MONEY MATTERS
One year on: Many happy returns?
There's scepticism about the asset market rallies of the past 12 months, with many questioning the sustainability of the rebounds
By LIM SAY BOON
ONE year has passed since the 'final capitulation' on global stock markets in March 2009. Economies are continuing to recover - modestly in the West but decidedly 'V-shaped' in most parts of Asia excluding-Japan. Corporate earnings have also picked up. And funds continue to flee safety for equities, corporate debt, commodities, and properties.
But there remains considerable scepticism about the asset market rallies of the past 12 months, with many continuing to question the sustainability of the rebounds.
It is not difficult to be bearish. The risks we had warned of at the start of the year continue to dog the markets. Concerns over the timing and speed of exit from monetary stimulus remain the biggest underlying drag on asset markets. And this is a global concern, evident everywhere from the US to India to China. But there are other issues.
The sovereign debt stress that we warned of at the start of the year surfaced as a major issue over the course of the quarter, with refinancing of Greece's sovereign debt (and the risk of default) in focus over the past three months. Although sovereign debt default was always unlikely - and now most unlikely given EU and IMF safety nets - fears revolving around the sovereign debt rating and credit default swap spreads of Portugal, Italy, Ireland, Greece and Spain (so-called PIIGS) could resurface again through the course of the year. More broadly, markets are likely to remain concerned about the fiscal deficits in other parts of the world, including the UK and the US.
In the United States, it is, again, not difficult to construct a bearish argument on the economic front - government fiscal stimulus and the inventory impact are likely to weaken in 2H10. Meanwhile, there is understandable scepticism of the ability of private sector consumption and capital expenditure to take up the slack in driving growth.
But it is said often that bull markets are born in despair and bear markets are born in euphoria. In that regard, there is some almost perverse comfort in the fact that the economic cycle in the G-7 is hardly robust. Certainly, they are still a long way from peaking - a long way from the commencement of interest rate hiking cycles.
There is a high probability of another positive year for US equities. Yes, it is true the greatest returns after a bear market are registered in the first year of the recovery. We are just past that first anniversary of the rebound. And typically, returns ease in the second year. But out of 11 recession-linked bear markets recorded in the US since the Great Depression, the cyclical rebounds in only two instances were restricted to the first year. Historically, this represents 82 per cent probability of further gains in the second year of the rebound. So it would be a relatively rare event for the US market not to have another positive close this year. It has to be noted though that returns this past year have been outstanding in historical terms. The S&P500 recorded its largest gains, since the Great Depression, in the 12 months from its cyclical trough in March last year. And given the size of the gains over the past 12 months, investors should lower their returns expectations over the next 12 months.
But ultra-low interest rates continue to drive assets away from 'safety'. Near-term, risk appetites remain buoyant. Asset markets have been resilient in the face of considerable negative newsflow surrounding the Euro area sovereign debt in 1Q10.
Assets continued to leave US money market funds. Indeed, ultra-low interest rates - near zero in many parts of the world - continue to be a major driver of funds into risky assets. The assets sitting in US money market funds and bank deposits as a ratio of the S&P500 market capitalisation is still quite some way from normalising to the levels before the collapse of Lehman Brothers. Meanwhile, the net inflows into US mutual funds are still some way from the previous cyclical peak which coincided with a termination of the rally in 2007.
For government bonds, there is a risk of aversion as yields recover from cyclical lows. Government bond yields appear well past their cyclical lows all around the world. The feared revisit of those lows on another round of risk aversion at this stage appears unlikely. Policy rates around the world have bottomed and have started to move up in Asia ex-Japan and in some developed economies such as Australia and Norway. The risk is now for yields to move even higher in coming months.
While we are overweight equities on a three-month view, we recognise this will be a volatile ride. Equities volatility appears underpriced at the moment. Over the coming months, we expect volatility to remain muted and this is bullish for stocks. But the risk is complacency. Investors should not be dogmatic in this environment - they would want to be nimble and be prepared to reposition when the mood changes. But for now, the upside momentum in equities appears to remain intact.
In commodities, the resumption of the US dollar weakness and stronger end-demand should nudge prices higher. Over the past quarter, the broad commodities complex generally traded sideways and more recently, lagged gains in equities. The strength of the US dollar was likely to have been a constraint on prices. A weaker US dollar from 2Q10 onwards is likely to see a narrowing of the recent divergence between commodities and equities - in favour of commodities. Stronger demand in Asia will also support prices.
Investors with greater appetite for risk could consider hedge funds. Broad market gains over the next 12 months are almost certain to be much lower than those registered over the past year. Riding the 'beta' wave is almost certain to be less rewarding. While the broad hedge fund space generally tracks equities - with a 0.98 correlation between the HFRX Global Hedge Fund Index and the MSCI World Index since 2003 (and 0.93 over the past six months) - there are specific strategies which could offer 'alpha' over the course of the coming year particularly if equities volatility rises significantly. But it has to be clearly said that there are huge sector differences within the hedge fund industry, in terms of strategies/styles, management skills, and risk management systems. With the greatest gains already pocketed, stock picking is going to be more important in generating returns over the next 12 months of the equities rebound. Indeed, long-short strategies, effectively executed, could generate better returns than simply riding market 'beta'. Similarly, given the dramatic tightening of credit spreads over the past year, the higher risk profile investor may want to look to hedge funds with expertise in distressed corporate debt and event-driven credit strategies. Again, it has to be stressed that these are higher risk investments than plain vanilla equities or corporate bonds. And that much depends on the skills and risk management systems of the individual fund managers.
The writer is chief investment strategist for Standard Chartered Bank, Group Wealth Management & Private Banking
Copyright © 2010 Singapore Press Holdings Ltd. All rights reserved.
Posts
No comments:
Post a Comment