Don't taper your expectations

The Fed may be trimming its stimulus and the mainland slowing, but Japan and China equities offer value, as do some bonds, top strategists say

PUBLISHED : Monday, 23 December, 2013, 4:47am
UPDATED : Monday, 23 December, 2013, 5:54pm

Hong Kong investors were at the mercy of powerful forces this year: the slowdown in mainland economic growth and the uncertainty over the United States Federal Reserve's bond-buying programme.

The importance of tapering was seen in May when the Fed hinted that it was looking at pulling back on the scheme. That pushed US Treasury yields up more than 1.2 per cent, sparking a massive reallocation of cash from Asian markets into US government bonds.

"Turkey, Indonesia, India and a lot of countries with balance-of-payment issues had an outflow of capital. A lot of money exited because the US interest rates went up," said Mark Mobius, executive chairman of Templeton Emerging Markets.

The Hong Kong market has been in the grip of the other big theme, the slowdown in mainland economic growth. Finance Minister Lou Jiwei said in July that he would be comfortable with expansion as low as 6.5 per cent. He quickly back-pedalled but the idea was planted in investors' heads - growth is in decline.

The Hong Kong share market has returned a desultory 0.7 per cent so far this year.

Investors, however, have stayed keen on mainland bonds, particularly those from the property sector, with issuance volumes triple that of last year, which was also a big year.

That's why last week's news of Fed tapering was such a big event. It marks a shift towards the end of quantitative easing and the beginning of rising interest rates and higher inflation - and that all speaks in favour of equities over bonds. The S&P 500 Index rose 1.7 per cent to a fresh high in response.

"Equities are where you want to be because inflation is going up," Mobius said.

It all suggests a gradual re-emphasis on equities, at the expense of bonds. In that spirit, market professionals discuss what to expect in Hongkongers' main markets next year.


The Nikkei-225 Index is up 53 per cent this year, making Japanese equities one of the world's best-performing markets.

In April, the Bank of Japan committed to doubling the country's money base to end deflation. This has devalued the yen, with the happy outcome of stimulating Japan's exports and increasing profits.

Credit Suisse projects 59 per cent aggregate growth for Japanese firms' earnings per share this financial year, suggesting equities are fairly priced in terms of their price-earnings ratio. Japanese equities' one-year forward price-earnings ratio comes in at 14.6, just below the three-year average of 14.9, it says.

Nomura's chief Japan strategist, Hiromichi Tamura, projects the Nikkei will hit 18,000 points by the end of next year, implying a further rise of about 14 per cent.

"We expect earnings will grow 19 per cent in 2014, and based on that figure and assuming equities trade at a [price-earnings ratio] of 15 times, we think 18,000 is a reasonable level," he said. "We think Japanese earnings growth will be the highest among global markets."

Tamura expects another monetary boost in April. The BOJ is committed to an inflation target of 2 per cent. But inflation is now at 0.9 per cent, which suggests the central bank will expand its securities-buying programme, likely to include exchange-traded funds.

Trading idea: Ben Williams, who manages a Japanese equities fund for GAM, likes Japanese stocks with lots of spare cash, on the view that these firms can be cajoled into buying back shares as their capital piles up.


The CSI 300 Index has dropped 9.7 per cent this year. The performance is primarily due to the slowdown in mainland economic growth.

Mona Chung, the chief investment officer for CIFM Asset Management, said the performance of A-share indices misled investors about the potential of Chinese equities. The benchmark indices are heavily weighted towards large-cap, state-owned enterprises involved in traditional industries.

But the firms that are generating the best growth and getting the most support from government policies are in environmental services, clean energy, health care and consumer spending. They tended to be small to mid-sized, privately owned and outside traditional indices.

Chung points to the ChiNext Index, which tracks growth stocks that trade on the Shenzhen exchange, gaining 77 per cent this year. "Companies that are in the SME index are in the more dynamic industries," she said, the message being that Chinese stocks were doing better than standard indices suggested.

Trading idea: Francis Cheung, head of China/Hong Kong strategy for CLSA, said Chinese equities had followed a pattern over the past three years: they sell off in the first half and then rebound in the second. He attributes this to rounds of mini-stimulus that Beijing rolls out in the middle of each year to ensure the mainland hits its growth targets in the face of disappointing data.

That leads to overcapacity by the start of the next year and market sell-offs. Cheung's solution: stay out of the market in the first half. Buy at the start of the second half and sell at year-end.


For Hong Kong investors, high-yield bonds means one thing: debt issuance from the mainland's real estate sector.

About half of the Asian high-yield are mainland property bonds and this year was a record one for bond volumes from the sector. There was three times as much debt issuance from the mainland property sector this year than last year.

Asian high-yield presents two challenges to investors: it is heavily concentrated in mainland property and Fed tapering suggests an era of higher interest rates - anathema to bonds.

Investors need to be mindful that all but a handful of mainland property issuers are sub-investment grade. "They need to do their picks very carefully as some firms issue bonds because they have too much debt and they need money … If you pick the wrong bond, it could be very risky," said Grace Tam, global market strategist for JP Morgan Asset Management.

Geoffrey Lunt, senior product specialist for fixed income at HSBC Global Asset Management, said there were powerful reasons to believe in the sector, such as urbanisation requiring that about 14 million mainlanders need new homes every year.

Trading idea: Chung of CIFM Asset Management advises staying out of mainland high-yield bonds issued offshore and instead buying investment-grade local bonds. "The yield gap between local investment grade and offshore high-yield is not great, but the investment-grade bonds are much safer," she said.