Sept rate hike chances fade as markets plunge

Singapore

GLOBAL stocks tumbled on Friday after the weakest manufacturing data from China since 2009 exacerbated negative sentiment. Singapore's benchmark Straits Times Index (STI) fell through its 3,000-point support to end the week at 2,971.01 points.

The night before, Wall Street had suffered its biggest fall in 18 months. Investors are fleeing to safety, with US 10-year bond yields at 2.1 per cent from 2.5 per cent a few months ago.

Given the volatility around the world in spite of improving conditions in the US, market players are scaling back expectations for a September rate hike, while predicting more easing from China's central bank.

"Financial market turbulence will inevitably reduce the chance of the Fed raising interest rates in September," said Richard Jerram, Bank of Singapore's chief economist, in an Aug 21 report.

"If conditions permit, then September makes sense. If there is some doubt, then waiting until December is more likely. There is still a month to go until the next policy meeting and probabilities are fairly evenly balanced," he said.

Tan Eng Teck, senior portfolio manager at fund house Nikko AM Asia, told The Business Times over the phone that there is a chance for China to roll out strong measures to bolster confidence in the economy after Friday's manufacturing reading.

"It will probably be in the form of monetary measures, reserve requirement ratio cuts. It's also a good time to instil some fiscal measures after the Tianjin incident. They need to rebuild a lot of things anyway," Mr Tan said.

On Friday, the flash Caixin China general manufacturing purchasing managers' index (PMI) fell to 47.1 in August, a 77-month low, compared to a final reading of 47.8 in July.

The closely-watched index comprises responses by purchasing executives in over 420 manufacturing companies to questions on indicators like new orders, output and employment. Scores below 50 indicate that China's manufacturing sector is shrinking.

Kelvin Tay, regional chief investment officer at UBS Wealth Management, said that the weak data points to further weakness in the Chinese yuan.

"As a result, Asian stocks are being liquidated by international funds keen to avoid a sharp drop in their portfolios which are largely measured in US dollars," he said.

Mr Tay added that the latest bout of market volatility is also caused by a host of other factors: falling oil prices amid rising US stockpiles, declines in energy and commodity stocks that make up a significant proportion of global stock indices, uncertainty over upcoming Greek snap elections, and mixed signals on a rate hike from the Fed.

"We are still moderately pro-risk and maintain our preference for equities over bonds, with overweight positions in European and Japanese equities where central bank policies are largely loose and pro-growth," he said.

The timing of the US rate hike - the first in almost 10 years - is highly significant for global markets. This is because higher interest rates mean higher discount rates, causing assets to be repriced lower assuming no substantial growth in incoming cashflows. Higher rates also mean funds will be attracted back to the US from emerging markets.

Aneta Markowska, chief US economist at French bank Societe Generale, said in an Aug 19 note that international developments have made a September rate hike a close call.

Yet she is still sticking to her view of a September hike because she thinks most Fed committee members regard inflation as driven by domestic developments. "They will be reassured by recent growth and employment statistics," she said.

An October hike will mean the lack of a scheduled press conference and announced forecast changes, while a December hike is not an attractive option due to year-end pressures on rates and a potential first-quarter slowdown in activity, she said.

Meanwhile, a delay till 2016 seems too drastic. "For the Fed to push the lift-off into next year, there would have to be a significant downward adjustment in the growth outlook which is highly unlikely in our view," she said.

Henderson Global Investors fund manager Sat Duhra, who manages Asian dividend income strategy, said that asset prices might only stabilise once the US raises rates and there is confidence that China will not devalue its currency further.

"It is only then that investors will begin to look towards a very attractive longer term reform based story in Asia supported by compelling valuations," he said.

Given weak growth elsewhere, a dividend growth strategy could outperform, Mr Duhra said.

He likes telco towers for their high returns, cashflow generation and exposure to data growth. Dividend plays can also be found in China, where more companies are paying dividends and payout ratios could increase as capital expenditure levels fall, the economy grows, and indebtedness levels stabilise, he said.

Nikko AM's Mr Tan said that he is looking to invest in the next two to three weeks. Mid-cap stocks in Asia are looking attractive, he said.

While mid-cap and small-cap stocks bore the brunt of selling, there are still quality companies around, he said.

"If you're a newcomer, you might have some advantage in terms of technology or product or marketing and service. Then your market share could go up from 3-4 per cent to 10 per cent, so that even if the market is stagnant, you can still grow earnings," he said.

He likes automation companies in Taiwan. They have done poorly because of competition from Japanese companies boosted by the devalued yen. But after a year of cost-cutting, these Taiwanese companies can compete again with lower prices, Mr Tan said.

These companies are trading at 15 to 18 times earnings, which is low compared to the 18 to 20 times that larger competitors with slower growth prospects trade at, he said.

On a broader note, Franz Wenzel, chief strategist at AXA Investment Managers, said emerging markets will continue to face headwinds due to poor fundamentals, like weak profit margins and high leverage.

"A stereotypical observer would point out that valuations are cheap and a lot is discounted already. We beg to disagree. Admittedly, emerging markets seem to trade at a decent valuation discount (13.5 times versus 20 times on trailing earnings, MSCI indices). Yet this discount is bang in line with historical norms," he said in an Aug 20 note.

A Citi asset allocation note on Aug 20 said that emerging markets are slightly more attractive, but not substantially so.

"We are now neutral all emerging market assets, up from overall underweight last month. But emerging market fundamentals and Fed tightening are still enough to stop us entering a contrarian overweight position."