The new asset landscape
Nick Westra, Amanda Lee and Peggy Sito
The United States central bank's plan for a second round of quantitative easing has been one of the worst-kept secrets in the market, pushing up asset classes across the board for months. Now that the proof is finally in the pudding, it is time to pinpoint how it will affect investments.
An unintended side effect of the Federal Reserve's decision to pump another US$600 billion into the system - the so-called quantitative easing 2, or QE2 - has been an exodus of liquidity to emerging markets where economic fundamentals are relatively stronger and yields more attractive.
'Expectations have been set on looser liquidity being available,' said Manpreet Gill, Asia strategist at Barclays Wealth.
Here we take a closer look at the possible effect of this liquidity on six important asset classes.
Asian stocks stand to extend sizeable gains, as QE2 will add even more impetus to an already steady stream of overseas fund flows into Asia.
'A lot of equity markets should be higher based on their fundamentals. Quantitative easing becomes the catalyst that helps them get there,' said Gill of Barclays Wealth.
Gill expects investors to focus on markets like South Korea, Taiwan, the mainland and Hong Kong, which are relatively cheaper than their southeastern Asian counterparts.
Hong Kong's Hang Seng Index is presently trading at about 15.4 times current earnings, the same level it was at in mid-2008 It has zoomed up 21.1 per cent since the start of September to 24,876.82 points, and Goldman Sachs predicted last week it could hit 29,000 within the next 12 months. Goldman highlighted upside in financial plays which should benefit from the yuan's internationalisation. It also singled out developers, citing a positive outlook for property prices
Investors might want to add Hong Kong Exchanges and Clearing to their shortlists. The stock exchange operator is up 57.4 per cent since the start of September after tacking on 12.5 per cent last week and stands to benefit from increasing trading levels.
Commodity prices are expected to receive a positive jolt, as QE2 could further debase an already weak US dollar, increasing the demand and value for real assets priced in dollars.
Bank of America Merrill Lynch said Brent crude oil prices could top US$90 per barrel this year even if demand remained sluggish. It jumped 6.1 per cent last week. 'In a tightening market, spot prices could rise,' analysts at the bank wrote in a report last week. 'The general perception that QE has been fully priced into commodity markets is misleading.'
Historically low interest rates in most developed countries have also reduced the costs associated with harvesting and storing raw materials. Rabobank expects soft commodities will continue to rally this year, citing a weak US dollar, lower production yields, and more demand. Gold is also expected to register further gains in the post-QE2 climate (see below).
According to Xavier Wong, director and head of research for Greater China at Knight Frank, Hong Kong's property sector will benefit the most from QE2. Easy liquidity and Hong Kong's sound economic fundamentals make the city's real estate market attractive as it is. 'US funds are interested in coming here as there are no currency risks,' Wong says.
The impact will be similar on property prices in places outside Hong Kong that have good fundamentals. Foreign funds are showing more interest in central London properties, where supply is limited. Annual new supply in the region is just around 600 units. The mainland, despite sound fundamentals, will not be very affected as a result of QE2, says Wong. The government is able to slow the capital inflow into the real estate market through administrative measures.
Andrew Ness, executive director of CB Richard Ellis' research division, said a weakening dollar as a result of QE2 will mean investment funds will seek to reallocate their portfolios towards emerging-market real estate and equities.
'Money will initially flow the most into Asia's more open and transparent markets such as Hong Kong and Singapore but will eventually try and find its way into the Chinese and Indian real estate markets. In addition, some investment funds may flow to property development in Southeast Asian countries such as Thailand and Vietnam to capture higher returns.'
Lee Wee Liat, regional head of property at Samsung Securities (Asia), said QE2 will translate into more demand for investment assets, property being one of the most important of them, in Hong Kong, Singapore and other Asian markets, driven by the fear of inflation. 'I can only see property prices continuing to go up,' said Lee.
Currency strategists believe the US dollar will remain weak in the coming months as a result of the Fed move. Already limp, QE2 inflicts more damage to the greenback, says Mitul Kotecha, head of global FX strategy at Credit Agricole. Because of its weakness, the US dollar has effectively replaced the yen as the funding currency for carry trades, according to Kotecha, adding that Scandinavian and emerging-market currencies are likely to perform well against the US dollar. The British pound, Swiss franc and Yen are the likely laggards among G10 currencies, Kotecha believes.
Barclays Wealth is advising investors to add exposure to emerging-market currencies such as the yuan. Gill, its Asia strategist, said the yuan is expected to have a modest 5 per cent revaluation in the next 12 months.
Compared with developed countries, Asian currencies have been relatively attractive for their strong growth and low valuation, said Gill. 'We recommend investors gain exposure to Singapore, Taiwan, India, Indonesia and Korea, and short the US dollar, euro and the yen.'
If you were to buy bonds now, analysts suggest it's better to look at European short-term bonds rather than emerging-market bonds, which are becoming more expensive because of QE2. In fact, if you have emerging-market bonds, you might consider selling some as local regulators contemplate measures to slow the flow of money into their bonds.
Fixed-income analysts expect more funds to flow into emerging-market bonds as a result of QE2. But while this capital inflow continues to support Asian currencies, regional regulators are wary the strength of their currencies against the US dollar will hurt their economies.
Thailand has already imposed a withholding tax on bond interests and has indicated it plans more measures to curb inflows depending on the impact of the QE2. South Korea has said it is 'seriously' considering taking measures. Bond prices will drop if countries introduce measures such as Thailand, so you could cashing in now.
Bond analysts believe the impact of QE2 on the debt markets is less profound than that of the sovereign bond crisis in Europe and the Bank of England's quantitative easing programme. The rescue effort by the International Monetary Fund and the European Union created an attractive opportunity for high yields on short-term debt backed by these two, said Gill of Barclays Wealth.
As QE2 is likely to hurt the US dollar, dollar bond fund investors will probably feel the pain, says YT Kum, senior research analyst at Morningstar.
'In USD terms, the average fund in the Morningstar USD government bond category gained 4.50 per cent over the past six months, while those in the Morningstar EUR government bond category were up 21.83 per cent,' Kum said.
Harpreet Sajjan, portfolio manager at wealth management firm Platinum Financial Services, advises investors to go for funds priced in US dollar or Hong Kong dollar but invested in assets not denominated in US dollar as dollar will weaken. Commodity funds are expected to do well as QE2 boosts commodities. This past week, BGF World Mining has gained 7.1 per cent while Threadneedle Global Energy Equities has risen 6.1 per cent.
As most of the QE2-triggered money flow will come in this direction, Asian, particularly Chinese plays, are a good idea. Investec Asia Pacific Equity last week returned 6.5 per cent while Allianz RCM China gained 6.5 per cent last week.
Two notable Hong Kong plays last week were MFS Meridian Hong Kong Equity (up 7.2 per cent) and Allianz RCM Hong Kong (up 7.1 per cent).
The percentage gain by the Hang Seng Index since September: 21%