Economic optimism points to rise in risk-taking

Five institutions are encouraged by underlying support for the global economy and see selective opportunities in equities and emerging markets in the Year of the Snake.
Economic optimism points to rise in risk-taking

Signs of improvement in the US labour and housing market and a pick-up in consumer sentiment are driving optimism that the global economic cycle may see an upturn in the Year of the Snake.

Here AsianInvestor summarises five core investment outlooks, with each house highlighting selective opportunities in equities and emerging markets.

Threadneedle Investments
Vanessa Donegan, head of Asia (ex-Japan) and global emerging market equities, points to a favourable backdrop for Asian equity markets, with economic growth across the region expected to pick up in 2013.

With monetary policy expected to remain accommodative and real interest rates to remain low or negative, that should support stocks markets particularly in Hong Kong, she says, where the HKMA is struggling to cope with upward pressure on the HK dollar peg amid strong inflows.

Threadneedle is ahead of consensus in terms of 2013 GDP growth forecasts for India (6.6%), South Korea (3.5%) and Taiwan (3.5%). In India it notes hopes that the softening inflation trajectory will continue and provide scope for a cut in interest rates in the first quarter this year.

The fund house suggests that the implementation of recently announced macroeconomic policy reforms in India should help to kick-start the corporate capital expenditure cycle.

But Threadneedle is 300 basis points below consensus on China GDP growth at 7.8%, with Donegan pointing to the fine balancing act that the country’s political leaders are now facing. They need to find a meeting point between economic growth and rebalancing the economy – meaning they are unlikely to deliver a meaningful fiscal stimulus in 2013.

The Asean economies of Thailand, Indonesia and the Philippines will likely see relatively strong growth in investment and consumption. Threadneedle forecasts a modest increase in Asian inflation (except India) in 2013, reflecting pressure from food prices and credit and wage growth in Asean.

Donegan argues that “bond proxy” stocks and areas such as consumer staples that have delivered consistent growth appear stretched, although where these stocks are backed by a sustainable dividend yield there will be investor interest.

As confidence in economic growth grows, she notes, the potential for a shift to stocks that stand to benefit could lead to a re-rating of quality cyclical companies in areas such as consumer discretionary and industrial sectors.

BNP Paribas
The French bank forecasts that Asia will be in a sweet spot among emerging markets in 2013. It may not be another year of 20% returns, but it sees a base case of 13% return from Asia (ex-Japan) equities predicated on about 10% earnings growth and a price/earnings (P/E) multiple of 13.3 times, against a long-term average of 14.5x.

It suggests five key themes for this year: central banks to continue to play a supportive role; growth in Asia is likely to be driven by China and India, with Korea and Taiwan lagging; the valuation convergence of China; moderate industrial recovery across the region; and market forces driving structural reforms.

BNP Paribas expects a moderate decline in earnings estimates, but lower than in 2011 and 2012. It says that exporting economies and global commodities could drive Asian earnings down by 3-4% from current estimates. But that still constitutes a 9-10% earnings growth in 2013 compared with around 3% in 2011 and 2012. 

On valuations, the bank notes that markets are cheaper than long-term averages on both P/E and price-book value (P/BV), more so on the latter. Comparing P/BV relative to return-on-equity (ROE) across sectors and markets, China and financials stand out as the cheapest country and sector. Healthcare and consumer staples are the most expensive.

As for sectors and stocks, BNPP's key overweights are financials, property, consumer discretionary, industrials and utilities. Its key underweights are consumer staples, materials and energy. The chief overweight markets are China, Hong Kong and India.

Its top picks in Asia are Samsung Electronics, AIA, Wharf Holdings and Mahindra and Mahindra. A slightly expanded focus list also highlights HSBC, Hyundai Motor, COLI and BPCL.

Northern Trust
Jim McDonald, chief investment strategist, expects risk-taking to be rewarded in 2013, but with risks appearing lower than at the start of 2012, the return potential is also likely more modest.

He expects volatility emanating from the European fiscal crisis to continue to moderate due to the ECB’s programmes and policy progress, with emerging markets set to benefit from gradually improving economic momentum.

Combining its expectations for growth and margins, it forecasts earnings growth of 5% in the US, 7% in emerging markets and 2% in developed markets (ex-US). “We think investors will be rewarded for allocating longer-term capital toward equities at the expense of their investment grade bond allocation,” he notes.

But McDonald sees limited upside in fixed income looking ahead. He points to muted inflationary trends in 2013, capping interest-rate pressures. He is more positive on corporate credit, while he sees mid-single digit return potential for high-yield debt over the next year as the higher current yields are partially offset by some modest spread widening.

Neuberger Berman
Portfolio managers and strategists at Neuberger Berman expect more muted macroeconomic concerns globally in 2013, allowing them to place greater emphasis on security and industry sector selection across asset classes.

Many of its equity managers favour global companies with meaningful operations in emerging countries. The firm notes that 60% of EM market cap is made up of locally driven stocks in sectors such as healthcare, consumer discretionary, consumer staples, utilities and industrials.

Their fundamentals are more insulated from a global slowdown. “We think investors may be well served by seeking targeted local exposure,” says a manager. “It’s possible to find domestic businesses offering sustainable growth and strong returns, trading at attractive valuations.”

Growth in the middle class in developing economies is seen as likely to drive demand for select consumer goods, as well as gas, oil and related infrastructure. It sees upside in inflation beneficiaries such as precious metals, agricultural commodities and speciality chemicals.

On the fixed income side, the firm sees diversification opportunities for investors willing to add incremental risk in high yield, bank loans, emerging market debt and residual loans.

It argues that conditions for US investment grade debt appear moderately favourable, with strong corporate fundamentals translating into balance sheets flush with cash, ample liquidity and low borrowing costs. It prefers areas not tied to global macro issues, including telecoms, food, beverage and tobacco.

Neuberger believes that high-yield debt and bank loan markets look healthy entering 2013, even after a multi-year run. “With spreads implying a significantly higher default rate than we believe is likely, there could be modest spread tightening in 2013 on top of what we consider an attractive coupon in a low interest-rate environment,” says Ann Benjamin, CIO for non-investment grade credit.

The bank notes the irony that while equity valuations moved up over the course of last year, and therefore would be not as attractive in 2013, on a relative basis they remain appealing as “safe-haven” bonds such as US Treasuries, UK Gilts and German Bunds continue to look unattractive.

It highlights that the European Central Bank’s bond-buying programme is a relief, but not a panacea. Neither is quantitative easing in the US. Emerging markets mostly remain in a relatively favourable position, despite stagnation in global trade. It forecasts that China will achieve 8-8.5% growth in 2013.

The bank has become more cautious on emerging market sovereign debt, noting that fund flows into the asset class remain supportive but credit quality shows signs of deterioration. Abundant supply and tighter spreads will constrain further spread tightening.

But it still sees attractive valuations for better quality corporate credits in investment grade and BB/B+ categories. The value of European fixed income is visible in high yield. The bank believes that 2013 will prove a very friendly environment for weak corporate credits.

HSBC also argues that equities offer compelling investment opportunities as part of a balanced portfolio. Equity valuations are attractive relative to their previous trading history in most regions, especially in cyclical sectors.

In terms of developed markets, it believes Japan, the US, UK, Italy, Netherlands and Australia look cheap from a price-to-book basis. For emerging markets, the bank names China, Malaysia and Thailand in Asia among its favoured global picks.

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