It's time to go cyclical, says JP Morgan AM

JP Morgan Asset Management is bullish on stocks such as financials, citing large Chinese banks as a buy, despite recent moves to curb lending on the mainland.
It's time to go cyclical, says JP Morgan AM

Following the recent sharp falls in Asian equity markets, defensive stocks are becoming increasingly expensive, so cyclical names are the way to go, according to JP Morgan Asset Management.

Such stocks are more volatile but cheaper now, argues Jeffrey Roskell, regional investment manager with the fund house Pacific regional group.

He notes that the MSCI Asia Pacific ex-Japan Reit index, a defensive benchmark, is posting a 16.2x price-to-earnings, while the MSCI Asia Pacific ex Japan cyclical index stands at 9.6x.

Paying so much for defensive securities such as real estate investment trusts (Reits) for just a 3% yield doesn't make sense, says Roskell. “I’d rather own a bank with a more volatile income stream with a 5% yield,” he told attendees at the bank’s investment conference in Hong Kong yesterday.

From June 2012 through the end of May, JP Morgan’s Asia Pacific income fund equity portfolio has significantly reduced its defensive-asset exposure to 46% of the overall fund from 68%, while increasing cyclical assets to 51% from 30% in the same period.

The firm is bullish on Chinese financials, for instance – a unusual stance, given the recent moves by China’s central bank to tighten liquidity and curb lending, which sent equity markets tumbling.

Although the People’s Bank of China has tried to inject some confidence into markets, saying it will provide liquidity to support financials, market participants don't seem convinced. Indeed, some argue that bankruptcies may emerge as a result, particularly among small and medium-sized firms.

Goldman Sachs Asset Management agrees that small banks are to be avoided, and notes it has been underweight Chinese financials for some time.

But larger financials are a different story, says Roskell, and they are a terrific buying opportunity at the moment, largely due to the US Federal Reserve’s hints that it will run down the quantitative easing programme. Cutting off the buy-back programme will send interest rates up and cause bank deposits to grow, he says.

One of JP Morgan AM’s top five holdings at the end of April was Bank of China (Hong Kong), at 2.2%, Roskell points out. Other top holdings include HSBC (2.9%) and ANZ Banking Group at 1.9%.

In addition, the firm's Asia equity dividend income fund and Asia-Pacific income fund have 3% of their holdings in Chinese banks. A quarter of the funds' total holdings are in banks, with 5% in other financials such as insurers.

While investing in Chinese financials is not without risk, says Roskell, the pricing at the moment is simply too good to miss.

The income funds also hold stocks in financials in Australia, Singapore and Thailand.

The firm is bullish on other cyclical sectors, including industrials, IT and consumer discretionary. Howevever, Roskell urges caution on materials and energy, citing falling demand from China as it tries to shift its investment-driven economy to become more consumer-focused.

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