Opportunities to outperform, but clouds on the horizon

Most respondents expect the outlook for the global economy to improve over the next 12 months, although, among this group, a larger proportion expects the pace of recovery to slow. This is likely to reflect concerns about recent shocks, including the political unrest in the Middle East and the earthquake in Japan, as well as fears about rising inflation.

There is a consensus that there are opportunities available in financial markets, but many investors are reluctant to make bold moves in light of major downside risks. But for 48% of respondents, the current environment provides more opportunities than usual to outperform the market. In contrast to the “risk on, risk off” environment of 2010, asset selection is expected to be a crucial determinant of investors’ returns over the coming year.

Emerging markets offer the best prospects, although there are concerns about overheating

According to respondents, emerging markets offer the best prospects for economic and asset-price growth. But there are also concerns that these markets could be overheating and that investors may be putting too much faith in them as a source of long-term stable growth. Investment in companies in the developed world with strong exports to emerging markets may offer investors another attractive way to take advantage of these growth opportunities.

Developed-world growth, particularly in the US, rebalances global economic growth

A more balanced global economic growth profile is expected, with the US in particular expected to make a stronger contribution than in recent years. This may help to offset slowing economic growth in emerging markets. The US is expected to benefit from an enhanced competitive
position, while strong capital expenditure from US corporations may be an underestimated source of growth.

Commodities offer good growth prospects, but will be a risky asset class

Respondents think that the industries that offer the best growth rates are those that involve commodities: oil and gas; agriculture and agribusiness; and mining and metals. Commodities are also regarded as offering very positive prospects for asset-price growth, but, again, there are concerns about overheating; commodities are viewed as being the asset class where bubbles are most likely to form and are seen as
the most risky asset class over the next 12 months. Policy tightening in the emerging markets may, however, slow down economic growth in these markets, and prevent commodity overheating.

The world is facing increased geopolitical risk and investors are concerned about rising inflation and the impact on social stability

Geopolitical risk has become a hugely important investment issue and one that is often underestimated by financial markets. In particular, there are concerns about the impact of rising food and commodity prices on economic and political stability. Respondents expect that central banks in emerging markets will need to continue their tightening of monetary policy in order to curb inflation. They also think that high prices could cause riots and unrest in some emerging markets. These factors are all expected to have a negative impact on portfolios, particularly unrest caused by rising food and commodity prices. Higher interest rates may not have a big impact on inflation, however, as inflationary pressures are, in many markets, food-related.

Ongoing concerns in the Eurozone, although monetary union should withstand the shock

The crisis in the Eurozone continues to deepen, with Portugal joining Greece and Ireland on the list of countries that have required emergency financial assistance from the European Commission. Respondents and interviewees questioned for this report agree that default of a Eurozone country is looking increasingly likely, although few expect that this will ultimately lead to the break-up of the Eurozone. Investors, for the most part, are steering clear of the peripheral markets.

A rebound for the banking industry, but tighter regulation looms, and there are concerns about the insurance sector

The prospects for the financial sector appear mixed. Although a significant minority of respondents expects that the government will sell off its remaining holdings in the financial sector, they also expect that new regulation will cause a dramatic drop in profitability. Within the financial sector, respondents think that investment banking, a leveraged play on economic growth, offers the best prospects for growth. This is likely to reflect a rebound in mergers and acquisitions (M&A) activity, along with the potential for fees from corporate and sovereign capital-raising. There is much less confidence in the prospects for growth from insurance, which is likely to reflect concern about the cost to the industry from natural catastrophes, including the earthquake and tsunami in Japan.

Further political unrest in the Middle East—lessons for investors

There is clear consensus among the respondents that there will be further political unrest in the Middle East. With the battle over Libya still unresolved, and continuing unrest in Syria, Yemen and Bahrain, respondents expect instability in the region to become even more
prevalent over the next 12 months. Indeed, among the scenarios considered in this report, it is widely seen as the most likely to take place. The lesson for investors is that they need to look more closely at countries that have “stagnant political regimes”, where socio-economic problems remain unaddressed and where an outwardly stable regime could prove brittle.

Challenges to global governance are hampering the recovery

If the financial crisis brought major economies together, the recovery appears to be driving them apart. A common theme from the scenarios is a lack of confidence in multilateral decision-making. A number of scenarios related to global governance are seen as extremely unlikely. For example, few expect there to be a formation of a single worldwide accounting standard, while there are low expectations for agreement on a global accord to replace the Kyoto Protocol, or a globally agreed solution to the “too-big-to-fail” problem. Yet, if solutions to these problems—and particularly the Doha round of trade negotiations—could be found, the resultant effect would be extremely positive, according to respondents.