Forget Bric and Asia ex-Japan equities – invest in Japanese stocks and non-Japan Asia short-duration bonds. So says Alain Bokobza, global head of asset allocation at Société Générale in Paris, who spoke to AsianInvestor while he was in Hong Kong recently.
China and India look set to overheat, he argues, thanks both to policy-makers in Beijing and elsewhere in Asia ex-Japan being “behind the curve” on tightening monetary policy and to the US’s quantitative easing (QE) measures.
In a report released on January 20, the French bank argues that People’s Bank of China policy rates should be 250 basis points higher than they are, leading to the emergence of two possible policy paths.
China is dealing with the side-effects of its own version of quantitative easing: Rmb16.5 trillion in bank lending (equivalent to more than 50% of GDP) over the past two years, says the report, The dragon which played with fire.
“The PBoC is right to step up quantitative measures to target liquidity directly via hikes of its reserve requirement ratios and, possibly, a lower loan quota for next year,” it says.
The consequences of being behind the curve on this front, says Bokobza, are that inflation and equity valuation contraction are already “at play” in China.
One scenario he foresees is that by trying to use these non-traditional policies, the Chinese authorities will let the economy overheat even more in a few quarters time than it is today. “And that will bring a fear of recession, as the more you are going to overheat,” says Bokobza, “the more you need to tighten later on and the more this triggers the fear of a bad scenario.”
There’s also a general view that India, with double-digit inflation already, is overheating, and Brazil is in a similar position, he says, suggesting Russia is “the only Bric that is safe” and has the best expected returns of the four.
Moreover, adds Bokobza, Bric equities are a “very tired, overplayed and expensive way to get access to emerging-market growth” and proposes switching out of them to other countries, including back to the US.
Japanese stocks, in particular, look attractive, he argues. Since the middle of last year, Bokobza has favoured being underweight non-Japan Asia equity markets and overweight the Nikkei 225 and non-Japan Asia bonds.
“I love Japan as an equity market – you get access to Asian growth, which is good and remains good. Inflation would, of course, be a dream for Japan; we’ve been waiting for 20 years. And it is coming.”
“We know Asian currencies are going up, and I don’t understand why people are playing equities [to capture that appreciation],” he adds. “I much prefer to buy short-duration bonds, which provide the yield as well as access to the expected tightening process, which means support for the currency.”
In addition, he recommends buying Asian domestic companies rather than international ones, thereby switching out of export-led to domestic-led growth. “A rising currency is good for domestic players,” he adds.
As for the US’s second round of QE, Japan equities would be the biggest likely beneficiary, as it is having the desired effect – as far as the US is concerned – on other Asian economies.
“Looking at politics, many are reading QE2 as an economic event, but I read it as a political event,” says Bokobza. “The US doesn’t need new liquidity – the US economy and financial markets were already very liquid. So my reading of the new $600 billion due by 2011 is designed as a policy to trigger currency appreciation as much of the new liquidity injection goes into Asia, due to the lack of yield on US assets such as Treasuries.”
He adds that what diplomacy has not achieved as a target over the past three years – following Western countries complaining about the massive under-valuation of non-Japan Asian currencies – QE2 is delivering results very fast and very successfully.
Other firms are taking mixed views on emerging markets. Lombard Odier, like Bozobka, advises caution on EM equities but also bonds.
Paul Marson, chief investment officer at the Swiss private bank, argues that the current liquidity cycle is maturing, given the tightening process in emerging markets. As a result, he says, investors should rotate away from emerging-market bonds and equities in favour of developed-market assets, of which developed equities should outperform in relative terms.
But Dutch asset management firm Robeco recommends selective “strategic and tactical overweights” on emerging markets in global equity portfolios. In a recent outlook, it agrees with Bozobka’s favourable view on Russia and recommendations to underweight India.
Meanwhile, Bozobka is bullish on global equities, which have risen in the past two years, and he sees them continuing to do so.
“Central bankers remain keen to provide liquidity to the economy and the financial sector, where some institutions remain very weak in terms of liquidity,” he says. “These factors alone are enough, with risky assets being not that expensive, to make it the third year running when equities will deliver.”
He notes that 2009 was a record year for global equities after the collapse, they were up 10% in 2010, and forecasts a third straight year of gains this year, with a 10-15% return.
Meanwhile, like other sell-side firms such as MF Global, SG has been building up its research team in Asia in recent months. The team is headed by Guy Stear, who moved to Hong Kong in September as head of Asia-Pacific research and credit research. He was previously deputy head of sector research in Paris.
Heading FX strategy for Asia-Pacific is Cliff Tan, who joined in September from Stanford University, where he was consulting professor. He also previously headed Asia local market strategy at Citi.
Two others joined in October. Joseph Lau is senior Asia economist, having moved from Credit Suisse, where he was North Asia economist, and Asia commodity strategist Jeremy Friesen came from Morgan Stanley.