The expert panel is queried on vexing topics of investor concern. Carl Berrisford (analyst, UBS Wealth Management Research) is asked: What is operation twist? Operation twist has some similarities to the quantitative easing (QE) policies carried out by the US Fed in that it seeks to buy long-term treasuries to bring down long-term rates. However, there are some important differences. One problem with the previous QE programme was that, while it raised banks' reserves (and the amount banks could lend on to consumers), banks themselves were not able to increase their lending much. Instead, they preferred to use cheap short-term funding rates to invest in higher rate long-term treasuries to lift bank profits. Operation twist seeks in part to address this by lowering long-term yields relative to short-term ones and forcing banks to lend more. Specifically, operation twist will replace US$400 billion of short-term debt with long-term debt by buying bonds with maturities of six to 30 years through June while selling an equal amount of debt maturing in three years or less. This should 'flatten the yield curve' and ultimately encourage banks to lend more. Unlike quantitative easing there is no extra liquidity and no 'specified quantity' of new printed money used to purchase bonds; it is self-funding. As a result, the US government's balance sheet does not expand and it is not deemed quite as inflationary as quantitative easing. This is important to US authorities who are concerned about the inflationary impact of increased liquidity given consumer price index rises of 3.5 per cent. Emil Wolter, (head of regional strategy, Asian equities, RBS) is asked: What is the best strategy for equity investing in this market? An impending recession in the developed world has now become our base-case scenario. Following the steep price declines of the past eight weeks, Asian equities have statistically become significantly cheaper. Specifically, the MSCI Asia Pacific ex Japan index is now trading at one standard deviation below its long-term average ('fair value') on our composite valuation indicator. At the same time, reported returns on equity are still close to one standard deviation above its long-term average. This may look odd and even attractive, but we think this simply means the market is beginning to price in the inevitable decline in earnings and returns that occurs during a recession. Unfortunately, we don't believe that process is yet complete and, in fact, Asian markets in aggregate have only priced in 'half a recession'. This conclusion is also reached using a different approach looking at declines in earnings per share during 'typical' recessions. So far, share price falls have discounted a 25 per cent drop in earnings per share, about half of that seen when global GDP contracts. Investors need to be careful when looking not only at overall regional valuations based on earnings but at those of cyclical sectors. Looking at earnings across the sectors during recessions over the past 20 years, the least exposed sectors are health care, telecoms and consumer staples, which all appear to have more realistic balances between typical declines and expectations. But we only recommend telecoms shares since valuations and fundamental trends do not appear good for the other two sectors. Telecoms easily represent the best risk-reward profile both globally and regionally with its combination of predictable cash flow [and] steady income through high dividends, particularly as data demand growth creates pricing power.
