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Leung, who is responsible for the lead management and sector coverage of Legg MasonÆs Hong Kong and China equities portfolios, shares his views on these markets with AsianInvestor.
What are the biggest opportunities that you see in Hong Kong and China in the coming 12 months?
Leung: With the recent economic downturn and compression in valuations, the pace of industry consolidation within China will likely gather momentum and that will favour market leaders with best-in-class management. The increasing transparency and effectiveness in legal framework, regulatory policies and the financial system result in healthier returns. We continue to focus on stock selection, favouring best-in-class companies trading on attractive valuations.
Which sectors do you expect to outperform in the coming year?
The markets flip-flopped back to a month of negative returns albeit to smaller magnitude than seen previously. While the Hong Kong market has been reacting to the expectation of lower US interest rates, the mainland market and policy makers have been grappling with a number of recent challenges such as the post-earthquake reconstruction in Sichuan, mounting nationwide inflation pressure and persistent capital inflow related to an appreciating renminbi.
In Hong Kong, positive response to the launch of luxury residential projects along with persistent negative real interest rates has recaptured investorsÆ attention towards the property sector. Given the attractive premium of projected rental yield over real mortgage rate, buying interest of end-users should persist unless employment expectation sharply deteriorates. We remain sanguine in this sector but are watchful on their valuations.
Which sectors do you expect to underperform?
The powerful market rallies and re-rating in the month of April was driven by the introduction of a combination of US and China-led financial policies aimed to ease recent downside pressures. The new liquidity facilities introduced by the Fed and cut in interest rates have partially alleviated liquidity problem within the US banking system. ChinaÆs capital market policies have also helped to arrest the sharp decline in the domestic A-shares market. While these measures along with pockets of better-than-expected results in the first quarter of 2008 have provided the much-appreciated market relieve, risk of further downgrade in earnings as global economies slow will continue to pose a challenge for markets to sustain at current levels.
The failure of local discount airline Oasis earlier this year is a reminder of the reality of the negative impact of rising oil prices and slowing economies. The export sector will be among the first to feel the decelerations in earnings. However, if global growth continues to slow and inflation remains unchallenged, sectors exposed to domestic economies may also be affected.
What are the main challenges that you expect to face in the coming 12 months?
Unfavourable external macro factors will continue to dampen earnings expectation. As such, compression in valuations may persist in the second half of 2008. Better-than-expected first half corporate results and reduction in risk of policy missteps will support an earnings rebound in 2009 leading to better market performance.
What are the main risks of investing in Hong Kong and China at the moment?
With the Hong Kong dollar pegged to the US dollar, Hong Kong has to endure the volatility induced by US monetary policies.
Near-term challenges for China include rising inflation, slowing exports and urgent need of post-quake reconstruction. Policy response by the central government has to balance national interests and spirit of free markets which may results in over reactions by investors.
Hong Kong and China should be able to weather these challenges given their robust fiscal accounts and low household gearing. We remain vigilant and sensitive to responses by corporate managers to these policies.
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