24-03-2013, 08:39 AM
By Teh Hooi Ling
The Business Times
Saturday, Mar 23, 2013
The rise of inflation, the overvaluation of bonds, the relative value of equities, especially in emerging markets, and Japan's turnaround were among the major themes of the Schroders Asia Media Conference held in Hanoi last week.
Perhaps Christopher Wyke, the firm's product manager for emerging market debt and commodities, summed up the investment thesis best.
Thirty countries in the world today are in zero or negative real interest rates environment. That's a record. Central banks are busy printing money.
The policy priority is higher inflation.
US Federal Reserve chairman Ben Bernanke has adopted a very tough employment target before he would consider turning off the tap of liquidity and start to raise interest rates.
And there is a long way for the US employment rate to go before that target is met.
Meanwhile, to tackle the government budget deficit, either taxes have to be raised significantly or spending cut sharply. The easier way is to inflate their way out. This strategy is being adopted in the EU and Japan as well.
Inflationary policies are popular: People will vote for inflation over recession. They like to see the price of their assets rise.
To Mr Wyke, there are three types of inflation: commodities inflation; wage inflation, as seen in China, the world's factory; and government inflation, through the debasing of their currencies. Emerging markets are particularly vulnerable to the former two.
He said: "The idea spread by the West, that there is no inflation, and so the right policy is to cut interest rate is simply not true! Particularly in many of the countries in the world where the bulk of the global population lives."
When inflation goes up, interest rates rise, bond prices fall and currencies rise.
Commodities and equities will benefit. According to Mr Wyke, some 50 per cent of the total global financial market assets are held in bonds.
In the last few years, a lot of money has poured into emerging-market bonds, their prices have gone up, and hence their yields at historical lows. "The upside of holding bonds is so limited, the downside is so huge that the opportunity cost of giving up bonds now is so small" is how he put it. "Fortunes are made of profits taken too soon."
There is a severe danger of a big sell-off in bonds across the markets. At the moment, people are taking more and more capital risk in order to get yields. "That's very dangerous. What matters is total return," he said.
People can lose money in emerging market (EM) debt in a number of interesting ways.
The risk is not default, as the emerging economies are generally in a much better shape fundamentally than in the developed markets.
The risk in EM is political, not economic. For example, in Venezuela, investors looked forward to a change in political leadership.
But now that President Hugo Chavez has passed away, there is a political vacuum. Nobody knows what is going to happen next.
Contagion is another risk.
Many of the investors in EM debt don't have to be in those markets.
So at the first sign of trouble, they will sell, and sell quickly.
And generally, there is little liquidity in emerging market bonds.
If there is a sell-off, whatever little liquidity there was before will disappear.
And at the moment, investment banks don't have the capital to support these markets if there is a sell-off.
So what could happen is a suspension in withdrawal. "There hasn't been a sell-off, and so people just don't realise the sheer fragility in that area." Yields fall slowly, but rise quickly, he warned.
The trigger for the great bond sell-off is difficult to pinpoint. It could be set off by a higher-than-expected inflation rate, or it could be triggered by yields rising and people losing money. "When you are so close to the edge of the cliff, a slight breeze will send you over," Mr Wyke said.
Turning to gold, Mr Wyke's view is that the fundamental case for the gold bull market is still intact.
Between 2003 and 2008, the rise in gold price was driven by fundamentals.
Between 2008 and 2011, it was driven by sentiment - the "fear trade".
In the last 18 months, we've seen the unwinding of that fear trade. A crisis was averted, and people are more confident of growth.
In the past 18 months or so, the weaker hands have sold off their gold holdings.
But there is little change in the central banks' and exchange trading funds' holdings of gold, he said.
Typically, a commodity bull market ends when production increases.
There has been no significant increase in the production of gold.
Ultimately, gold is an insurance. One would hope that one doesn't have to make a claim on it, he said.
As for equities, there are opportunities to be had around the world. Alan Brown, senior adviser at Schroders, said that the bond bubble is most vulnerable to bursting when the quantitative easing ends.
That may be as soon as next year. "The question we can't answer now is, when the bond bubble bursts, will it have a positive or negative correlation with equities."
He reckoned that would depend on the rate of adjustment. If interest rate jumps to 4 per cent in a short time, equities will come to a halt.
Central banks will have to walk a fine line: unwind their easy monetary policy too quickly and the market may get a shock; do it too slowly and they risk a runaway inflation.
In any case, his view is that global equities are at their most attractive levels relative to intrinsic value.
And in that space, EM equities are good bets.
The growth in the global economy is dependent on the EMs.
EM consumption as a percentage of global consumption exceeded that of the US in 2008.
With the growing middle class in emerging economies, the percentage can only rise.
By the end of this year, it is estimated that consumption from EMs as a percentage of global consumption would exceed 40 per cent while the US will account for just 25 per cent.
EMs now account for under 40 per cent of global gross domestic product (GDP) but over 10 per cent of global stock market capitalisation. "Ultimately, the stock markets will reflect the importance of the real economy. Don't lose faith," said Allan Conway, Schroder's head of emerging market equities. The price increase in these markets will more than make up for any currency depreciations.
Currently, various valuation metrics suggest that EMs equities are at attractive levels.
In the past few years, although institutional investors have been buying growth and emerging markets, most are still underweight relative to the MSCI World Index.
EMs are a low-risk investment.
The risk premium should be in the developed markets, Mr Conway said.
If the world consists of just EMs, then the returns from those markets can be 20 per cent or more this year. "If we muddle through this year, EMs can bring in 20 per cent or more. But there is still too much uncertainty coming out of Europe. Greece hasn't even begun to tackle its problems. It is not time to be a hero," said Mr Conway.
As a validation to his view, the Cyprus banking crisis erupted the day after the conference ended.
In any case, the two Asian markets that Mr Conway likes best are South Korea and Thailand. But the most exciting markets to him now are the frontier markets - the likes of Vietnam, Bangladesh and Sri Lanka.
Perhaps, showing the strongest conviction is Shogo Maeda, head of Japanese equities.
He has been won over by Abenomics - the policies put in place by Japan's new Prime Minister Shinzo Abe to lift the country out of deflation, he said.
As a result of Mr Abe's policies, in the past six months, the Japanese yen has fallen by 23 per cent, from 78 yen a US dollar, to about 96 now.
The stock market meanwhile has surged by 36 per cent. Mr Maeda thinks that the yen will continue to weaken to about 100.
The depreciation of yen will boost corporate earnings by 8 per cent in the fiscal year from April 2013. Earnings should go up by another 10 per cent in FY2014.
Mr Maeda is especially bullish on Japanese carmakers and Japanese multinationals which have done some cross-border acquisitions, especially of Asian companies, last year.
He also likes Japanese banks which own a lot of local stocks.
He is also overweight on Japanese trading companies such as Mitsui and Mitsubishi because they own substantial stakes in some of the world's biggest resource companies.
Mr Maeda is so convinced of the continued recovery of the Japanese market that he said that he has invested 100 per cent of his defined contribution pension plan into the Japanese equities market.
He has done the same for his daughter's.
The rise in equity prices, he assured overseas investors, will more than make up for the depreciation of the yen.
http://news.asiaone.com/News/AsiaOne%2BN...025/2.html[/b]
The Business Times
Saturday, Mar 23, 2013
The rise of inflation, the overvaluation of bonds, the relative value of equities, especially in emerging markets, and Japan's turnaround were among the major themes of the Schroders Asia Media Conference held in Hanoi last week.
Perhaps Christopher Wyke, the firm's product manager for emerging market debt and commodities, summed up the investment thesis best.
Thirty countries in the world today are in zero or negative real interest rates environment. That's a record. Central banks are busy printing money.
The policy priority is higher inflation.
US Federal Reserve chairman Ben Bernanke has adopted a very tough employment target before he would consider turning off the tap of liquidity and start to raise interest rates.
And there is a long way for the US employment rate to go before that target is met.
Meanwhile, to tackle the government budget deficit, either taxes have to be raised significantly or spending cut sharply. The easier way is to inflate their way out. This strategy is being adopted in the EU and Japan as well.
Inflationary policies are popular: People will vote for inflation over recession. They like to see the price of their assets rise.
To Mr Wyke, there are three types of inflation: commodities inflation; wage inflation, as seen in China, the world's factory; and government inflation, through the debasing of their currencies. Emerging markets are particularly vulnerable to the former two.
He said: "The idea spread by the West, that there is no inflation, and so the right policy is to cut interest rate is simply not true! Particularly in many of the countries in the world where the bulk of the global population lives."
When inflation goes up, interest rates rise, bond prices fall and currencies rise.
Commodities and equities will benefit. According to Mr Wyke, some 50 per cent of the total global financial market assets are held in bonds.
In the last few years, a lot of money has poured into emerging-market bonds, their prices have gone up, and hence their yields at historical lows. "The upside of holding bonds is so limited, the downside is so huge that the opportunity cost of giving up bonds now is so small" is how he put it. "Fortunes are made of profits taken too soon."
There is a severe danger of a big sell-off in bonds across the markets. At the moment, people are taking more and more capital risk in order to get yields. "That's very dangerous. What matters is total return," he said.
People can lose money in emerging market (EM) debt in a number of interesting ways.
The risk is not default, as the emerging economies are generally in a much better shape fundamentally than in the developed markets.
The risk in EM is political, not economic. For example, in Venezuela, investors looked forward to a change in political leadership.
But now that President Hugo Chavez has passed away, there is a political vacuum. Nobody knows what is going to happen next.
Contagion is another risk.
Many of the investors in EM debt don't have to be in those markets.
So at the first sign of trouble, they will sell, and sell quickly.
And generally, there is little liquidity in emerging market bonds.
If there is a sell-off, whatever little liquidity there was before will disappear.
And at the moment, investment banks don't have the capital to support these markets if there is a sell-off.
So what could happen is a suspension in withdrawal. "There hasn't been a sell-off, and so people just don't realise the sheer fragility in that area." Yields fall slowly, but rise quickly, he warned.
The trigger for the great bond sell-off is difficult to pinpoint. It could be set off by a higher-than-expected inflation rate, or it could be triggered by yields rising and people losing money. "When you are so close to the edge of the cliff, a slight breeze will send you over," Mr Wyke said.
Turning to gold, Mr Wyke's view is that the fundamental case for the gold bull market is still intact.
Between 2003 and 2008, the rise in gold price was driven by fundamentals.
Between 2008 and 2011, it was driven by sentiment - the "fear trade".
In the last 18 months, we've seen the unwinding of that fear trade. A crisis was averted, and people are more confident of growth.
In the past 18 months or so, the weaker hands have sold off their gold holdings.
But there is little change in the central banks' and exchange trading funds' holdings of gold, he said.
Typically, a commodity bull market ends when production increases.
There has been no significant increase in the production of gold.
Ultimately, gold is an insurance. One would hope that one doesn't have to make a claim on it, he said.
As for equities, there are opportunities to be had around the world. Alan Brown, senior adviser at Schroders, said that the bond bubble is most vulnerable to bursting when the quantitative easing ends.
That may be as soon as next year. "The question we can't answer now is, when the bond bubble bursts, will it have a positive or negative correlation with equities."
He reckoned that would depend on the rate of adjustment. If interest rate jumps to 4 per cent in a short time, equities will come to a halt.
Central banks will have to walk a fine line: unwind their easy monetary policy too quickly and the market may get a shock; do it too slowly and they risk a runaway inflation.
In any case, his view is that global equities are at their most attractive levels relative to intrinsic value.
And in that space, EM equities are good bets.
The growth in the global economy is dependent on the EMs.
EM consumption as a percentage of global consumption exceeded that of the US in 2008.
With the growing middle class in emerging economies, the percentage can only rise.
By the end of this year, it is estimated that consumption from EMs as a percentage of global consumption would exceed 40 per cent while the US will account for just 25 per cent.
EMs now account for under 40 per cent of global gross domestic product (GDP) but over 10 per cent of global stock market capitalisation. "Ultimately, the stock markets will reflect the importance of the real economy. Don't lose faith," said Allan Conway, Schroder's head of emerging market equities. The price increase in these markets will more than make up for any currency depreciations.
Currently, various valuation metrics suggest that EMs equities are at attractive levels.
In the past few years, although institutional investors have been buying growth and emerging markets, most are still underweight relative to the MSCI World Index.
EMs are a low-risk investment.
The risk premium should be in the developed markets, Mr Conway said.
If the world consists of just EMs, then the returns from those markets can be 20 per cent or more this year. "If we muddle through this year, EMs can bring in 20 per cent or more. But there is still too much uncertainty coming out of Europe. Greece hasn't even begun to tackle its problems. It is not time to be a hero," said Mr Conway.
As a validation to his view, the Cyprus banking crisis erupted the day after the conference ended.
In any case, the two Asian markets that Mr Conway likes best are South Korea and Thailand. But the most exciting markets to him now are the frontier markets - the likes of Vietnam, Bangladesh and Sri Lanka.
Perhaps, showing the strongest conviction is Shogo Maeda, head of Japanese equities.
He has been won over by Abenomics - the policies put in place by Japan's new Prime Minister Shinzo Abe to lift the country out of deflation, he said.
As a result of Mr Abe's policies, in the past six months, the Japanese yen has fallen by 23 per cent, from 78 yen a US dollar, to about 96 now.
The stock market meanwhile has surged by 36 per cent. Mr Maeda thinks that the yen will continue to weaken to about 100.
The depreciation of yen will boost corporate earnings by 8 per cent in the fiscal year from April 2013. Earnings should go up by another 10 per cent in FY2014.
Mr Maeda is especially bullish on Japanese carmakers and Japanese multinationals which have done some cross-border acquisitions, especially of Asian companies, last year.
He also likes Japanese banks which own a lot of local stocks.
He is also overweight on Japanese trading companies such as Mitsui and Mitsubishi because they own substantial stakes in some of the world's biggest resource companies.
Mr Maeda is so convinced of the continued recovery of the Japanese market that he said that he has invested 100 per cent of his defined contribution pension plan into the Japanese equities market.
He has done the same for his daughter's.
The rise in equity prices, he assured overseas investors, will more than make up for the depreciation of the yen.
http://news.asiaone.com/News/AsiaOne%2BN...025/2.html[/b]