The key theme which is driving markets at the moment is sovereign debt overhang, the need to reduce that overhang in the medium term, and fears of what that process means for economic growth and whether that creates a new normal or a new paradigm.
From my perspective, this theme is sticky and will dominate for years to come. However, there are two roads from here: deleveraging or devaluation. The problem with deleveraging is that it creates deflation and the lesson of Japan is that this doesn't solve a debt problem, it makes it worse. Instead, the debt overhang is best solved by devaluation - exactly what the US and the UK have been doing with their quantitative easing programmes and the ECB is now doing by the back door with its long term refinancing operation.
If you reduce the value of money then you also reduce debt to GDP. The way to play this theme of devaluation is to seek out real returns - think commodities (ones people use, not gold), infrastructure because of its inflation linked cash flows, and emerging market currencies because of their positive real interest rates which are in marked contrast to developed currencies. Avoid developed market government bonds because they deliver negative real returns, preferring high yielding credit that still offers meaningfully positive real yield.
On the flip side, my belief is that Asian and emerging market currencies are likely to appreciate because they have no debt overhang. This creates a wealth effect - emerging market incomes buy more because they are denominated in a strengthening currency. This wealth effect is likely to create a consumption boom in emerging markets so within equities you should look for thematic plays on emerging market consumption, particularly for Brazil where there is already a wealth effect and China where there will be. There is also a strong case for agricultural producers.
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