Current market sentiment seems to be at a crossroad and moves by global central banks are telling a different story than we are seeing in market prices. Assuming the current state of affairs holds true, embarking on a trail of more QE by Japan and a potential asset purchase program in Europe, the global economy will be able to pull itself from the disinflationary spiral we have seen in the past year. Should this occur the current state of asset prices, specifically real assets will come center stage as inflation starts to increase. This will cause a rethink on where to apply capital and what assets are able to outpace the rate of inflation and look attractive after interest rate increases.
This will lead to real assets being a choice class on many fronts. The rebuilding of infrastructure, resource acquisition, and inflation hedging will all become key support cases. What investors will look for is a generation of cash while having the ability to maintain pricing power in the global marketplace, many popular asset classes to date can't retain those conditions in a higher rate, higher inflation environment. Some of these asset classes will see more profound outflows than others and the shift from current allocations to the end state will have many tests and shocks along the way. This is why the move to real assets will be a measured one and will provide fertile ground to start a vine strategy to play out these markets moves.
Stocks: With stock markets near all time highs the relative success of overall markets will come down to the amount of real assets that the indices hold. This will leave some sectors doing better than others and could see developing markets (especially energy intensive ones) outpace the developed world. Sectors that have seen rallies based on hot money (QE money) could see selloffs unless Europeans and Japanese investors feel the same way about these investments. The energy sector, and utilities should see a renewed interest as stimulus starts to increase the demand for oil and gas to power the recovery, however supply side issues still prevail.
Bonds: Bonds have long been a beneficiary of QE and the subsequent volatile markets that have come from the end of stimulus. This has pushed hard currency bonds down to record lows in volatile times and a narrowing of spreads on all bonds in sanguine times. This trend supported US treasuries during the 3 quantitative easing cycles and could look the same for Japan and Europe. This time around that may not be the case as tightening will be starting to take place in countries such as the US and England. Unlike when the US was conducting QE, there will be more attractive assets abroad for Japan and Europe to buy with their increased liquidity. To diversify out of these positions investors can put money into real assets or emerging markets which provide a real return.
Commodities: Recently commodities have been shunned by many, with oversuppy meeting dropping demand. This has led major commodities to drop in value leading to negative annual return for sectors such as energy and metals for 5 years running. These declines are despite geopolitical tensions, sanctions on Iran and Russia, and a total shutdown of nuclear reactors in Japan. Much of the pressure on energy prices comes from the US shale boom, and the slowdown in China has depressed industrial metals prices.
Real Estate: The real estate market has seen a recovery in most parts of the world yet there is still attractive yields to be had in the sector. In terms of income generation REITs can provide a good source of revenue, even in a rising rate environment. While rates are set to rise in the US they are expected to be slow and calculated, in other countries that look set to stay low for some time. So long as the rate in which interest rates rise remain manageable REITs can provide good income generation that will be able to keep pace with expected interest rates.
Currencies: Currencies will depend on the current makeup of the economy. A commodity producing economy will no doubt see growth, inflation, and interest rates increase as a result of higher commodity prices and therefore see the currency rise. The real question is which currency to fund in. The Euro and the Yen are obvious candidates with perhaps the Dollar should the government look to stem recent strength (this is obviously a contrarian play and does not seem to be on investors radar at the moment). Longer term the currencies that become the recipients of excess liquidity from Japan, Europe, and even China will be the winners.