We continue to expect equities to produce the best total return over the long term, even after the rally in prices in recent months. In contrast we expect cash and government bonds to produce returns that struggle even to match inflation given the low level of staring interest rates and yields. Corporate bonds offer an attractive yield premium over government bonds and remain a core holding even after recent falls in the yield premium.
At the same time we accept that the economic background is not an easy one. Growth in the developed world in particular is constrained by excessive debt and this will weigh on global growth, although emerging economies are likely to perform better.
However this bias of growth towards the developing world along with the ending of some powerful dis-inflationary forces mean that the trade-off between growth and inflation is likely to be less favourable than in recent years. This difficult environment is likely to prevent equities in particular from embarking on a sharp or sustained bull market, while interest rates are expected to remain low for an extended period.
but have trimmed positions somewhat in recent weeks following the good run in markets. Within equities we have a preference for emerging markets where growth prospects are better and valuations attractive, and feel that Chinese stocks in particular are attractively valued.
In bonds we are overweight corporate bonds and also favour bonds in emerging market, particularly Asian, currencies which we believe have the potential to appreciate over the long term. We aim to keep cash holdings modest given the near zero interest rates.
Despite further slowdown in 3Q, monthly data were overwhelmingly positive in September. Increasing signs suggest that the destocking process is winding down amid improved domestic and external demand. With policies staying accommodative, conditions are ripe for a growth rebound in 4Q. Meanwhile, policy support has been measured and may become neutral when downside risk is curtailed.The upcoming 18th National Congress of the Communist Party of China (CPC), starting from November 8, will usher in a new generation of party leaders who will likely endorse a more pro-active economic rebalancing plan and market-oriented reforms. The government is expected to accelerate project approvals and implementation, with faster fiscal appropriation and credit support which would help sustain the final demand and facilitate a mild growth rebound in 4Q.
For the remainder of 2012, we believe attractive valuation & better risk appetite as a result of the QE3 and the removal of tail risk in Europe could support the domestic Hong Kong index, although absolute upside may be limited.We also believe that if and when the Chinese economy shows signs of sequential improvements, domestic HK stocks might significantly underperform their Chinese counterparts given the valuation premium.We are already seeing nascent signs of the above happening, and we expect this to sustain towards year end.We prefer the Chinese banks and property stocks.We continue to favor the gaming sector and have also turned more positive on the upstream cyclical and selective exports related stocks.On the other hand, we are cautious on the domestic property developers.
We think the safe haven premium in yields will eventually be priced out, especially once policy action in Europe and the US improve, forcing yields to rise. The eurozone sovereign debt crisis has been in ‘pause mode’ this past month, but the volatility could return in the next few months, as progress towards an eventual resolution of the crisis ebbs and flows. In the short term, safe haven assets could remain well-supported until the US fiscal cliff uncertainty is resolved.We prefer corporate bonds and emerging market debt from both fundamental and valuation perspectives. Over time, we expect corporate bonds to outperform government bonds as investors search for higher yielding assets, given the low global interest rate environment. We also expect emerging markets sovereign debt to outperform core developed bond markets in the medium to long term.
Recent actions of the ECB and the Fed have resulted in widespread enthusiasm for the EUR, but might lack sustainability. Two upcoming events will probably impact the Asian currencies, which are China’s leadership transition and the US‘fiscal cliff’. On the other hand, the commodity currencies should remain volatile as the risk on risk off sentiment that we have witnessed in markets this year will continue, especially driven by the looming ‘fiscal cliff’. Overall, short term movements may be dictated by inflationary expectations and central bank actions, and thus policy remains a risk.
The recent decline in industrial metal prices offers some opportunity in the medium term. Meanwhile, crude oil still offers opportunities in the event of a cyclical recovery in a context of accommodative monetary policies (i.e. record low interest rates and QE). We believe gold could benefit from the debasement of money as central banks engage in more money printing via QE and, more generally, high levels of uncertainty.At the same time, gold remains a potential hedge against the risk of depreciation of the US dollar going forward. Russian equities which give significant exposure to energy and hard commodities and Latin American equities which give exposure to both soft and hard commodities and commodity-related currencies are ways to invest in the commodity theme. However, investors need to bear in mind that commodities as an asset class tend to be particularly volatile.
All returns are in terms of local currencies
Source: HSBC Global Asset Management (Hong Kong) Limited