Faced once again with the prospect of rate rises in the United States, investors in Asia are no longer selling and running as in the past, choosing instead to stay in markets like India and South Korea, that are relatively sheltered from global forces.
The two bouts of market turmoil in May 2013 and January this year demonstrated the perils of selling out of markets prematurely and indiscriminately.
This time, investors have already begun preparations for a rise in U.S. rates by mid-2015 at the earliest, albeit with a degree of caution about the different moving parts to the policy story.
For one, central banks in Europe and Japan could soon be injecting stimulus, which would compensate the world for the cash the Federal Reserve is withdrawing.
And secondly, it is entirely plausible that U.S. growth disappoints, thereby keeping yields down but pushing stock markets sharply lower.
Standard responses to a spike in U.S. rates, such as avoiding Indonesia, India and other countries which rely on external funding, may no longer be appropriate, given how rapidly Asia has changed in the past year.
The region’s current account deficits are smaller, bond yields are high and currencies already quite weak. Governments perceived to be more reform-oriented have taken over in India and Indonesia, and Asia’s rallying stock markets are backed by robust growth in company earnings.
“You should be in countries where idiosyncratic forces are more dominant drivers than the global forces,” said Jahangir Aziz, head of Asian research at JPMorgan. “They allow you to hedge against global changes.”
As of now, both Asian equity and bond markets are still riding a six-year long rally spurred by the heavy quantitative easing policies of the Fed and other developed economies.
But investors are prone to worry, says Aziz, and this abnormally long period of very low volatility and memories of the vicious selloff in 2013 have made them uneasy.
“There could be significant pre-emptive reaction in the market to the likelihood of better U.S. growth, jobs or inflation numbers. That is where the concern is,” he said.
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The basis for investment is belief that, unlike the scares in 2013 and early 2014, the Fed will raise rates only when it is confident that the economy is on track for higher growth, more jobs, better demand and investment.
“You are at that stage of the global cycle where the traditional growth or high-beta assets are what you want to own,” said Huw McKay, Westpac’s chief Asian economist based in Sydney. “You don’t want to be back in safe haven assets such as U.S. bonds.”
The decision to stay invested in high growth emerging markets in Asia is the simpler one.
Markets are pricing little change in the already low U.S. yields – 10-year yields are around 2.4 per cent, and the forwards markets indicate little to no growth or inflation prospects. The equity market meanwhile is consistently reaching for record highs.
The more challenging issue for investors is that of deciding which shoe drops first, bonds or equities. As yields rise, bond prices would drop.
“Secular stagnation is being priced into the bond markets, strong nominal growth is being priced into the equity markets. One of these is more wrong than the other, or even both could be wrong,” said UBS strategist Bhanu Baweja.
Still, that happy co-existence of surging bond and equity prices could very well continue, and should fund managers sell before an actual turn in the market they could risk underperforming peers and global indices.
“You’ve got to survive to that point,” says Baweja. “You can’t go short the markets right now.”
The consensus however ends there.
Westpac’s McKay finds India has made greater strides in fixing its current account problem, more so than Indonesia which was one of the worst hit in 2013. Plus, in a scenario where a rise in U.S. yields is preceded by strong global growth, India’s services exports would benefit hugely.
McKay also reckons the winning markets this time might be in countries, like South Korea, that offer foreigners a seamless transfer from equities to bonds.
“If you have both asset classes to offer in local currency, you can actually see a transfer rather than switching out of the currency altogether to go back to the dollar,” McKay said.
JPMorgan’s chief Asian economist Jahangir Aziz warns that now is not the time to look for global plays, or heavy bets on assets linked to U.S Treasury yields or broader emerging market risk.
“India and Indonesia is where you want to be right now,” he said, citing the new governments and possible policy changes in both economies that will proceed regardless of global factors.
Investors should be wary of being too exposed to China, should there be a decline in global demand and therefore in the exports that are driving Chinese growth, he said.
Blackrock’s head of Asian equities prefers being more exposed to North Asian markets such as China, Taiwan and Korea, both because of their valuations and healthier current accounts.
“As a recipient of little investor flows in recent years, we believe Asian equities are well placed to receive more interest even if U.S. rates begin to rise,” he said. Blackrock has $US344 billion of long-term assets under management in Asia.
(Editing by Simon Cameron-Moore)
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