Buy commodities, avoid long-tenor EM bonds: HSBC
HSBC Global Asset Management is bullish on emerging markets, but urges caution over how to play them. The firm’s global head of macro and investment strategy, Philip Poole, told AsianInvestor why on a recent trip to Asia.
The larger emerging markets such as the Brics are all trading on forward multiples below their historical averages, particularly Russia, he says. Moreover, while the Brazilian real is fully valued if not overvalued, the renminbi, rupee and most other Asian currencies are significantly undervalued, which is another significant reason to own emerging markets.
Poole is particularly positive on currencies because he believes the interest-rate differential between emerging and developed markets is likely to continue to widen, with the former tightening faster than the latter. The US Federal Reserve and the Bank of England are likely to keep rates on hold for several more months, he points out, while inflation “has probably surprised policymakers in emerging markets with its severity”.
He suggests playing emerging-market currency appreciation through stock or currency exposure. “I would be less positive on local bond markets – particularly due to duration risk – because I think in some cases they haven’t properly priced-in inflation,” he says. Hence he recommends tenors shorter than five years.
Still, globally, HSBC Global AM likes corporate bonds, since, in the developed world, corporates have been deleveraging over the past 10 years, while governments have been raising leverage. For example, US debt-to-GDP has risen by more than 70%, notes Poole, whereas corporates have slashed their debt and have big cash piles.
But sovereign debt is a different matter. He believes US Treasury yields, for example, will rise further and that there’s a risk of a repricing of the entire fixed-income market.
“The debate [over US debt] is going to be very public,” Poole says. “The risk is that it leads to a sharp correction in Treasuries and a correction in the rest of the fixed-income market as well. If it’s going to happen, it will happen in the next six to 12 months.”
In Europe, the problems are already “out on the table”, he notes, but in the US and Japan there’s been little attempt to deal openly with the underlying debt dynamics. “That will have to change.”
There’s a question of whether local-authority debt across the board is higher than has been reported, says Poole. However, in China, for example, the authorities hold huge amounts of assets, whereas in Europe and the US they don’t.
The US Fed owns government debt, which doesn’t really count as assets the same way as those owned by the Chinese government, he says. “We shouldn’t lose sight of that fact.”
Still, China needs to do more to deal with inflation, so another rate hike will come, along with probably more reserve requirement hikes, Poole says, arguing that markets should welcome this tightening rather than worry about it.
So what’s his take on the European debt crisis?
Core eurozone economies are buying time to work against their debt issues, he notes, adding that there are two schools of thought around this. One is that in two years’ time banks will be in much shape and thus much better able to deal with debt problems. The other is that if the situation is not dealt with appropriately now, contagion risks will increase and will be harder to deal with down the line.
However it plays out, he adds, the workout in Greece will be a very difficult process; it’s a long-term issue, not something that will be solved in six or 12 months.
“I don’t think the euro is doomed, because the political commitment is so strong,” says Poole. But the single currency is certainly compromised. “The cat’s out of the bag, with all these issues at large and the focus on the risk of not getting the fiscal house in order.”
“We already knew the problems: monetary union without fiscal union has been the main issue for Greece, Ireland and Portugal,” adds Poole. “They were able to borrow on very good terms, and they borrowed too much,” he says. “To sustain the euro, it will be imperative to move more towards fiscal union, in line with the German perspective.”
Turning to commodities, Poole is bullish on prices in the long term, largely because of issues such as urbanisation in markets like China and India.
The growth in construction and consumption that will be spurred by urbanisation will be very commodity-intensive, he says, both in terms of hard and soft commodities. And whereas high commodity prices would normally be expected to have led to new and increased supplies, that hasn’t happened, and is unlikely to happen until 2013. That’s because of cancellation of investment projects in the sector – for example, more than $200 billion worldwide of investments in iron ore, coal and copper were cancelled or postponed due to the recent crisis.
Meanwhile, the next thing to worry about, says Poole, will be global water supplies; that will be a “massive issue” in the next 10 years. Producing beef and other edible produce requires a lot of water, hence rising demand for meat, for example, will put yet more pressure on the water supply, he notes.