact for both

equities and fixed income

Chart 20 Equity risk premium of the top 5 has fallen sharply relative to the bottom 5

Source Bloomberg Authorrsquos calculations Top 5 US Canada Japan South Korea and

Switzerland Bottom 5 India Mexico Taiwan Thailand and the Philippines Equal-

weighted baskets

Wesley Fogel

-10

-5

0

5

10

15

20

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

-15

-10

-5

0

5

10

15T o p 5 eq uit y ret urn

vs lo cal 10 yr b o nd yield

(Left HS )

T o p 5 equit y ret urn

vs lo cal 10 - yrbond yield

(Left HS )

Top 5 bo t t om 5 d if erent ial

(Right HS bp)

Wesley Fogel

Investment Strategist

Tel +44 7860 264 902

Email fogelhotmailcom

Wesley Fogel

Investment Strategist

Tel +44 7860 264 902

Email fogelhotmailcom