As it stands, Asian governments, faced with the threat of inflation, have started to normalise fiscal and monetary policies. China, in particular, has moved fairly aggressively to curb the rapid rise of real estate prices. In contrast, those in the West have been fairly content to retain stimulatory policies - at least until Europe's sovereign debt crisis erupted. Beginning with what seemed like a peripheral problem, the continent - and the world - was sucked into a spiral of anxiety as sovereign solvency fears spread beyond Greece. Efforts by EU policy-makers appear to have successfully stabilised the contagion.
On the other hand, medium-term worries about an over-leveraged global economy are probably warranted. Public debt in the developed world has ballooned as governments deploy massive amounts of fiscal stimulus to prop up economic activity. Fiscal deficits are starting to reach unsustainable levels that necessitate spending cuts that are likely to be a drag on economic growth, especially in the industrialised nations, for many years to come. Still, the effects of such fiscal tightening are unlikely to be felt immediately and may well be overcome eventually by gathering momentum in the global recovery.
Indeed, emerging markets, especially in Asia, are likely to continue to grow strongly, and that seems to be underscored by China's move to allow greater flexibility in the yuan exchange rate. While actual latitude for yuan appreciation has been fairly limited and gradual, the policy change seems to signal that policy-makers are at least more confident about the outlook for the domestic economy. In addition, monetary tightening in Asia may be delayed. Europe's sovereign debt problems are likely to prompt policy-makers to be a tad more circumspect about global growth, and hold off raising rates until later in the year, or even next year. In the US, momentum from the first half of the year is expected to be sufficient to keep activity growing through the rest of the year, albeit at a more moderate pace. Unsurprisingly, Europe is set to bring up the rear. Growth is expected to be sluggish as fiscal tightening is expected to be a significant drag even into 2011.
Current price-earnings valuations seem to imply a brutal double dip in which the economy contracts even more than in 2008-009, down one per cent in nominal GDP terms in both 2011 and 2012. Even in such a severe scenario, corporate earnings would be expected to grow more than 10 per cent in 2010, before declining 10 per cent in 2011 and 2 per cent in 2012 - much less than the 56 per cent plunge in 2008-09.
Still, it could take some time for markets to realise that a double dip is not a probable scenario and that corporate earnings are likely to be more resilient if it does happen. In the meantime, volatility is likely to persist, calling for nimble toes - and fingers, while an uneven recovery warrants judicious market selection and stock-picking. These moments of volatility may yield good trading opportunities - and are unlikely to derail the fundamentally bullish long-run outlook for emerging markets. Even if China, and Asia overall, prove unable to escape the cycle of bubble, these economies remain well-placed to continue strong growth over the next few decades. Against this backdrop, emerging markets remain preferred over developed ones, as investors are likely to recognise their strong economic fundamentals and keep capital flowing into these more vibrant markets. Among the developed markets, the US is looking the most attractive, buoyed by robust economic momentum of its economy.
In conclusion, balancing risk to opportunity is going to be key to portfolio performance where equity markets are expected to remain volatile and range-bound for at least the rest of the year. Even though we remain optimistic about the long-term prospects for emerging markets, especially in Asia, and remain cyclically positive on the US, events in Europe do present significant short-term threats to the recovery. In this scenario, it is even more important to ensure that diversification and regular risk assessments remain a fundamental anchor to ensure balanced growth in one's portfolio in these interesting times.