Stocks to do well amid taper this year: DBS

Fed strategy to exit bond-buying programme bodes well for economy

Published Fri, Jan 3, 2014 · 10:00 PM
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STOCKS will do well in 2014 amid tapering by the US Federal Reserve, says DBS wealth management chief investment officer Lim Say Boon, who calls for an "overweight" stance across the United States, Europe, Japan, emerging markets, Asia ex-Japan and China equities for investors with a 12-month horizon.

He is "neutral" on emerging markets, Asia ex-Japan and China on a three-month basis.

Speaking at a media briefing yesterday, he said: "Our views on 2014 are a continuation of themes developed in 2013. We continue to favour equities over bonds. In equities, we favour developed markets over emerging markets.

"In bonds, we favour corporate bonds over government bonds, and within corporate bonds, we favour high-yield over investment-grade."

DBS' stance is in line with most other banks'.

Mr Lim believes that tapering, the major theme shaping financial markets since May 2013, is not to be feared. This is because the Fed's strategy to exit its bond-buying programme bodes well for the economy and has historically benefited equities.

As the Fed "tapers" this month and buys fewer long-term assets, causing demand for them to fall, prices will fall and bond yields will rise, raising the cost of borrowing.

Investors typically fear that higher interest rates will negatively affect stock prices, by inducing a drag on the economy and causing assets to be valued less due to a larger discount rate on future cash flows being used.

But they need not worry, Mr Lim said, pointing to history.

While a higher US 10-year Treasury yield causes price-to-earnings multiples (PE ratios) on the S&P 500 to fall, there is still some way to go before yield increases start negatively affecting stock valuations. The 10-year Treasury yield is at 3 per cent now and it is not until after the 6 per cent mark that valuation multiples typically fall, he said.

Meanwhile, the equities risk premium - how much investors are willing to pay for stocks over bonds - is still high, meaning there is much more to be gained from stocks than bonds.

Another indicator is how the Fed's exit strategy for its bond-buying programme had caused the bond yield curve to steepen, with higher rates for longer-term bonds and lower rates for short-term bonds.

Mr Lim said: "Historically, it is unusual for the US to have a recession and go into a bear market under these conditions."

More importantly, consumer confidence is recovering in the US along with corporate investment. And even though earnings multiples point to the US market trading at above historical averages, investors "should not be overly obsessed" with them, he said.

"Just because the market is cheap doesn't mean the bear market is over. Just because they are expensive doesn't mean the bull market is over. They tend to overshoot on both sides," he said, adding that price-to-book (PB) ratios, another valuation technique taking into account a company's net-asset value, are still below average.

In Europe, the picture is one of slow but significant improvement, he said. Primary balances, a measure of whether the government spends more than it gets in revenues, have improved from five years ago. Italy and Greece are even running primary balance surpluses now - although this measure does not include interest payments on debt.

Europe stock valuations, at 14.9 times forward earnings, are no longer cheap. But they are still lower than the 15.3 times for Japan and 16.6 times for the US. Corporate earnings should catch up along with the US as a cyclical recovery takes hold, Mr Lim said.

In Japan, stocks are likely to continue to do well because the Bank of Japan's money printing will devalue the yen, stimulating the economy and improving inflation expectations. If the percentage of stocks held by Japanese households goes back to 2007 levels of 12 per cent, up from current levels of around 7 to 8 per cent, a 20 to 25 per cent rally in the Nikkei can still take place. "There's a huge amount of cash out there," Mr Lim said.

For emerging markets, valuations are near lows. Observers have been urging investors to stick to countries with current-account surpluses, as they will be less affected by fund outflows as US long-term yields go up and US bonds become a more attractive proposition than local-currency stocks and bonds.

China, Russia, Malaysia, Singapore, Korea and Taiwan are examples of current-account surplus markets, favoured over deficit countries such as India, Indonesia and Brazil, Mr Lim said.

China's economic restructuring, positive in the medium term, might cause "some discomfort" and stocks might not go up in the near term, but valuations "trudging along at a bottom" signal opportunities, he added.

The most significant risk to Mr Lim's positive stock views are US corporate earnings growing less than expected, as higher costs cause profit margins to come down from cyclical highs.

"But that's not the central case," he said.

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