The end of Asian eq­uity mar­ket un­der­per­for­mance?

Financial Mirror (Cyprus) - - FRONT PAGE - By Louis Gave

With Asian equities hav­ing un­der­per­formed their global equiv­a­lents by al­most 40% since 2011, the past five years have not been much fun for regional in­vestors. En­cour­ag­ingly, how­ever, just as the panic over a pos­si­ble China cur­rency cri­sis and eco­nomic im­plo­sion reached its apex last sum­mer, Asia’s un­der­per­for­mance seems to have abated. Over the fol­low­ing eight months or so, Asian equities have held their own with a num­ber post­ing de­cent YTD gains in US dol­lar terms. Tai­wan, for ex­am­ple, is up 4.7% for the year, the Philip­pines 3.7%, Korea 5.7%, Sin­ga­pore 6%, Malaysia 11.6%, In­done­sia 12.4%, and Thailand 15%.

Last week, our an­a­lysts Joyce and Udith ar­gued that the preva­lence of high cor­po­rate lever­age and in­dus­trial over­ca­pac­ity re­mained a sig­nif­i­cant threat to Asian eq­uity mar­kets. But at the same time, one could ar­gue that mar­kets are made at the mar­gin; and on this front, the three key de­vel­op­ments of re­cent months are:

1) The fact that the US dol­lar is done ris­ing.

While the end of US dol­lar strength has been a con­stant theme of Gavekal Re­search for the past year, we prob­a­bly should have spilled more ink on the in­vest­ment con­se­quences of this “squeeze” end­ing. One of the most im­me­di­ately ob­vi­ous con­se­quences is that a US dol­lar which has stopped ris­ing of­fers emerg­ing mar­kets ev­ery­where a huge gulp of oxy­gen. Hence, if the US dol­lar re­ally is done ris­ing, his­tory sug­gests that emerg­ing mar­kets’ un­der­per­for­mance will cease. In that re­spect, the re­cent moves in the Sin­ga­pore dol­lar are very in­ter­est­ing: last week, the Mon­e­tary Author­ity of Sin­ga­pore sur­prised the mar­ket with unan­nounced eas­ing and a very dovish stance. This trig­gered a sharp pull­back in the Sin­ga­pore dol­lar. But in­ter­est­ingly, the pull­back faded quickly and within 48 hours, the Sing dol­lar was above the level be­fore the an­nounce­ment.

2) The col­lapse in bond yields.

The past ten days or so have shown that in­vestors around the world are back to chas­ing yield. From yields on US sub-in­vest­ment grade en­ergy debt con­tract­ing by more than 9pp, to Ar­gentina pulling in US$50bn of or­ders for a new 30-year bond is­sue (has Ar­gentina ever gone 30 years with­out de­fault­ing on its debt?), to Saudi Ara­bia rais­ing US$10bn at Li­bor+120bp, emerg­ing mar­kets’ cost of fund­ing is again head­ing lower. In Asia, exhibit-A has been In­done­sia where the govern­ment’s lo­cal cur­rency fund­ing costs have fallen from 9% at the start of the year, to 7.5% to­day. What is par­tic­u­larly in­ter­est­ing about the In­done­sian yield com­pres­sion is how, this year, it has been com­pletely un­cor­re­lated to the greater risk-on/risk-off moves in the broader mar­ket (In­done­sian yields fell in Jan­uary and Fe­bru­ary even as global equities sold off).

3) China.

The

sta­bil­i­sa­tion

of

While in­vestors fret­ted about a ren­minbi de­val­u­a­tion or a Chi­nese debt cri­sis, the real es­tate mar­ket was busy bot­tom­ing with a pick-up in prices, hous­ing starts, new con­struc­tion and sales. At the same time, Chi­nese cen­tral bank re­serves started to inch higher while bond yields con­tin­ued to de­cline. Of course, all these pos­i­tive trends could once again re­verse. Still, as long as they en­dure, an im­me­di­ate col­lapse in China seems highly un­likely. This new re­al­ity is shown by the re­bound in the price of com­modi­ties such as iron-ore, crude oil and sil­ver.

Stay­ing with China, one di­rect con­se­quence of the past nine months’ for­eign in­vestor panic was a bru­tal sell-off in the Chi­nese off­shore (dim-sum) bond mar­ket (red line in the chart). Sim­ply put, no for­eign in­vestor wanted to be seen hold­ing any kind of ren­minbi pa­per. Mean­while, in the do­mes­tic mar­ket, the Peo­ple’s Bank of China con­tin­ued to ease mon­e­tary pol­icy and in­ject liq­uid­ity, thereby driv­ing do­mes­tic yields lower (blue line in chart). In fact, do­mes­tic ren­minbi yields fell so much that a mas­sive gap opened up be­tween the on­shore and off­shore mar­ket. Of course, as mar­kets have now started to nor­mal­ize, this dif­fer­ence in yield is be­ing squeezed away (even if there is still a good 100bp of juice left in the “long dim-sum” bond trade). And if, as seems likely (given the grow­ing fi­nan­cial dereg­u­la­tion in China), the yields on on­shore and off­shore bonds go back to con­verg­ing (as they did for most of the first half of 2015), then this fall in in­ter­est rates, and nor­mal­i­sa­tion of fund­ing mar­kets, could well un­der­pin the val­u­a­tion of Chi­nese off­shore equities (that re­main close to record lows).

So, if as I be­lieve, the new macro en­vi­ron­ment is de­fined by a roughly sta­ble US dol­lar, a roughly sta­ble China, and a re­newed ap­petite for yield among in­vestors, then, cur­rent val­u­a­tions and in­vestor po­si­tion­ing im­ply that the most likely sce­nario is for Asian eq­uity mar­kets to break the past five years’ un­der­per­for­mance trend.

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