Equities outlook stays dim as Alibaba leaves Hong Kong

The third quarter numbers confirm what we've known all along; that equity markets are sluggish.

Equity volumes have been a fraction of the US$71 billion in offshore bonds issued by mainland firms so far this year, and have been left in the dust by the US$111 billion taken down by such borrowers in syndicated loan markets in the same period.

Loan markets are set to stay strong thanks to the return of European banks to Asia this year, after staying out of the region for much of the past two years due to the euro-zone crisis.

But the equities outlook remains dim, after a 23 per cent year-on-year decline in total proceeds from equity sales in the first nine months of the year - down to just US$27.5 billion, according to data from Thomson Reuters.

Hong Kong has repeatedly held the crown as the world's biggest initial public offering market, and it could have regained the title had regulators been willing to brush aside some governance principles, clearing the way for the HK$100 billion Alibaba float on the local bourse.

It was not to be. Now bankers' hopes are pinned on Cinda, one of the four asset managers set up in the late 1990s to manage non-performing loans from the mainland's banking sector.

Bond markets are harder to predict, with the big variable being rising interest rates. Ten-year US treasury yields are up about 1 per cent since May, and the spread paid by mainland issuers with a BBB rating has widened about 40 basis points in the period.

Rising rates will hit bond prices, pushing investors out of this market. A foreshadowing of that scenario was seen over the summer, with investors pulling tens of billions of dollars from emerging market bond funds after US Federal Reserve chairman Ben Bernanke hinted he would unwind quantitative easing.

"Some investors may be shell-shocked by moves in treasury yields," said Anup Kuruvilla, RBS's managing director, loan syndicate. "They are thinking of rising interest rates. How do you compensate investors on a long-tenor bond for the possibility that interest rates are going to rise?"

But there are other, more supportive trends at play. Asian private banking clients have emerged as big buyers of mainland bonds, particularly the high-yield bonds coming from the property sector. So long as equity markets stay volatile and returns low, they will stay debt focused.

Likewise pension firms are becoming keener on bonds as rates rise, as these securities are starting to pay income that match their long-term liabilities.

The only factor that could really derail things is a series of messy defaults on the mainland. The coal sector is already looking shaky, with coal prices below many mainland issuers' cost of production, and with Winsway Coking Coal technically defaulting in August after asking investors to accept a bond exchange that wiped out more than half their investment.

The bigger, longer-term concern perhaps lies in mainland property bonds, which dominate Asian high-yield, creating concentration risk. Mainland real estate firms sold US$11 billion in bonds in the year to date and the base of issuers keeps expanding, as newer, lower-quality credits come to market.

"Only half of the Chinese developers listed in Hong Kong have accessed the US dollar bond market," said Terence Chia, Credit Suisse's head of debt capital markets syndicate. "There is another 50 per cent left who have not issued bonds. That suggests a lot of growth."

Some privately-placed property deals this year have been structured to generate annual returns in the realm of 30 per cent.

"Such deals don't exist without risk, and probably without sacrificing a good chunk of [trading] liquidity," said Gregor Carle, fixed-income investment director at Fidelity.

No mainland property company has defaulted on an offshore bond, a fact that bankers repeat like a mantra, presumably to ward off bad luck.

But mainland property bonds are volatile, and in 2011 and 2008 the securities registered big losses. Should the sector finally get hit with a default, the reverberations would be felt throughout emerging markets, and the securities would join mainland equities in the cellar of neglected assets.