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Broadgate: Weekly Briefing 16/6

16th June 2014

Emerging Market Debt – Investors poured money into emerging market debt funds last week as expectation of the European Central Bank’s monetary easing sent them in search of higher-yielding markets.

At its monetary policy meeting on 5 June, the ECB unveiled aggressive measures designed to stimulate the eurozone economy and fight off the threat of deflation across the currency bloc.

The central bank took the unprecedented step of introducing negative interest rates on deposits, in addition to reducing its benchmark interest rate from 0.25% to 0.15% and offering a package of cheap long-term loans to banks. ECB president Mario Draghi also suggested that further stimulus could be unveiled in future.

Data from fund flow analyst EPFR Global shows that emerging market bond funds witnessed their strongest weekly inflow of the decade during the week ending 4 June, taking $2.1bn in fresh money.

The analyst says the move took place as investors anticipated that the ECB would loosen policy and that this would be “really good news” for emerging market bonds.

Trends – The amount of private wealth held by households rose by 14% last year, fuelled by rising stock markets.

According to a report by the Boston Consulting Group, wealth held in equities rose 28%, leading to gains in all regions surveyed.

Asia Pacific excluding Japan led the rises, up 31% to $37tn. By 2018, the region will overtake the U.S. as the world’s largest wealth market, the report said.

The number of millionaire households in dollar terms rose to 16.3m, up from 13.7m in 2012.

The number of millionaires in China rose by more than half, surpassing the number in Japan as the yen fell sharply against the dollar.

China – China has announced new measures aimed at bolstering its economic growth.

These include plans to build railways, roads and airports along the Yangtze River, which connects China’s less developed inland provinces to Shanghai.

Meanwhile, China’s central bank said it will encourage banks to lend more to exporters to boost shipments.

The moves, the latest in a series of steps taken in recent weeks, come amid concerns over a slowdown in China’s economy, the world’s second-largest.

China’s economy expanded by 7.4% in the January-to-March period, from a year ago, down from 7.7% growth in the final quarter of last year.

After years of robust expansion, China has seen its growth rate slow in recent years, in part due to a slowdown in demand for its exports from key markets.

India – India’s new government has unveiled a programme for rapid economic reforms aimed at creating jobs and boosting foreign investment.

The announcement by President Pranab Mukherjee included plans designed to simplify taxation and reduce inflation. Industrial reforms included attracting private investment to the coal and defence sectors.

He also spoke of India’s hopes for good relations with neighbours and pledged to tackle violence against women.

The President’s parliamentary address was made to lawmakers elected in Prime Minister Narendra Modi’s landslide victory last month.

Mr Mukherjee said that the government would introduce a general sales tax, encourage foreign investment and speed up approvals for major business projects. It would also tackle bottlenecks that make India’s food inflation the highest among major economies.

Japan – Investors are again warming to Japanese equities due to cheap valuations, a shake-up in the domestic investment market, and rising inflation.

Japanese equities have struggled this year, with the Nikkei 225 dropping more than 7% between January and February following 2013’s steep rise, while a higher sales tax introduced in April also triggered investor concern.

But multi-managers and wealth managers are now taking advantage of low valuations to add to their positions. In particular, they are reacting to inflation, which rose at the fastest pace for 23 years in April.

The past week has been a key one for Japanese data, with the core consumer price index 3.2% higher in April than the same time last year: the highest level since 1991. The consumer price index as a whole was up 3.4%.

It marks nearly a year since the country broke out of its deflationary cycle, and represents a boost for Prime Minister Shinzo Abe, who made inflation targets a key policy.

Spotlight on: The opportunities from decaying demographics?

Peter Kirkman, manager of the JPM Global Consumer Trends fund, explores what Japan’s ageing population and the rapid emergence of Asia’s middle class means for investors.

Access to the JPM Global Consumer Trends fund is available via the HIL JPM Global Consumer Trends fund (MC142/MC142(S2).

Over the last 50 to 60 years, China has been one of the most successful countries in reaping the ‘demographic dividend’. China, and other countries like it, have taken advantage of a youthful, growing population and a favourable working age-to-dependent ratio to drive economic transformation. This has lifted millions of rural poor out of a subsistence existence and allowed them to reach rising levels of affluence.

However, as in the case of Japan, demographics can also be a headwind. Failure by Japan to supplement this age-related dividend with greater labour participation of women and a relaxation of immigration controls has left the country facing a demographic time bomb of a rapidly ageing population.

Rapid growth

But deteriorating demographics present opportunities too.

Globally, the fastest growing population segment is the over 60s, with the number of people in this age group expected to almost triple, to two billion by 2050. This has the potential to put a huge burden on society in future years, a fact not lost on European governments who have very recently had their fiscal viability scrutinised.

Austerity measures in Europe have brought about new regulations that promote higher generic drug use (as opposed to more expensive branded drugs), which has traditionally been low in the region.

Teva Pharmaceutical, the largest generic manufacturer in the world, is a company which is benefiting from greater generic penetration. Allergan is another healthcare company benefiting from shifting demographics. The company has a significant Botox business which, while primarily addressing aesthetic needs, also remedies ailments such as muscle stiffness and migraines.

The huge level of innovation has led to the biotechnology sector being one of the best performers over the last 18 months. New drugs have been developed for multiple sclerosis, age-related macular degeneration and cholesterol reduction.

Demographic shift

The Brookings Institution estimates that two billion people can be classified as middle class today.

By 2030, Asia alone will be home to three billion middle class people, and the global middle class will be approaching five billion, 90% of which will come from what we today consider emerging market countries.

Figuring out how this growing and increasingly wealthy group wants to spend its money is key to understanding good long-term investments. For example, discretionary spending patterns will shift as a newly empowered class of consumers gains purchasing power.

Aspirational brands

Targeting ‘aspiration’ among emerging world consumers can be done by owning stocks such as Burberry, LVMH and Kering. Many of these stocks have been sharply de-rated over the first three months of the year reflecting concerns about emerging market inflation and slowing growth. Increased luxury goods consumption by an expanding middle class is a multi-decade theme underappreciated by markets at present.

Emerging market banks, which will provide the credit to fund the increased consumption and growth brought on by the rise of the middle class consumer, are also a good bet. Indian financials such as Yes Bank, Federal Bank and ICICI are interesting names at the moment.

Credit penetration remains very low in India and the earnings growth potential for these banks over the next 10 to 15 years is exceptional vs. developed market peers. Current valuations more than compensate for the inherent risks of operating in these markets.

Demographics

The information set out herein has been obtained from various public sources and is by way of information only. Broadgate Financial can accept no liability of any sort in relation thereto and readers should obtain their own verification of any statement before making any decision which may have any financial or other impact.

Neither the information nor the opinions herein constitute, or are they to be construed as, an offer or a solicitation of an offer to buy or sell investments.

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