This year will be marked by volatility in asset prices and investors should go long on risk and regard price dips as an opportunity to buy, argues HSBC Global Asset Management.
Philip Poole, the division’s global head of macro and investment strategy, points out that ultra-loose monetary policy by central banks, particularly the US Federal Reserve, has anchored government bond yield curves, effectively forcing jittery investors back into riskier trades.
Tension has arisen between the need to find yield and returns and the fear of certain risks – most prominently a double-dip in the US, the debt crisis in the eurozone periphery and concerns about inflation and asset bubbles in emerging markets.
“I do think the markets will fret several times during the course of the year,” he says. “This will disturb trades and is going to create volatility. But the lesson from 2010 is that when that happens it’s a time to buy, or at least to hold onto your positions. You need to find investment opportunities, be long risk and accept there is going to be volatility along the way.”
Outlining his favoured generic trades ahead of a scheduled media conference today, Poole says he is optimistic that the markets will end 2011 higher than they began it.
He believes playing emerging-market currencies makes sense for the yield pick-up, rather than nominal appreciation, amid a likely background of continued government intervention.
He urges investors to target emerging-market carry currencies that are fundamentally undervalued, face little or no intervention and where central banks have strong inflation-fighting credentials. Examples versus developed-market currencies include the rupee, the ringgit, the Singapore dollar, the Mexican peso and the Chilean peso, with a case to be made for the Australian dollar as an indirect play on continued strong Chinese growth.
In terms of equities, Poole argues that while developed markets look cheap on a historical basis – given that they are now only trading at a small premium to the emerging market world – the valuation gap that existed at the beginning of 2004 in fact was a misrepresentation of the truth (see image, right).
“No one really at that time was thinking about the problems in the developed world, although they were building up” he reflects. “The de-rating of the developed world now actually fits with the fundamentals.”
Via a graph displaying earnings-per-share growth relative to price-to-earnings multiple, Poole names Russia as a standout market on valuation grounds (P/E of less than seven for earnings growth of around 17%).
He notes that India has similar earnings expectations, and while it is considerably more expensive (16x) it is not particularly rich relative to its long-term trading history. Markets between the two which offer decent value include Turkey, Korea, Taiwan and China.
“I think there is a case for overweighting in an Asian context markets like Taiwan, Korea and China, particularly if you believe the world, and the US in particular, is not going to double-dip.” He lists Indonesia as one market that looks rich relative to where it has traded in the past.
In terms of equity themes, he is bullish on emerging market consumption, seeing the shift in the balance of global consumption from developed to emerging markets as a powerful secular trend. Emerging and developed market stocks that are geared towards consumption themes in emerging markets will benefit.
HSBC Global Asset Management is also overweight emerging infrastructure in markets such as India, Indonesia and Russia, which are growing rapidly and where capacity constraints are evident. Again Poole says this should be played via emerging and developed market stocks.
Meanwhile, the asset manager is overweight credit too, given that ultra-low government bond yields will likely push investors into credit in order to hit return targets, while corporate balance sheets are generally in good shape at the same time.
Plus HSBC Global Asset Management is overweight on both hard and soft commodities, with prices supported by strong demand from rapidly growing and populous emerging economies where per capita consumption is coming off a very low base.
In terms of food, consumers in emerging countries such as India, China, Indonesia and Brazil are moving up the food chain, putting upward pressure on grain prices, says Poole.
For hard commodities, the short-term response will be limited by project postponements during the crisis, likely fuelling M&A activity. This theme can be expressed via outright exposure to commodities, or to stocks in the sector. Russia is the bank’s preferred equity market in Bric to play this theme, while it sees Gulf Cooperation Council markets as attractive in valuation terms.
Further, Poole says that quantitative easing is debasing developed world currencies and creating inflation pressure in emerging economies, both of which should support gold and precious metals demand. Given a desire to diversify away from US dollars, developed market central banks have also turned into net buyers of gold.
Poole also believes it makes sense to buy some inflation protection. He notes there are three key sources of CPI inflation pressure in many emerging economies: food price inflation, unsterilised currency intervention and tightening capacity constraints. The liquidity generated by quantitative easing is also adding to real estate and financial asset price inflation.
“If you look at the break-even levels on inflation-linked bonds, they are well below where they were prior to the crisis and in some cases below long-term averages; in other words, they are still affordable,” says Poole.