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My new report attempts to integrate the key secular geopolitical, political and social trends with the underlying fundamentals of the most significant global economies and financial markets to produce a very rough roadmap for the next decade. This was a relatively easy task in the immediate aftermath of the GFC and eighteen months later when I wrote a report in December 2010 for Deutsche Bank, predicting many years of underperformance for emerging market equities and other so-called alternative assets such as hedge funds and commodities. 

The best decision then would have been to load up with US equity index funds, my recommendation being S&P (though NASDAQ would have been a better choice) and then go away and do something more interesting with your life, other than think about investment for the next ten years or so. 

Since the GFC, the underlying strengths of the widely despised US economic and financial model have been belatedly recognised by investors and market commentators, leading to massive outperformance by US equities. In contrast, emerging market equities relatively poor performance mainly reflects the structural flaws in sovereign and corporate governance, which were present but mainly overlooked in 2007-10 amidst widespread investor enthusiasm.

The situation now is very different to 2010, as it’s difficult enough to take a six-month view, let alone look ahead ten years. There is no longer any obvious candidate among the major equity markets that combines investor disgust with a sound underlying investment case. Instead, US equities have moved into the hubris phase of the cycle, with exceptionally high valuations on all measures except the Fed model, driven by record levels of retail participation. Other global markets have fared less well, but have mostly still generated robustly positive returns in USD once dividend payments are added back. 

At this point in the bull market, the majority of investors are focused on monetary and more technical mainly short-term factors, at the expense of the underlying social and political secular trends that are a critical driver of market cycles. With the exception of the currency volatility around the eurozone crisis in 2010 and Brexit in 2016, financial markets in developed economies have generally shrugged off the underlying political and broader governance concerns, which have become increasingly evident since the GFC. 

However, growing social and economic imbalances together with shifting demographic trends, mean that this is unlikely to be the case for very much longer, so that developed markets equities face the prospect of a lost decade or more, similar to that experienced by their emerging markets peers following the peak in 2007-08. 

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It is difficult to make a strong case for any of the major equity markets to exhibit the sort of secular outperformance that the US has managed over the past twelve years. 

The US appears to be most extended in terms of valuations and the dominance of momentum driven money, however it is not facing such severe economic and political headwinds compared with Europe and China, over 2022 at least. Earnings from overseas which comprise around one third of total S&P earnings appear vulnerable to weak economies in Europe and China, while longer term, companies are also likely to face increased tax and regulatory intervention.

Still, some of the best global opportunities will be found among innovative US small and mid-cap stocks given falling correlations with the main benchmarks, so it’s worthwhile to take the time to identify active managers with credible research who specialise in this area of the market.

There is no obvious macro case for buying European equities other than the hope that they may prove more defensive than their US peers in the event of a severe market correction. Europe is much more exposed than the US to geopolitical risks, an ageing workforce, higher natural gas prices and the slowdown or worse in China. 

Despite the emollient initial statements emanating from the new German coalition, the EU could face a major internal schism as the Franco-Italian alliance seeks to impose and institutionalise higher deficits and inflation on Northern Europe. Immigration from the developing world remains a toxic political issue even compared with the US, despite the increasingly obvious labour shortages in Europe (including the UK). 

Granted, European equities appear cheaper than their US peers, but much of this advantage dissipates once differences in the sector composition are taken into account. Nor do European markets have anything like the depth of the US in terms of small and mid-caps or companies that specialise in technological innovation.

The UK market is now virtually irrelevant to non-British investors other than as a dividend paying machine, which might offer some downside protection, although sterling once again appears vulnerable as the incumbent Conservatives continue their plunge down the opinion polls in the face of rising prices, their inability/unwillingness to control immigration and in-fighting over the botched implementation of Brexit.

Japan is more interesting, with equities trading at a discount to their global peers even on a sector adjusted basis and also to the Japanese market’s own 15-year history, as foreign investors have generally been underweight. Unlike the US, valuations have not matched the recovery in Japanese corporate earnings while the yen looks cheap relative to other major global currencies. 

The political backdrop is more stable than in the US or Europe, given far lower inflation and a near consensus to address labour shortages through the application of technology rather than immigration. One obvious vulnerability is Japan’s exposure to the faltering Chinese economy so it might be better to wait until the outlook there becomes clearer. There are plenty of value plays outside the technology sector compared with other major global markets, but investors will have to be patient as there are no obvious catalysts in the offing.

The strategic outlook for positive absolute and relative returns from EM equities remains poor, mainly due to the jeopardy facing the Chinese economy and financial sector. Although the current round of stimulus efforts might generate a brief sugar rush in the financial markets, an increasing proportion of the proceeds will prop up potentially insolvent industrial companies and local governments, along with economically unviable infrastructure projects. While the current issues in the interbank market are unlikely to be the start of a systemic crisis, they are indicative of the growing fragility of the Chinese economy and financial system, due to the build-up of moral hazard and Beijing’s failure to implement market-oriented reforms.

Notwithstanding the prospects for a truce in the US/China trade dispute, more systemic areas of difference will deepen the estrangement between the West and the China/Russia axis to an extent that will partially reverse the post-1991 settlement and impose costs upon all of the major global economies. As the political and economic systems of these two blocs continue to diverge, there will be increasing pressures on institutions to divest from the West’s major antagonists for political and ESG related reasons, with Marco Rubio’s recent letter to MSCI most likely the start of a key shift in the mindset of US policymakers, so index based investment in EM will no longer be a viable strategy.

At present, the Kremlin appears to be in a position to determine the presidential succession in 2024. In the first two of five scenarios highlighted in the full report, Putin is either able to select his own successor or else manages to change the constitution by adopting the Belarus or more likely the Kazakh variant, in order to retain power himself. There is however evidence of increasing rivalry within the Russian elite which might result in a contested succession, while pressure for a change from below will rise if the Russian authorities fail to address issues such as service delivery, corruption and above all the big drop in real household incomes.  

The current consolidation of power, assets and rents around the Kremlin establishment with the siloviki seemingly in the ascendant, is likely to lead to a further redistribution of assets and cement the estrangement from Western countries, companies and investors. The continuing expansion of the role of the state in the economy as the central part of the shift towards a more Autarkic Governance Regime, bodes ill for future productivity and economic growth. The further blurring of boundaries between the private and state sectors means more moral hazard and possibly greater hidden financial risks, given the increasingly opaque financing structures.   

Following the US move against Huawei, China’s reliance on the goodwill/self-interest of the US and its allies has become even clearer. Without access to Western components and technology, Beijing’s strategy of moving up the value-added chain to surmount the middle-income transition becomes much harder. Over the past two years, China has also started to depend upon inflows of money from overseas portfolio investors as external surpluses dwindle. However, the rising weighting of Chinese onshore listed bonds and equities in the most widely followed benchmarks appears increasingly anomalous as direct investors start to de-integrate China from their global supply chains.

Notwithstanding the likelihood of a tactical rally if there is a partial settlement to the trade and/or Huawei disputes, the longer term prospects for investors in the Chinese equity market(s) remain bleak due to i) slower productivity growth and rising debt levels driving a further deterioration in economic growth possibly leading to a significant financial event; ii) the Chinese authorities increasingly mobilising all available resources to head off such an event including those under the nominal control of the listed corporate sector; iii) the accumulation of significant moral hazard in the corporate and financial sector exacerbating the impact of a poor economy; iv) the possibility of more US sanctions and other measures against Chinese companies; v) the prospects for further weakness in the renminbi due to falling confidence and a looming dollar shortage.