Investors should take a medium- to long-term view on markets in 2012 to identify instruments that provide portfolio diversity, although key entry points are emerging, say Philip Poole and Bill Maldonado of HSBC Global Asset Management.
In a joint presentation, Maldonado – the firm’s Asia-Pacific CIO and equities strategy CIO – suggests that now is the time for equity investors to be courageous.
He points to valuation as a key driver of returns in the region, something he says HSBC’s rivals often overlook. “There is a huge focus on growth, but valuations are important,” he states, noting that the MSCI Asia ex-Japan index is trading one standard deviation cheap on a 15-year basis.
What makes the valuation level especially attractive is that not only is it cheap historically but profitability has far from collapsed, as it did during previous troughs such as the 2008 global credit crisis, Severe Acute Respiratory Syndrome and the dot com bubble.
“At the moment you have a very nice opportunity to buy the market at quite a cheap level while it is still very profitable, and we expect that profitability to remain robust,” states Maldonado.
Poole, global head of macro and investment strategy whose outlook of a year ago can be found here, had earlier noted that equity markets in China (CSI -23.7%) and India (BSE -18.9%) fell more in 2011 than the S&P 500 (1.3%) and Eurostoxx (-16.4%).
“It was the higher beta emerging equity markets that sold off more, principally on concerns about Europe,” he says. “We think this opens up some opportunities.”
On the back of bearish sentiment last year, Maldonado notes there was a big migration to traditionally defensive stocks, which as a consequence have in effect lost their defensive qualities.
This, he says, presents equity investors with a conundrum in that it's difficult to invest in the stock market today from a defensive perspective. “Basically you have to have something more of a risk-taking attitude,” he argues.
He suggests cyclical sectors such as industrials and materials as well as financials and energy offer value. “When we look across the region, those are sectors that give us a lot of ideas and a lot of positions in our portfolios are coming from those sectors,” he says.
In a trade-off of profitability versus valuation, Maldonado points to Thailand and China as well placed with strong, profitable companies – notably with reference to the latter’s banking sector.
And he points out that you need to look back to some nasty periods in history to find equally compelling valuations in China. “It may be that we have seen the bottom of the market [in China] and that things should improve from here,” he adds.
Poole had earlier noted that central banks in emerging markets have more ammunition than developed peers to offset drags on growth as they are starting from a point of higher interest rates and tighter credit restraints.
“We have seen the likes of Brazil, Indonesia and Thailand cutting rates, and we have seen China cutting reserve requirements,” says Poole. “We should expect to see more of that, helping to offset the drag on growth from the developed world.”
Maldonado, too, reflects that China will likely cut its reserve ratio requirement once or twice more in the first quarter this year, while interest rates will likely decline and tax cuts are a possibility. Further, he points to the legitimisation of bond markets for local governments, giving them greater flexibility in financing projects, while infrastructure spending has also resumed.
“All of these things will be used to support growth in the country, which is quite positive for the equity market and gives us a lot of comfort that we will have a good outcome in terms of growth for China next year, and that will be very supportive for the rest of the region,” says Maldonado.
Poole points to a rebalancing in global consumption that is forecast to take place towards China and other parts of emerging Asia and the emerging world and away from the US, UK and Europe. “It is an important trend and we think we should play that globally,” he says.
On fixed income, they argue that the economic backdrop in Asia is positive with falling inflation, low interest rates, no real chance of overheating and a pretty strong fiscal picture.
Poole notes that Treasuries and Gilts look expensive fundamentally and argues that the best place to be is in quality corporate credit, whether investment grade or emerging market.
“There has been an indiscriminate sell-off which has generated entry points into these types of trades,” he says. “Corporate balance sheets are in good shape in most parts of the world, they are cash rich and that will help them if banks in Europe are delevered.”
Maldonado echoes this view, adding that Asia is also likely to see sovereign ratings upgrades, including the Philippines. He says Asian bond markets in 2010 and 2011 demonstrated low correlation with developed markets, making them useful tools for global portfolio constructors.
He points to Hong Kong’s dim-sum bond market as an example and dismisses talk about declining interest and issuance. “We don’t see that at all, we see a lot of appetite for CNH assets and we see a lot of interest from a diverse range of issuers coming into this market,” he says.
“Although there has been a hiatus, we would expect issues in the market to be strong again at some point in 2012. We don’t think this is a story that’s over, it’s something we are very focused on for 2012.”
He notes, too, that commodities sold off and created interesting entry points through equity markets. “If investors are prepared to take a medium- to long-term view, valuations look cheap on a price-to-book and forward price-earnings basis,” suggests Poole.
He adds that emerging market currencies have been hit hard in 2011, with the Turkish lira and Indian rupee being sold off over 20% versus the yen. The key exception is the renminbi.
“Emerging market currencies look significantly undervalued in some cases,” says Poole. “With interest rates expected to be very low in the developed world, we think carry will be emphasised once we start to see market sentiment stabilise towards the end of the first half of 2012.”