Market E-digest October 2018 Issue A) Emerging Markets: Diminishing Risks VS. Fears Emerging market (EM) economies are facing a number of insecurities. Investors have grown increasingly concerned about Turkey, particularly its high inflation, its large debt burden, and the economic policies of its president. Worries about emerging-market countries being able to service their debt in light of the strength of the US dollar have caused further equity declines. Assets in Argentina were particularly hard hit when President Mauricio Macri said he would ask for faster support from the International Monetary Fund. Meanwhile, the trade conflict between the US and China has continued, with both countries imposing additional tariffs on each other s goods. However, the current level of unease may be premature. In fact, it is observed that the market starts to price-in the expectation of upcoming US rate hikes gradually. Viewed through a long-term lens, macroeconomic and market fundamentals provide solid ground for EM companies to deliver results and for investors to prosper. Still, it is normal that investors may take a cautious wait-and-see approach for the EM in the current stage. EM Volatility on the Decline Headlines about EM risks are unsettling, yet they tend to obscure the more general trend of declining volatility in EM stock markets. In the past, EM stocks were more volatile than developed-market stocks, as investors perceived them to be much riskier. But while US market volatility has spiked this year, EM volatility has been relatively subdued. Why the change? Consider the composition of the key benchmark. Over the last 10 years, the weight of highly cyclical sectors such as energy and materials in the MSCI Emerging Markets Index has dropped dramatically, while technology stocks have become the largest sector weight. This change has reduced the economic sensitivity and risk profile of EM equities. Yet the index now trades at a price/forward earnings ratio of 11.6x, a 25% discount compared to global developed-market stocks, suggesting that investors still believe developing stocks are significantly riskier. 1
Big Improvements in Deficits and Debt In the past, rising US interest rates and a stronger US dollar were bad for EM assets. But the evidence point to emerging markets becomes less vulnerable to external shocks. Inflation is under control in many countries, which fosters low domestic interest rates. EM currencies are more competitive and external balances are much healthier, with rising foreign investment and less dollar-denominated debt. As a result, neither rising US interest rates nor a stronger dollar are likely to have the same impact on EM countries and companies as in the past. China s Banking Fears Dissipate China s banking system has long been seen as a tinderbox, and over the last two years regulators have reined in the growth of the shadow banking system and throttled credit growth toward nominal GDP growth. Slower credit growth should help improve credit quality for the industrial sector, as should government initiatives to reduce capacity in old-economy sectors like steel while focusing more on the environment. In addition, an increasing focus on profitable retail banking businesses could provide another boost to lenders return on equity. This would further buttress a sector which was seen as a potential destabilising force for years. Political Risk: It s Not All About Turkey China s new focus on environmental issues reflects the government s commitment to pursuing sustainability as a key component of stable long-term growth. While this shift may have been driven in part by political motives, it nevertheless indicates that political risk is declining in the world s second-largest economy. Beyond China, politics are also a diminishing risk factor in other major EM countries such as India and Indonesia. Narendra Modi, who became India s prime minister four years ago, has inspired investor confidence by tackling complex reforms, ranging from anticorruption moves to easing foreign investment restrictions. Indonesia s pro-reform government is also attracting foreign investment and developing infrastructure, while maintaining flexibility to adjust near-term policies to new market challenges. The contrast with the political turmoil in Turkey, Argentina, and Brazil demonstrates that EM countries are far from homogenous. During fifteen EM sell-offs over the last decade, some countries, like Malaysia and the Philippines, have fallen much less than the MSCI Emerging Markets Index did. Others like Brazil and Russia fell more than the index, with a downside capture exceeding 100%. Lower Risk Differential, Stronger Growth Profile Of course, there are real risks in emerging markets. But the fact that a business is exposed to EM dynamics does not necessarily make it riskier. EM countries aren t uniform, and opportunities can be found in diverse companies with business profiles which aren t directly exposed to major risks. How should equity investors react to macroeconomic fears? Macro-analysis is an important risk factor for emerging markets, because currency sell-offs typically trigger a simultaneous downturn in all asset classes. As a result, even strong stocks will be hit hard in a crisis. 2
On the other hand, a positive macroeconomic outlook isn t reliable as a single guide. Companies in stable regions which have strong business, a healthy balance sheet, and a robust outlook to support equity returns are the most likely to continue performing. The risk differential between emerging and developed markets is much lower than in the past, while emerging markets still offer superior growth potential. Profitable EM companies that are deploying capital well may be attractive, especially in the period before an upturn. In identifying stocks with strong growth profiles and unappreciated return potential, company fundamentals are often more important than headline noise. Disclaimers As of 31 st August, 2018. Source: AB. The information contained here reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein L.P. makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realised. Past performance does not guarantee future results. The views expressed here may change at any time after the date of this publication. This document is for informational purposes only and does not constitute investment advice. AllianceBernstein L.P. does not provide tax, legal or accounting advice. It does not take an investor's personal investment objectives or financial situation into account; investors should discuss their individual circumstances with appropriate professionals before making any decisions. This information should not be construed as sales or marketing material or an offer of solicitation for the purchase or sale of, any financial instrument, product or service sponsored by AllianceBernstein or its affiliates. Investment involves risk. This document has not been reviewed by the Securities and Futures Commission. The issuer of this document is AllianceBernstein Hong Kong Limited. 2018 AllianceBernstein L.P. The [A/B] logo is a service mark of AllianceBernstein and AllianceBernstein is a registered trademark used by permission of the owner, AllianceBernstein L.P. Source: AllianceBernstein Hong Kong Limited October 2018. Information herein is based on sources we believe to be accurate and reliable as at the date it was made. We reserve the right to revise any information herein at any time without notice. No offer or solicitation to buy or sell securities and no investment advice or recommendation is made herein. In making investment decisions, investors should not rely solely on this material but should seek independent professional advice. 3
B) Market Update United States Non-farm payrolls increased by 134,000 jobs in September, lower than the market expectation of 185,000 job gains, following the previous month s upwardly revised jobs gain of 270,000. Meanwhile, the unemployment rate dropped to 3.7%, the lowest level since December 1969, while market expectation had been that it would edge down to 3.8%. The federal funds rate is expected to gradually increase as supported by economic conditions, but to stay at 2.00% - 2.25% in the near future. Canada The unemployment rate was down 0.1 percentage points in September to 5.9%, in line with the market forecast. Yet there was a net drop of 16,900 people in full-time employment during the same period, while the number of those in part-time employment increased by 80,200. The market generally expects that the Bank of Canada raising the interest rate to 1.75% at its coming monetary policy meeting. Eurozone Retail sales in August dropped by 0.2% month-on-month, worse than the market expectation of 0.2% growth. On a year-on-year basis, retail sales rose by 1.8%. It is expected that the European Central Bank will hold the interest rate at 0.00% in the near term. United Kingdom The nationwide house price index rose 0.3% month-on-month in September, while the services PMI dropped to 53.9 from 54.3. The market generally expects interest rates to stay unchanged in the near term. Australia Retail sales rose 0.3% in August from the previous month, higher than the market expectation of a 0.2% growth. It is expected that the cash target rate will stay at 1.50% in the near term. Japan Total cash earnings for labour rose by 0.9% in August when compared with the same period last year, below market expectation and down from a 1.5% gain in July. Yet overall household spending rose by 2.8% annually, better than the market expectation of a 0.1% gain. It is believed that the Bank of Japan will continue with loose monetary easing policy in the short term, including maintaining a benchmark rate of -0.1% for excess reserves. China According to the Government Work Report 2018, monetary policy should be kept at a prudent neutral. The Chinese government is expected to keep interest rates on hold. Hong Kong The average 3-month LIBOR rose from 2.38% to 2.40% during 28th September 4th October, while the average 3-month HIBOR rose from 2.19% to 2.20%. It is expected that the prime rate will stay at its current level in the near term. Source: BEA Economic Research Department 4
C) Major Indices Major Equity and Bond Index Major Currency and Commodity Index Data as of 30 th September, 2018. Source: Bloomberg 5
Important Notes: The commentaries in this document are prepared by The Bank of East Asia, Limited ( BEA ) with support from AllianceBernstein Hong Kong Limited. The remarks made by author from AllianceBernstein Hong Kong Limited in the article in this document represent his/her personal opinions only and do not represent those of the Bank. The information and commentaries in this document (i) are provided solely for informational purpose and reference only, (ii) do not constitute any offer, solicitation, invitation or advice to buy or sell any securities or investment products, and (iii) are subject to change without notice. BEA makes no guarantee, representation or warranty as to the accuracy, adequacy or completeness of the contents of this document and under no circumstances will BEA be liable for any loss, costs, damages or whatever caused by the use of or reliance on the contents of this document. Investment involves risk. Before making an investment decision, investors should refer to the relevant investment product offering documents for detailed information including the risk factors. Investors should not make any investment decision based on this document. If investors are in doubt, independent professional advice should be sought. BEA hereby expressly disclaims any liabilities in connection with the use of or reliance on the contents of this document. Issuer of this document: The Bank of East Asia, Limited This document has not been reviewed by the Securities and Futures Commission in Hong Kong. Issued by The Bank of East Asia, Limited 6