27-03-2013, 09:53 AM
Amid the volatility, opportunities beckon
Lim Say Boon
The Sunday Times
Wednesday, Mar 27, 2013
The ride on the risk asset markets is about to get a lot bumpier again. Get used to this - recurrent bouts of volatility and periodic resurgence of fears surrounding the structural problems of debt and deficit will stay with us for years. Fixing these problems may take a decade.
But amid the recurrent bouts of risk-on/risk-off, investors have a unique opportunity to focus on attractively-valued assets for long-term capital appreciation, particularly those leveraging the big trends in Asia ex-Japan.
Market confidence has been rattled this time by events in Cyprus, where the government had proposed a levy on bank deposits as part of a bailout plan. This has triggered fears of contagion to the rest of the euro zone through fragile banking systems in Spain and Italy. And this comes at a time of ongoing concerns about the possibility of Italians rejecting austerity amid political gridlock. Then, there is the feared impact of the programmed government spending cuts in the United States, the so-called "sequester".
These diverse headlines have a common thread. The West continues to struggle with the problems of debt and deficit, both private and public - legacies of excesses built up over the past one to two decades.
And while there are many opportunities in the "super-cycle trends" in Asia ex-Japan, we should be under no illusion that we can decouple from the West. We are all "beasts of beta" - captives of global volatility, connected by interdependent economies and capital markets. Contagion comes through capital flows which dry up when there are crises and fear.
But the good news is the West is healing. And this will allow Asia to continue to access the capital required for the great transformations, such as urbanisation. Media headlines will naturally focus on the unfinished business in the West - the unfinished struggle with dysfunction. But the real news is there has been progress in redressing the problems of debt and deficit.
The surge in housing foreclosures in the US over past years is good news. Yes, it has inflicted pain on the unsustainably indebted. But this is a market-clearing mechanism. As a result, US house prices have been recovering, housing starts have surged and this is likely to flow over to business investment.
Meanwhile, hydraulic fracturing and horizontal drilling technologies have made accessible vast amounts of shale oil and gas, raising the possibility of US energy self-sufficiency eventually. And before that, there are already benefits in investments and jobs in the energy industry.
Even in Europe, there has been significant progress on at least one of the two problems (of debt and deficit) confronting governments. Primary deficits - before interest repayments - have been dramatically reversed over the past few years. And while there will be periodic political resistance, the culture of overspending is being tackled.
Meanwhile, with the European Central Bank managing down government borrowing costs through its threat of unlimited purchases of European sovereigns, the most heavily indebted economies of the European periphery will have a little more breathing room to balance austerity and growth.
But beyond suffering occasional "collateral damage" on the fringes of the problems in the West, Asia will also have to tackle its own structural economic challenges.
In Asia, markets have been particularly nervous about the ability of the Chinese government to engineer strong, sustainable economic growth amid tight limits on credit and money supply growth and inflation.
The Chinese economy is at the start of what will likely be a dramatic transformation - rebalancing away from a credit-intensive focus on fixed asset investment growth towards greater contribution from consumption growth.
The Chinese government will likely gradually ease its controls over the "impossible trinity" - controls over its currency rate, interest rates and the capital account.
The recent appointments of officials associated with the Zhu Rongji reforms of the 1990s signal determination by the Chinese government to complete unfinished business.
But these reforms will be difficult and messy. And there will be winners and losers.
Gradual liberalisation of trading in the yuan will likely see long-term strengthening of the currency. This will be equivalent to a transfer from exporters to consumers. With capacity utilisation in China down to around 60 per cent - comparable to the US - this will accelerate the process of sorting out the competitive from the weak among exporters.
Internationalisation of the yuan has opened up huge opportunities in the offshore yuan business. Meanwhile, liberalisation of the capital markets allowing foreigners to invest in China, using offshore yuan, will deepen the Chinese equities market.
Interest rate liberalisation - which is already under way - will likely accelerate, squeezing the profitability of Chinese banks. In the process, allocation of credit will likely shift from state-owned enterprises to privately-owned small to medium enterprises.
In China's "Great Rebalancing", consumer and retail stocks will be obvious winners as the government seeks to raise the household share of gross domestic product (GDP) for economic and social reasons.
The household share of GDP has fallen from 70 to 80 per cent during Maoist China, to under 40 per cent today. Health-care stocks will also benefit from the likelihood of greater government spending on social priorities. Similarly, widespread public concerns over pollution will benefit clean energy and water companies over coal companies and utilities.
Beyond China, the great urbanisation of a relatively youthful population in Asean will offer long-term stock investment opportunities in housing, banking, consumer goods/retailing, cars and transportation.
Talk among investors of equities being too expensive now that prices have more than doubled since the lows of the global financial crisis is superficial. It addresses only the price side of the valuation multiple - not the earnings denominator.
Earnings have moved up over recent years, taking some of the load off valuation "multiple expansion". Further, the depressed prices at the worst point of the global financial crisis were outliers under pressure from extreme fear - they do not represent the valuation ranges under more normal perceptions of risk. In short, you are not likely to see those valuations again any time soon.
This leads me back to the topic which I started with - that markets are getting nervous again as a result of the events in Cyprus and concerns over China's new economic model. Buy or sell?
Contagion from Cyprus is likely to be contained. It is unlikely to lead to another full-fledged crisis similar to that which emerged amid the Greek elections last year.
And in the US, government spending cuts will likely eat into GDP by only 0.6 per cent. It is not likely to be a game-changer for equities. Governments and central banks will likely continue to manage these periodic bouts of uncertainty, driving sideways various indicators of volatility - from the equities volatility index in the US to government bond yields in the euro zone. Meanwhile, negative real returns on both cash and government bonds will likely continue to push a "Great Rotation" out of cash into all manner of risk assets first before they drive money out of bonds.
In the East, market uncertainties over the impact of China's economic reforms will likely keep downward pressure on both A-shares and H-shares over the coming months. But valuations are close to cyclical lows in Chinese equities and the downside is likely to be limited (see charts).
While private-sector debt-to-GDP is high as a result of the credit explosion of recent years, the Chinese central government's own debt-to-GDP is modest. This will continue to be a source of strength and policy flexibility for China. Investors with a longer-term view should consider buying rather than selling the correction.
The writer is the chief investment officer at DBS Group Wealth Management and Private Bank
http://www.asiaone.com/A1Business/News/S...11205.html
Lim Say Boon
The Sunday Times
Wednesday, Mar 27, 2013
The ride on the risk asset markets is about to get a lot bumpier again. Get used to this - recurrent bouts of volatility and periodic resurgence of fears surrounding the structural problems of debt and deficit will stay with us for years. Fixing these problems may take a decade.
But amid the recurrent bouts of risk-on/risk-off, investors have a unique opportunity to focus on attractively-valued assets for long-term capital appreciation, particularly those leveraging the big trends in Asia ex-Japan.
Market confidence has been rattled this time by events in Cyprus, where the government had proposed a levy on bank deposits as part of a bailout plan. This has triggered fears of contagion to the rest of the euro zone through fragile banking systems in Spain and Italy. And this comes at a time of ongoing concerns about the possibility of Italians rejecting austerity amid political gridlock. Then, there is the feared impact of the programmed government spending cuts in the United States, the so-called "sequester".
These diverse headlines have a common thread. The West continues to struggle with the problems of debt and deficit, both private and public - legacies of excesses built up over the past one to two decades.
And while there are many opportunities in the "super-cycle trends" in Asia ex-Japan, we should be under no illusion that we can decouple from the West. We are all "beasts of beta" - captives of global volatility, connected by interdependent economies and capital markets. Contagion comes through capital flows which dry up when there are crises and fear.
But the good news is the West is healing. And this will allow Asia to continue to access the capital required for the great transformations, such as urbanisation. Media headlines will naturally focus on the unfinished business in the West - the unfinished struggle with dysfunction. But the real news is there has been progress in redressing the problems of debt and deficit.
The surge in housing foreclosures in the US over past years is good news. Yes, it has inflicted pain on the unsustainably indebted. But this is a market-clearing mechanism. As a result, US house prices have been recovering, housing starts have surged and this is likely to flow over to business investment.
Meanwhile, hydraulic fracturing and horizontal drilling technologies have made accessible vast amounts of shale oil and gas, raising the possibility of US energy self-sufficiency eventually. And before that, there are already benefits in investments and jobs in the energy industry.
Even in Europe, there has been significant progress on at least one of the two problems (of debt and deficit) confronting governments. Primary deficits - before interest repayments - have been dramatically reversed over the past few years. And while there will be periodic political resistance, the culture of overspending is being tackled.
Meanwhile, with the European Central Bank managing down government borrowing costs through its threat of unlimited purchases of European sovereigns, the most heavily indebted economies of the European periphery will have a little more breathing room to balance austerity and growth.
But beyond suffering occasional "collateral damage" on the fringes of the problems in the West, Asia will also have to tackle its own structural economic challenges.
In Asia, markets have been particularly nervous about the ability of the Chinese government to engineer strong, sustainable economic growth amid tight limits on credit and money supply growth and inflation.
The Chinese economy is at the start of what will likely be a dramatic transformation - rebalancing away from a credit-intensive focus on fixed asset investment growth towards greater contribution from consumption growth.
The Chinese government will likely gradually ease its controls over the "impossible trinity" - controls over its currency rate, interest rates and the capital account.
The recent appointments of officials associated with the Zhu Rongji reforms of the 1990s signal determination by the Chinese government to complete unfinished business.
But these reforms will be difficult and messy. And there will be winners and losers.
Gradual liberalisation of trading in the yuan will likely see long-term strengthening of the currency. This will be equivalent to a transfer from exporters to consumers. With capacity utilisation in China down to around 60 per cent - comparable to the US - this will accelerate the process of sorting out the competitive from the weak among exporters.
Internationalisation of the yuan has opened up huge opportunities in the offshore yuan business. Meanwhile, liberalisation of the capital markets allowing foreigners to invest in China, using offshore yuan, will deepen the Chinese equities market.
Interest rate liberalisation - which is already under way - will likely accelerate, squeezing the profitability of Chinese banks. In the process, allocation of credit will likely shift from state-owned enterprises to privately-owned small to medium enterprises.
In China's "Great Rebalancing", consumer and retail stocks will be obvious winners as the government seeks to raise the household share of gross domestic product (GDP) for economic and social reasons.
The household share of GDP has fallen from 70 to 80 per cent during Maoist China, to under 40 per cent today. Health-care stocks will also benefit from the likelihood of greater government spending on social priorities. Similarly, widespread public concerns over pollution will benefit clean energy and water companies over coal companies and utilities.
Beyond China, the great urbanisation of a relatively youthful population in Asean will offer long-term stock investment opportunities in housing, banking, consumer goods/retailing, cars and transportation.
Talk among investors of equities being too expensive now that prices have more than doubled since the lows of the global financial crisis is superficial. It addresses only the price side of the valuation multiple - not the earnings denominator.
Earnings have moved up over recent years, taking some of the load off valuation "multiple expansion". Further, the depressed prices at the worst point of the global financial crisis were outliers under pressure from extreme fear - they do not represent the valuation ranges under more normal perceptions of risk. In short, you are not likely to see those valuations again any time soon.
This leads me back to the topic which I started with - that markets are getting nervous again as a result of the events in Cyprus and concerns over China's new economic model. Buy or sell?
Contagion from Cyprus is likely to be contained. It is unlikely to lead to another full-fledged crisis similar to that which emerged amid the Greek elections last year.
And in the US, government spending cuts will likely eat into GDP by only 0.6 per cent. It is not likely to be a game-changer for equities. Governments and central banks will likely continue to manage these periodic bouts of uncertainty, driving sideways various indicators of volatility - from the equities volatility index in the US to government bond yields in the euro zone. Meanwhile, negative real returns on both cash and government bonds will likely continue to push a "Great Rotation" out of cash into all manner of risk assets first before they drive money out of bonds.
In the East, market uncertainties over the impact of China's economic reforms will likely keep downward pressure on both A-shares and H-shares over the coming months. But valuations are close to cyclical lows in Chinese equities and the downside is likely to be limited (see charts).
While private-sector debt-to-GDP is high as a result of the credit explosion of recent years, the Chinese central government's own debt-to-GDP is modest. This will continue to be a source of strength and policy flexibility for China. Investors with a longer-term view should consider buying rather than selling the correction.
The writer is the chief investment officer at DBS Group Wealth Management and Private Bank
http://www.asiaone.com/A1Business/News/S...11205.html