With global economic growth now gaining steam, stock markets are expected to have a solid year, according to global portfolio managers and strategists.

Although the performance of equities won’t be as spectacular as it was in 2013, returns averaging 7%-10% are likely, portfolio managers predict, and astute stock-picking could push the return higher for individual clients. This outlook is based on global economic growth reaching 3.2%-3.5% compared with the estimated 3% in 2013.

Meanwhile, with long-term interest rates on the upswing, the returns on fixed-income investments will be on the decline. This means your clients will run less risk by increasing the equities portion of their portfolios.

Value-style portfolio manager Don Reed, president and CEO of Toronto-based Franklin Templeton Investments Corp., is finding plenty of opportunities in equities – including in Europe, a market that makes many portfolio managers nervous. “Europe is in infinitely better shape,” Reed says, “and its companies have a lot of cash that they have to spend or give back to shareholders.”

Charles Burbeck, co-head of global equity portfolios with UBS Global Asset Management (U.K.) Ltd. in London, also is digging into Europe by taking “big bets” on stocks in the periphery countries. He finds companies in Spain, including banks, the most interesting because they are bigger and more liquid than stocks in other beaten-down markets, such as Greece.

Furthermore, Burbeck advises buying European banks before the results of European Central Bank-ordered stress tests are released in the autumn. The authorities understand the need for strong banks, he says, so he doesn’t think the results will be as “severe” as is priced into current valuations.

The eurozone is expected to post positive economic growth this year, but only by 0.5%-1%. And the region is not out of the woods yet because there’s no clear plan to bring sovereign debt in the periphery countries to sustainable levels. As a result, there’s a decided preference among some portfolio managers for global multinational exporters whose valuations have been beaten down because of their location rather than because of their financial results or prospects.

Next: Stock-picking will be essential
Stock-picking will be essential

Stock-picking will be essential in sectors or regions that are out of favour, such as resources and emerging markets.

Global growth is not expected to be strong enough to push up resources prices, which means those resources companies that increase production or lower costs are likely to see share price appreciation. However, there also are some service providers and chemical companies that could do well.

Emerging markets have seen an outflow of money due to the rise in U.S. long-term interest rates, which has brought down equities valuations. This is likely to continue, as investments in these markets are seldom core in portfolios.

Nevertheless, a few portfolio managers are increasing their exposure to emerging markets because of the low valuations – although, Burbeck says, it might be better to wait for a year to invest. Valuations are expected to be driven down further as money exits these regions as a result of the increase in U.S. long-term rates.

However, Steven Way, senior vice president and portfolio manager, global equity funds, with AGF Management Ltd. in Toronto, warns that some of the decline in valuations in emerging markets is justified because it comes from deterioration in return on invested capital and margins.

The prospects for equities prospects in industrialized countries are much better. Many portfolio managers are overweighted in the U.S., where economic growth is accelerating. The only caveat is that the U.S. equities market is fully valued for the most part, so there could be some downward corrections. In light of this possibility, it would be advisable for your clients to have cash that can be invested after such a correction.

There also is some enthusiasm among portfolio managers for investing in Japan, mainly because of the momentum from the policy-induced decline of the yen, which is enhancing profits for exporters. However, investments should be hedged against the yen because the value of Japan’s currency is still dropping, which will reduce returns when translated into Canadian dollars.

Regarding fixed-income investments, portfolio managers suggest that duration be kept short. Long-term interest rates are trending upward, decreasing the value of existing bond holdings, and short-term rates also will rise at some point, although perhaps not until 2016.

Many portfolio managers recommend high-yield bonds, including emerging-market debt, to enhance returns, arguing that with global growth accelerating, the risk of defaults is dropping. But investment in high-yield securities should be kept to only 5%-10% of clients’ portfolios.

However, several portfolio managers hold a bleaker view of overall economic prospects for this year. For example, Ross Healy, chairman of Strategic Analysis Corp. in Toronto, and Nandu Narayanan, chief investment officer at Trident Investment Management LLC in New York, both say another global credit crisis is possible in the next few years.

If that turns out to be the case, stock-picking is both important and needs to be focused on safe, dividend-paying firms rather than on growth opportunities. Gold bullion would be favoured once again, as well as government bonds, particularly of solvent countries such as Canada, Australia, Norway and Sweden.

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