Equities a buy despite risk of macro blow-up: BlackRock

Andrew Swan highlights an environment of low valuations in Asia combined with loosening monetary conditions. But Schroders underlines macro worries.
Equities a buy despite risk of macro blow-up: BlackRock

Now’s the time to invest in Asian equities on valuation grounds, notably Chinese stocks, argues BlackRock, even as rivals warn of a potential macroeconomic blow-up.

The world’s largest asset manager with $3.67 trillion noted this week that Asian companies had seen their earnings forecast revised down 20% to date this year amid a slide in China’s GDP growth rate (7.4% in the third quarter).

Such negative sentiment has filtered down to 2013 earnings expectations. But while this has created pressure on regional equity valuations, it coincides with rate cuts taken by central banks in the region, including China, which are expected to underpin earnings and drive valuations.

“Loosening monetary conditions across the region should drive an uptick in industrial production, spurring economic growth,” Andrew Swan, head of Asian fundamental equities at BlackRock, told a media briefing this week. “Historically, this is the type of environment where Asian equities should perform strongly.”

The People’s Bank of China (PBoC) has cut its interest rates twice this year, trimming 25 basis points of the one-year deposit rate in July just a month after another 0.25bp cut.

This easing marked the first time that China had cut its rates since 2008, indicating growing anxiety in Beijing over the decline in the country’s economic growth rate.

Still, such action appears to have had a positive impact on the real economy, with HSBC’s Flash China Manufacturing PMI hitting a 13-month high of 50.4 this month, indicating expansion.

Swan said defensively positioned investors should take a second look at Chinese equities, pointing to the earnings potential of companies versus current valuations.

“If we go back five years, the Chinese equities market traded at 30 times price-to-earnings (P/E) ratio. You have seen continuous economic growth and continuous earnings growth in the market, yet the market has deflated… [with equities now trading] at about 10 times P/E,” noted Swan.

With the risk of a Chinese hard landing having receded, BlackRock sees opportunities in Asian and Chinese corporates with strong balance sheets and resilient earnings. Sectors it favours include healthcare and non-banking financials, which stand to benefit as Beijing strives to drive domestic consumption and improve social welfare.

But Schroder Investment Management has warned investors to take note of looming macroeconomic risks in Europe and the US and their likely impact on Asian assets.

Senior advisor Alan Brown pointed to potential for a partial breakup of the euro, in which case Schroders forecasts a contraction in global GDP of more than 1%.

Were the “fiscal cliff” issue to materialise in the US – existing legislation that threatens to impose government tax rises and spending cuts in January to target the nation’s ballooning budget deficit – Schroders knocks another 1% off global GDP.

Given China’s continued reliance on exports to drive economic growth, the impact of either macro event would have grave implications for its goods and services industry (the US and Europe are China’s top two export markets).

Contrary to its traditional stance, Schroders recommends that investors diversify into gold as a defence against potential devaluation in major currencies, admittedly in small quantities.

On the flipside, Brown quips: “One hopes that gold will do extremely badly, because if it does it will mean 90% to 95% of [client] portfolios are doing just fine.”

He also sees agricultural commodities as an attractive asset class, with demand for grain supported by an increasingly wealthy Chinese populace demanding more meat; climate change causing volatility at harvest time and leading to price spikes; and biofuels competing for productive land.

“I see agricultural prices as having a bias rise in the long haul following a return path that is totally uncorrelated with anything else,” adds Brown. “So I like it as a diversifier.”

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