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Asset allocation: China, the emerging markets and global growth are the core concerns

The essential

In this article, we will explore the themes currently drawing our attention and prompting us to further protect our portfolios or establish protection plans. With regard to the macroeconomic scenario, three themes have come to the forefront in recent quarters. They are:

Theme #1: the growth of China and the shift toward a new growth model, accompanied by a very significant decline in potential growth.

Theme #2: the health of the emerging economies, damaged in the first instance by anticipations of an end to QE in the United States in 2013, the effective ending of the programme in 2014 and the correction of the excess flows that had entered these markets, followed by the decline in commodity prices and finally by China, along with fears of a shift in China's currency regime in 2015 and of monetary tightening in the United States.

Theme #3: global growth, which is gradually eroding due to growth revisions in the major emerging countries; we believe that growth in the developed countries will be more solid over the coming quarters, though we expect a slowdown in 2017.

In the absence of a crisis, the stronger growth prospects of the developed countries and the deteriorating prospects of the emerging countries, coupled with the risk of a continued slowdown in China, strengthen our conviction in our asset allocation. Nonetheless, the increasing risks—some of them systemic—require us to protect our positions.







Last month, we reviewed the components of our central scenario in addition to the main risk factors, namely a hard landing of the Chinese economy, monetary policy misjudgement by the Fed and the weakening of the emerging economies. Next month, we will publish a special edition with our outlook, strategies, forecasts and expected returns for 2016 and beyond. The forecasts and expected returns will be presented both for our central scenario and for all of the alternative risk scenarios.

In this article, we will explore the themes currently drawing our attention and prompting us to further protect our portfolios or establish protection plans.

With regard to the macroeconomic scenario, three themes have come to the forefront in recent quarters. They are:

Theme #1: the growth of China and the shift toward a new growth model, accompanied by a very significant decline in potential growth

China remains our core concern because a hard landing by its economy would lead to an additional wave of capital outflows from the emerging markets. Two crucial considerations should nonetheless be kept in mind:

  • What is happening in China is not particularly extraordinary. The problem is that it has not necessarily been correctly or fully "priced in". Indeed, it is normal for a country's growth and savings rate to diminish over the course of its development. All countries (the United States, European countries, Japan, South Korea, etc.) have gone through this. It is also normal for a country's potential growth to fall in line with declines in productivity gains and a shrinking working-age population. We have pointed out on numerous occasions—and it is a well-known fact—that demographics and productivity determine the bulk of potential growth. What is striking—and undoubtedly less well-known and certainly not priced in—is that China's potential growth has been cut in half in little over a decade. Though still not a rich country, China has the demographic problems of a developed country. It is already an "old country", suffering all of the problems of major stagnation, from unfavourable demographics to weaker productivity gains and a large debt burden.
  • China's domestic demand remains relatively strong. The source of concern is the fact that growth is diminishing and the composition of growth has changed. Indeed, China is in the process of shifting from an export-led model, in which exports serve as the main driver of growth, to an internal demand-led model fuelled by investment and consumption. In itself, this development is highly favourable for the global economy. But such a shift in growth models, and decline in potential growth, is however clearly not without its bumps in the road. And we are experiencing precisely such a process today.

Is China's growth ultimately headed to the 3-4% level? The answer is yes. Will it be at this level in 2015 and 2016? We believe it will not. Does China still have the means to maintain growth of around 6%? We believe it does. Is China's central bank in the process of orchestrating a major devaluation of the yuan? Certainly not, though the developments in August generated legitimate concerns. Will the shift in the growth model mentioned above continue moving forward? Absolutely. China's new normal is weaker, domestic demand-driven growth and potential growth of 3-4%.

Theme #2: the health of the emerging economies, damaged in the first instance by anticipations of an end to QE in the United States in 2013, the effective ending of the programme in 2014 and the correction of the excess flows that had entered these markets, followed by the decline in commodity prices and finally by the decline in China's growth, along with fears of a shift in China's currency regime in 2015 and of monetary tightening in the United States.

The emerging markets decline is not a new development. For some time now, these markets have also been the topic of many of our internal discussions. The essential question is when—now, or later—to re-enter this asset class.

In any event, the factors behind the capital outflows from these markets have been well established:

  • QE in the United States generated significant capital flows as investors sought out avenues for growth and returns. The emerging markets commodities and drew in investors beyond expectations. According to some estimates, over 20% of the liquidity generated by the Fed flowed into the emerging markets.
  • Unsurprisingly, once anticipations of an end to QE took hold, the downturn in the emerging markets was immediate. And the downturn intensified once the Fed effectively ended its unconventional programme.
  • The slowdown in China, visible as early as 2011 through indicators of fuel and electricity consumption, prolonged this trend, which was further intensified as oil prices plummeted. With the slowdown in China, excess production, exploration and operating capacities over the past 15 years, shale oil in the United States (US crude production up 65% in five years), Canada's oil sands, the new geopolitical situation in Yemen and the decision by Saudi Arabia to abandon its role of guarantor of oil prices, the situation resembles that of 1985-1986, when the price of oil fell by more than 50%. For countries whose exports and fiscal revenues are sensitive to oil, the result is paralysis, as in the case of Venezuela, an inevitable drop in current account (Russia, Bahrain, Nigeria...) and budget surpluses (Oman, Venezuela, Saudi Arabia, Azerbaijan...) or a deterioration of existing deficits.
  • The economic slowdown and fall in oil prices resulted in an across-the-board slump in commodity prices, impacting countries like Brazil and Russia.
  • The movement in the yuan in August of this year led to a new round of depreciation by all of the emerging currencies.
  • The prospect of monetary tightening by the Fed, stage two of the post-QE plan, weakened many countries, especially those sensitive to interest rates.
  • What is the new normal for the emerging countries? Unfortunately, there can be no comprehensive answer given this segment's fragmentation. It is easy to demonstrate that geographic proximity alone cannot justify investment decisions. There is no more of an Asia bloc, Europe bloc or Latin America bloc as there is an emerging countries bloc as a whole. The capacity to generate independent growth, the  relation to commodities (producers vs. consumers), the level of potential growth (productivity gains and the growth of the working-age population) and debt sustainability have become essential criteria for categorising this grouping of countries. This is what the new normal looks like for the emerging countries. But while the emerging countries do not constitute a bloc under "normal" conditions—in the absence of a crisis, the investment criteria listed above exert significant influence—the same cannot be said of crisis situations, when all markets and all currencies are impacted. Needless to say, the past two months have been proof of this.

Theme #3: global growth, which is gradually eroding due to growth revisions in the major emerging countries; we believe that growth in the developed countries will be more solid over the coming quarters, though we expect a slowdown in 2017.

In any event, global growth is the third topic of discussion at our asset allocation meetings. It should be borne in mind than Amundi is among those with below-consensus views with regard to many macroeconomic outlooks. Overall global growth is an important factor, but its composition is even more so.

In the space of two years, our forecast shifted from 3.8% to 2.9%. The bulk of this downward revision took place in 2014. For the past year, our forecast on world growth lies around 3%. It is important to recall this revision was fully attributable to the emerging economies, primarily China, Russia and Brazil. For the rest, particularly the US and Europe, our forecasts were revised upward.

In the absence of a crisis, the stronger growth prospects of the developed countries and the deteriorating prospects of the emerging countries, coupled with the risk of a continued slowdown in China, strengthen our conviction in our asset allocation, which:

  • favours risky assets;
  • favours search for yield;
  • employs equity themes such as (i) dividends (low interest rate environment); (ii) consumers (Europe & US: low long-term rates, low oil prices, purchasing power, wages and employment; Europe: credit cycle; China: transition to a more consumption-based model); (iii) the recovery in Europe and Japan and the more mature cycle in the United States; and (iv) regional characteristics (buybacks, M&A and earnings per share in Japan and Europe);
  • is overweight on European equities in a priority, followed by Japan;
  • is overweight on European vs. US equities;
  • is overweight on US bonds vs. the European core;
  • is overweight on corporate credit vs. sovereign credit in the core countries;
  • employs interest rate themes such as search for spreads and yields;
  • no longer applies any particular preference on high yield vs investment grade in Europe;
  • employs forex themes such as search for value: commodity currencies (Canadian dollar, Norwegian krone and some EMG currencies) and other undervalued currencies such as the yen;
  • no longer wagers substantially on a continued depreciation by the yen (long positions on Japanese equities gradually de-hedged over the past three months);
  • is underweight on emerging assets, equities and debt instruments alike, with investments having been highly selective for quite a long time: commodity-consuming countries capable of independent growth—not highly reliant on China today, not highly reliant on the developed countries yesterday—and equipped with credible economic policies, political stability and moderate debt denominated mainly in local currency, etc.;
  • is underweight on commodity currencies and commodity-producing countries;
  • no longer substantially incorporates the possibility of a further weakening of the euro: the improved economic health, the Fed's decreased willingness to hike its rates and the current accounts situation now serve to reinforce the euro's resilience;

This asset allocation represents minimal change since 2014, apart from the themes employed. It should be emphasised nonetheless that numerous risks are causing concern on the financial markets, and these are far more systemic in nature than Greece or European elections. These risks are summarised in the table below. Note that all these risks are not independent.



All of these concerns are legitimate. Putting aside their probability—which is difficult to quantify—their consequences would be so significant that asset allocation and macro-hedging activities must take them into account.

Increasing long-term exposure to US Treasury bonds and German Bunds makes sense in terms of protecting the portfolios from risks 2, 3, 4 and 5.

Going long on volatility makes perfect sense in scenarios 1, 2, 3 and 4.

Increasing the liquidity of portfolios is in line with risks 1, 2 and 3.

Going long on the USD is useful in scenarios 2, 3, 4 and 5.

Going long on the JPY is appropriate in scenarios 2, 4 and 5.



Three major themes: China, the emerging economies and global growth




What is happening in China is not extraordinary, but neither is it adequately priced in









From the end of QE to lower oil and commodity prices, the position of the Fed, the slowdown in China and the situation of the yuan, the situation is ripe for an emerging markets downturn




In an increasingly fragmented emerging bloc, good investment opportunities exist—in the future




More than overall global growth, the composition of global growth is crucial








Developing and implementing macro-hedging strategies makes perfect sense in the current environment








Equity portfolios

Bond portfolios

Diversified portfolios

  • Beta of portfolio around 1
  • Prefer Eurozone and Japan.
  • Neutral on the US.
  • Emerging markets: country selection is key within emerging markets:
    - Overweight India, Gulf countries, Russia, Thailand, Peru and Mexico.
    - Neutral on Brazil, China, Indonesia, Korea.
    - Underweight Malaysia, Taiwan, Chile, Colombia, Greece, Turkey.
  • Maintain overweight position in credit. No major call between IG and HY.
  • Risk budget reduced on risky assets.
  • Yield curves flattening trades.
  • Preference for US vs. core Eurozone.
  • Emerging debt:
    - Prefer hard currencies debt (long USD),
    - Prefer local debt only on a case by case basis,
    - Play thematics on EMG,
  • Maintain long USD and GBP,
    short JPY and EUR.
  • Prefer Eurozone, then Japanese to US equities.
  • India our favourite amongst EMG equities...
    Cautious on emerging markets.
  • Additional caution on corporate bonds (positions reduced in the past months).
  • Keep overweight position on sovereign bonds of peripheral Eurozone countries vs. core (i.e. Germany).
  • Duration increased.
  • Maintain the flattening position on US yield curve.
  • Reduce positions on emerging debt in hard currencies.
  • Long USD vs. EUR.


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ITHURBIDE Philippe , Senior Economic Advisor
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Asset allocation: China, the emerging markets and global growth are the core concerns
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