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Rising geopolitical risks may not dent asset prices

[SINGAPORE] With a sudden escalation of geopolitical risks last week, markets are due for a bout of renewed volatility. But market players say this does not necessarily mean asset prices would fall.

All eyes are on a string of data to come this week, such as US consumer price index figures and corporate earnings, as well as a China flash manufacturing report.

Given current market confidence, higher volatility is more likely to result in asset prices going up, said fund manager Fidelity's equity income franchise investment director Charles Payne. "If higher volatility results in downsides, (investors could) increase their equity weightings ... it doesn't feel like the world is ridiculously overvalued. Large caps still have some more to go," he told The Business Times yesterday morning.

Citi strategist Mark Schofield said yesterday that he sees geopolitical risks as "localised" provided central banks continue to support markets.

Citi sees the three key risks to market stability as a tighter US Federal Reserve policy next year, a significant China growth slowdown and a surge in oil prices due to a supply shock.

But ultimately, global equities still have upside despite recent gains, due to a "steady improvement in the macro backdrop and better earnings prospects", Citi said. "We are forecasting 9 to 10 per cent earnings per share growth in both 2014 and 2015," it said.

Mr Payne highlights opportunities in large oil and pharmaceutical stocks as well as Asian stocks in countries like Taiwan, Korea and Japan.

Big oil players have spent the last 10 years spending money on exploration and are now poised to be more shareholder-friendly in giving more dividends, he said.

A Bloomberg search shows that Shell and BP are trading at forward earnings ratios of around 11 times, with dividend yields of about 4 to 5 per cent.

Pharmaceutical companies, meanwhile, could benefit from long-term trends of an ageing population, and are less affected by cyclical factors, he said.

Fund managers have been agonising over whether extraordinarily low volatility in the past few months portend a coming crash. A survey of 562 investors by Bloomberg last week found that three in five say the market is on the verge of a bubble or already in one. Two thirds expect the Chicago Board Options Exchange Volatility Index, or VIX, to rise in the next six months. VIX tracks the implied volatility of the S&P 500 index options.

Historically, stock market volatility is higher in the second half of the year, Mr Payne said. It was not surprising that volatility was low in the first half, he said. "This could be because of reporting cycles in March and September. Once you've absorbed the March results, you wait for the next cycle. Many cultures also take holidays in summer," he said.

But three geopolitical worries are coming to the fore: the heightening risks of a West-Russia conflict; the invasion of Gaza by Israel to quell Palestinian resistance group Hamas; and the Islamic State of Iraq and the Levant's (ISIS) ascendancy in Syria and Iraq, which has escalated violence and uncertainty in the Middle East.

Last week, Espirito Santo International, the holding company for Portugal's second-largest bank, filed for creditor protection.

But market reactions to all the above have been relatively muted. Mr Payne argues that market players are more confident than ever. "If this was 2012, if the world was in a shaky place, there would be an immediate reaction," he said.

One risk, however, is that US third-quarter earnings disappoint, he said.

Dividend income might also look attractive if global growth remains slow, said Threadneedle's chief investment officer Mark Burgess. He likes UK equities for their attractive dividend yield. Fidelity's Mr Payne points out that after last year's "multiple expansion" - an increase in the number of times of a stock's earnings investors are willing to pay - investors will start looking at yield stocks again.

But Societe Generale cautioned that the spike in geopolitical risk is a threat to some Asian markets.

"Rising risk aversion would tend to push up safe-haven currencies such as the yen and perhaps the Korean won, while depressing emerging market currencies in the region, with the Indian rupee arguably especially vulnerable," it said.