Global Investment Outlook for 2H 2016 Major central banks apart the Fed may stay in easing mode due to heightened economic and political risks. China s economy in 2H 2016 may continue to stabilize but with downward pressure on growth while the government may instigate more fiscal policy and maintain its prudent monetary policy to avoid an economic slowdown. Lowering view on global equity markets to neutral ; remain positive on U.S. Dollar high-yield corporate bonds. The USD may remain strong on safe haven buying and monetary policy divergence between the Fed and other major central banks. Key Themes for 2H 2016 Investment Market Tepid Global Economic Growth SHK Private expects Brexit to cast a shadow over the global economy and the uncertainty it brings may materially weaken the global economic outlook in 2016. This prolonged period of uncertainty and associated declines in business and consumer confidence may result in lower global growth. Economic growth in China may also remain weak as the second largest economy in the world sheds its prior excesses of strong credit and investment growth and transitions to a more balanced growth economy. The U.S. was one of the relatively bright spots on the back of an improving job market and rising personal income. Rising Political Risk - Brexit opened Pandora's Box in Europe, which may embolden other European skeptic parties to call for more exit referendums in the coming months. Meanwhile, the forthcoming Brexit negotiations and elections in Europe next year have raised political risk in the region. On the other side of the Atlantic, uncertainty over the U.S. presidential election in November is also a matter for concern, which has two unpopular candidates running against each other. Such escalating political risks may bring more volatility for global equity markets in 2H 2016. Central Banks ready to provide ample liquidity - The roadmaps of central banks policies have changed after Britain decided to leave the EU. The Bank of England is likely to cut its key interest rates and expand the asset-buying program to combat potential recession risk. At the same time, the European Central Bank may provide more stimulus as plunging confidence and market turmoil may dent investments and growth in the euro zone, weighing on inflation. Meanwhile, Brexit may delay any interest rate July 05, 2016 Page 1 of 5
"normalization" by the Federal Reserve. In the Far East, the Bank of Japan is also poised to ease. The result is even more global liquidity, further entrenching the low interest rate environment. China - The economy to stabilize China s economy to stabilize - SHK Private expects China s economy to continue to stabilize in 2H but with escalating downward pressure as global economic conditions worsens while Brexit and the November U.S. presidential election may create a period of great uncertainty going into Q4. China s economy is undergoing an L shape recovery led by the growing property and related sectors, the increasing domestic demand for services and a slowly improving industrial sector. In particular, State Owned Enterprises (SOEs) are undergoing more accelerated reforms in 2H including reducing overcapacity by lowering production, mergers, strategic restructuring and SOE mixed ownership. China s Gross domestic product (GDP) growth for Q2, due on July 15, may show the economy is still relatively stable at 6.7% YoY, the slowest pace since the global financial crisis but still in line with Beijing's official 2016 target range of between 6.5%-7.0%. RMB to stabilize before inclusion in the SDR - The PBOC will continue its strategy of supervising RMB weakness as China s policymakers attempt to manage investors expectation while avoiding depreciation of the RMB in a one-off move similar to last August which depleted China s Forex reserves as China supported its currency to slow capital outflow. The PBOC ultimately will slowly steer the central parity fixing rate lower with reference to the CFETS RMB Index s currency basket while stabilizing the currency before its official entry into International Monetary Fund (IMF) s global basket of reserve currencies (SDR) in October. PBoC likely to cut RRR - The PBoC may not cut interest rates before the RMB s entry into IMF s SDR as this may indicate a clear signal for the currency to depreciate further. However, further cuts in reserve requirement ratios (RRR) is a preferred option coupled with cash injections in the financial system as such prudent monetary policy lowers lending rates while not pressuring the RMB. A shares to recover - Meanwhile, China A shares are expected to edge higher in Q3 as China's strict capital controls have helped shield Chinese stocks from the worst of the global market turmoil which was triggered by Brexit. Sentiment has improved on numerous fronts including; the imminent commencement of the Shenzhen-HK Stock Connect, the campaign to reduce overcapacity in the steel and coal sector this year, more accelerated SOE reforms, financial reforms including further opening up of the bond market and A shares being included in MSCI Inc. s global indexes before 2017. Asset allocation - Neutral on global equities; Positive on U.S. High Yield On the heels of the Brexit developments and uncertainty over U.S. presidential election, SHK Private lowers its view on equity markets to neutral, but prospects for global liquidity provided by central banks worldwide may continue to support global equity markets. Government bond yields in U.S., Eurozone, July 05, 2016 Page 2 of 5
Japan and the UK have approached or reached their multi-year lows, but they may go even lower on the back of ample liquidity. Some of the funds sitting in negative yielding government bonds may turn to corporate bonds in search for yield. We remain positive on U.S. Dollar denominated high-yield corporate bonds as energy prices have stabilized and the asset class offers attractive yields to investors. U.S. Dollar investment grade credit may also benefit on flight-to-quality demand. Overall, we continue to hold a neutral weight in bonds in our asset allocation. China and Hong Kong - HSI year-end target 22,300; HSCEI target 10,000 SHK Private is positive on Hong Kong and China equity markets. The year-end target for the Hang Seng Index (HSI) remains at 22,300 as the delay of raising interest rates by the Fed may support Hong Kong utilities and property stocks while Brexit uncertainty and moderate China economic data raises hope of possible further targeted monetary easing and fiscal stimulus by the Chinese government. The year-end target for the Hang Seng China Enterprises Index (HSCEI) remains at 10,000 as H-Shares become more attractive to investors as: 1) Trading in HKD and not in RMB and thus avoiding possible Forex losses; 2) Trading at a discount to A shares by 35% according to the HS China AH Premium Index; 3) Cheap valuations with a 6.76x F12M P/E and a 0.84x F12M P/B; 4) The launch of the Shenzhen-Hong Kong Stock Connect in 2H; 5) More SOE reform and supply side reforms; 6) Further fiscal and monetary easing in 2016; Our year-end target for the Shanghai Composite Index remains at 3,500 as China's policymakers primary priority now is to stabilize the economy and the stock market while deepening financial reform, setting up framework on cross-border capital flow, and opening up in 2016. The potential inclusion of China s A- shares in the MSCI Emerging Markets Index and other global and international benchmarks coupled with opening up the stock markets make China s various equity markets more liquid and more balanced and enabling more Chinese companies to utilize this platform to raise capital. U.S. - Presidential Election on focus; Fed to delay next rate hike U.S. presidential election will be held in November this year with Democratic candidate Hillary Clinton and Republican candidate Donald Trump running head-to-head. Although it is impossible to ascertain who will win this November, a Trump presidency may cause a great deal of uncertainty across the nation which has the potential to cause a shakeup in global equity markets. In the wake of Brexit vote that stunned investors, we now expect that Federal Reserve may raise its benchmark interest rate again as early as December. A tight U.S. labour market, rising wages and stable growth are factors that could compel the Fed to move. However, the impact of Brexit to U.S. equities should be fairly modest as less than 10% of sales for S&P 500 Index companies come from Europe. SHK July 05, 2016 Page 3 of 5
Private reiterates its target of 2,160 points for the S&P 500 Index by the end of 2016 on the back of earnings growth and stabilizing energy prices this year. Europe - Brexit brings more uncertainty to the region; More easing from BoE Brexit will bring into focus the negotiations between the EU and the UK in the second half of 2016, but EU has little reason to make it easy for the UK as this will create a dangerous precedent for other EU members. Meanwhile, Brexit may also bring more political uncertainties in the region, and escalate the possibility of more upheaval for populist parties in some of the countries facing elections this year. In response, the Bank of England is likely to cut interest rates and expand its asset-buying program over summer to combat a post-brexit vote slowdown, and the European Central Bank may expand the scale and scope of its qualitative program if a severe crisis happens. Japan - Doubt over Abenomics ; Strengthened Yen hurt Japan Inc. The Bank of Japan may unleash another round of monetary stimulus but the central bank s capability to push down the Yen is now in doubt. The adoption of a negative deposit rate earlier this year failed to curb its gains. A resurgent yen since the beginning of this year may hurt earnings growth of export-oriented Japanese companies. Meanwhile, the lackluster Japan economic data heighten concerns over the effectiveness of Abenomics to stimulate economic growth and to reach central bank s 2.0% inflation target. Strengthened Yen and weak economic growth may cap Nikkei 225 at 17,000. Global FX - U.S. Dollar to remain strong; CNH to depreciate to 6.8 The U.S. Dollar should remain strong against its peers as monetary policy divergence between the U.S. and other major markets re-emerges. It is likely that the Bank of England and the European Central Bank may loosen their monetary policies to mitigate the fallout of Brexit. Concerns of offshore Renminbi (CNH) depreciation had slowed over the last few months but the downside risk remains for the second half of 2016 amid weak economic growth. The Bank of Japan may expand its asset-buying program to combat strengthened Yen but investors appear to be losing patience with Abenomics, which may limit Yen s downside risk. Disclaimer Neither any opinion contained in this article constitutes a solicitation or an offer by any member of SHK Private, their directors, representative and / or employees to buy or sell, whether as principal or agent, any securities, futures, options or other financial instruments. The instruments and investments discussed may not be suitable for all investors, and this article has no regard to the specific investment objectives, investment experience, financial situation or needs of any particular investors. Investment involves risk. The prices of securities, futures contracts, options and other derivatives may move down and up, sometimes dramatically. Investors must make their own investment decisions based on their own investment objectives and financial position and consult your independent professional advisor as to the suitability of your situation prior making any investment. July 05, 2016 Page 4 of 5
SHK Private Address: 19/F, Lee Garden Five, 18 Hysan Avenue, Causeway Bay, Hong Kong Telephone: (852) 3920 8020 Facsimile: (852) 3920 8000 Email: enquiry@shkprivate.com July 05, 2016 Page 5 of 5