Grantham Mayo Van Otterloo & Co (GMO) has increased its forecast returns for emerging market equities, as the asset allocation team predicts the market is overestimating the long-term impact of the trade war between the US and China, while falls in US equities are expected to deepen.
According to the investment firm's Q4 seven-year asset class real return forecasts, emerging markets continue to offer the best value across both equities and fixed income.
Emerging market equities are expected to return 3.2% on an annual basis, an upgrade from the 2% forecast made in Q4 2017, while GMO has predicted emerging market debt to deliver annual returns of 2.2% over the next seven years, higher than the 0.4% forecast made in Q4 last year.
Meanwhile, the firm expects US large-cap equities to fall 5.2%, more than the team's estimates of 4.4% made in Q4 last year and making the spread between US and EM equities the widest since 2003.
Tommy Garvey (pictured), a member of GMO's asset allocation team, said the reason for the wide spread between the two asset classes was due to relative valuations and sentiment about the escalating trade tensions between the US and China.
Emerging markets have had a torrid time amid trade war concerns and a strengthening US dollar, with the MSCI Emerging Markets index falling 10.8% in sterling terms this year to 31 October 2018, versus a rise of 7.4% for the S&P 500 and 3.4% for the MSCI World, according to FE.
"Emerging markets face challenges but fundamentally they look fine," Garvey said. "The poor performance has been driven by trade wars, which we think is overdone.
"It is more sentiment-related than having any fundamental long-term impact," he continued. "There is unlikely to be a winner and the fact US equities were rampant through to September, when the country was involved in a trade war, seemed perverse."
Additionally, US small caps are expected to drop 2.1% on an annual basis, according to the forecasts, while US ‘high-quality' stocks will fall 4.7%.
On the fixed income side, US bonds will produce zero returns annually over the next seven years and US cash will deliver 1%, up 0.8 percentage points from Q4 2017, according to the forecasts.
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