When will the Fed taper, and what of EM?

Market opinion over the timing of tapering is divided, but even expectations of it are expected to divide better-placed North Asian markets from their South and Southeast Asian counterparts.
When will the Fed taper, and what of EM?

Some key questions for 2014 revolve around when the US Federal Reserve will begin to taper its quantitative easing programme, and what impact this will likely have on emerging markets.

In late May, Fed chairman Ben Bernanke first talked of slowing its $85 billion-per-month bond-buying programme, and yet that’s all it remains today – talk.

The market is divided over when tapering will begin. Pinebridge Investments, for example, is of the view it will not happen in 2014, with all major measures trending away from the Fed’s 2.0% inflation target.

Other market participants have also predicted that a reduction in QE will not happen anytime soon. However, most expect tapering to start in the first half of next year.

Regardless of when it starts, Tai Hui, Asia-Pacific strategist for JP Morgan Asset Management, observes that even expectations of Fed action – and the tapering itself – will likely drive a wedge between Asian markets, separating North Asia from South and Southeast Asia.

He notes that India, Indonesia and Brazil suffered a lot of downs this year. And he believes markets in North Asia are better placed to withstand future tapering action.

Hui says that while the MSCI Southeast Asia Index has sunk -6.46% in US dollar terms year-to-date (after rising +18.96% in 2012), the MSCI Korea index is in positive territory over the period at +0.27% (after a similar +20.54% rise in 2012). So too the MSCI China Index has risen +3.63% in dollar terms (+18.98% for 2012).

Three factors will continue to support North Asian markets even amid the prospect of tapering, he argues.

One is currency, with the renminbi, Korean won and New Taiwan Dollar having all appreciated on the back of national current account surpluses, making them more resilient to Fed tapering.

The RMB has appreciated nearly 2% against the dollar since the start of the year. By comparison, the Indian rupee has depreciated 13% over the period.

Further, export-orientated North Asian markets are well placed to continue exporting to the US and Europe. One example is continuing growth in demand for cars. Light vehicle sales in the US hit 16 million from January to August this year, already surpassing average annual sales of 15.2 million cars since 1994.

Moreover, valuations in North Asia are more attractive, with the MSCI China Index at 8.5 times 12-month forward price-earnings (P/E) ratio by end-September against a 20-year average of 12.2 times.

Similarly, MSCI Japan index is trading at 14.7 times forward P/E ratio, well below its 20-year average of 22.9 times forward average. 

By contrast, the MSCI Southeast Asia Index stands at 14.1 times forward P/E ratio, above its 13.4 times 20-year average.

Hui reasons that these statistics reflect lack of earnings growth in North Asia, which has remained flat since mid-2011. However, he is hopeful this will change next year with inflation expected to be kept in check in Asia.

“For Asia and emerging markets, the crux is they have been growing business but they have also been growing on cost. Part of the reason is the cost of doing business in Asia has continued to rise, especially labour cost,” says Hui.

The Asian Development Bank expects inflation in China to trend downwards to 2.7% for 2014, from an earlier forecast of 3.5%. “My expectation is that inflation should be benign in Asia in the next 12-18 months. That is helpful,” suggests Hui.

Added to this, there is a domestic story in Asia. PineBridge Investments notes that China sold over 16 million cars in 2012, having overtaken the US to become the world’s largest automobile market in 2009.

The tertiary sector – including consumer services, retail and property – had by 2013 overtaken the secondary sector in China to account for the largest share of GDP at 45.5%.

China’s service industry is underdeveloped and investment into it will accelerate, driving valuations for such stocks in future, argues Desmond Tjiang, portfolio manager for Hong Kong and Greater China equities at PineBridge.

Sectors the fund house is adding to its portfolio include IT, property and private firms (as opposed to state-owned enterprises). Its bullish views on China's property sector contrast to market talk of a developing bubble.

But Tjiang says data point to a different story. A property in Shanghai is estimated to cost 19 times average annual salary. That is above the 16-times for Beijing and 12-times for second-tier cities. But in Hong Kong, the ratio can be up to 40 times.

Where PineBridge expects to find value is in the A-share market, with prices below equivalent H-shares.

The MSCI China Index was trading at an average of nine times forward P/E, one standard deviation below its post-2001 average of 12 times. MSCI Hong Kong Index is already trading at an average 15 times P/E on a 12 month-forward ratio.

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