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Emerging markets now back on strategists' radar

Pundits expect less hawkish Fed and weaker greenback - conditions favourable to EMs

After last year's battering due to US interest hikes, emerging markets (EMs) have re-emerged on strategists' radar, as these pundits foresee a less hawkish Fed and a weaker greenback - conditions favourable to these markets.


AFTER last year's battering due to US interest hikes, emerging markets (EMs) have re-emerged on strategists' radar, as these pundits foresee a less hawkish Fed and a weaker greenback - conditions favourable to these markets.

Besides going overweight on emerging markets (EMs), pundits also suggest going long on the yen, gold and the Chinese yuan. Some say they would short the US dollar.

And volatility is to stay if they are spot on.

Saxo Bank Group's chief economist and chief investment officer Steen Jakobsen expects central banks and governments to renew their fiscal and monetary policy support for the economies, and that the intervention would present investment opportunities for the Chinese, Japanese and European Union currencies, gold, EMs and fixed income.

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He said four forces plagued 2018, listing them as the collapse in the quantity of money, the higher price of money, costlier energy and the wave of anti-globalisation (trade tensions).

This year, however, some of these forces will turn favourable, he said. For example, the price of money is set to fall, as the US Federal Reserve is widely expected to halt rate hikes; it may even cut the benchmark for pricing loans.

Mr Jakobsen said major central banks and politicians are responding to these four disruptive forces by "massively trying to undo what happened in 2018".

But the impact of any of their moves will not be felt immediately because the quantity of money takes about nine months from initiation to show its full impact on the economy.

The strategist also noted that the US market is the most expensive, with stocks trading at 15 times the forward price-to-earnings (PE), whereas the Chinese market and EMs are trading at 11 times the forward PE.

He said this is unusual because EMs have higher growth and inflation, and should, theoretically, have a higher PE.

Mr Jakobson said: "Cheap play to be had, to be long China, long EMs, long MSCI World, relative to the US... early part of this year is underweight the US, overweight everything that benefits from the global policy panic, which comes through the US dollar's lower rates and weaker US dollar... you would see EMs doing very well."

UBS global wealth management's regional chief investment officer Kelvin Tay noted that EMs are trading at about a 20 per cent discount to developed market equities, based on trailing PE.

Asset manager Schroders sees brighter prospects for EMs as well - as long as the Fed rate hikes stop, which would provide much needed respite for the EMs that were hit hard by higher Fed rates and had also experienced an exodus of foreign capital last year.

James Ashley, head of international market strategy on the strategic advisory solutions team at Goldman Sachs Asset Management, prefers EMs to developed markets, because asset prices and market expectations have adjusted significantly lower after a challenging 2018.

With valuations looking more attractive, "we believe 2019 can offer important advantages relative to 2018".

While lower interest rates bode well for EMs, they would reduce the allure of the US dollar, which in turn would enhance the lustre of gold.

Stefan Hofer, managing director and chief investment strategist at LGT Bank Asia, echoed Mr Jakobsen's views on the greenback's expected depreciation, saying that this would set the stage for gold prices to go up.

"A weaker dollar will simply keep gold supported. I don't think gold... is going to shoot to the ceiling. It's not going to be a huge money-maker. In an environment where the dollar has lots of reasons for depreciating, the flip side of that is to buy gold," he said.

UBS' Mr Tay said recent market volatility has confirmed that gold remains a safe-haven asset and helps to reduce volatility in a portfolio.

"Hence, as we enter the later stages of the cycle, we still like gold's insurance qualities in a portfolio context. We expect gold to trade at US$1,300 an ounce in six months, and US$1,350 an oz in 12 months."

Despite roller coasters in the markets last December, LGT's Mr Hofer advised staying invested, but to buy defensive stocks such as US technology and healthcare counters. "As this cycle matures, one thing that investors ought to be doing is becoming a little more defensive."

He thus recommends having a sizable portion of cash on hand, so that one can take advantage of dips during the year, which he expects to be "extremely volatile".

Cash was the best-performing asset class last year.

Mr Hofer pointed out that the investment cycle has not reached the point where investors need to be super defensive and cut out risky assets, which might result in their "missing out on some interesting rallies in the market".

Goldman Sachs' Mr Ashley believes economic fundamentals are robust, and the operating environment is still solid. He said: "Our macro outlook reflects an ageing economic cycle, but not the end of it. In a nutshell, while it is too early to de-risk, it is not too early to diversify. Hence we still view as more attractive those asset classes with a higher beta to global growth."

UBS' Mr Tay is overweight on Asia (excluding Japan) equities, "given the current valuation discounts plenty of negative factors".

Among the Asian countries, China is preferred by several strategists. LGT's Mr Hofer, for example, has faith in the strength of the Chinese economy despite it hitting speed bumps.

He cited the Singles' Day retail sales last Nov 11 on the Alibaba online platform, which amounted to about US$30 billion - equivalent to 8 per cent of Hong Kong's annual gross domestic product, in just one day .

Pundits also are bullish about the yuan as they expect it to be revalued upwards if there is a trade deal between the US and China.

As for the yen, Japan's quantitative and qualitative easing and yield curve control have weakened the currency considerably in recent years, said UBS' Mr Tay said.

"We believe monetary policy bias is turning less expansive. A reversal is eventually expected over the longer term and should help strengthen the yen, " he added.

But there was a word of caution for fixed-income investors.

UBS' Mr Tay singled bonds out as a less-than-ideal asset class in a late cycle, because rising default rates will erode coupon accumulation.

Goldman Sachs' Mr Ashley reminded investors of late-cycle characteristics - tighter credit spreads, increased leverage, potentially increasing defaults and higher volatility.

"Fundamentals remain intact, but beta-driven caution is warranted in both investment grade and high yield, as security selection becomes increasingly important," he said.

He said that as the cycle matures, fundamental, bottom-up security selection (looking for "alpha") becomes increasingly important relative to owning the whole market at the index level (the "market beta").

"It is important to be selective and to diversify (by sector and above all, at the stock level) for credit investors. Avoiding 'big losers' (company defaults) is key, and this can be done only by being active and focusing on bottom-up selection."

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