Anticipated US rate hike spurs markets and bad debt fears

Investors fret about rates going up faster than expected, but optimists say Fed will eye global conditions


ASIAN markets rallied on Thursday after the US Federal Reserve made a historic and widely anticipated move to raise interest rates, but concerns over bad debt dampened sentiment in some quarters.

Bearish commentators warn that slowing economic growth, coupled with interest rates going up faster than expected, will further stress companies trying to repay their loans. Banks are thus not favoured.

But bulls say rates will not go up as fast, nor will the US dollar. They say Asia is cheap and still growing faster than the West.

Among the pessimistic is Kevin Scully, executive chairman of independent research house NRA Capital. He expects Singapore's benchmark Straits Times Index (STI) to hit 2,500 points. The STI closed at 2,861 points on Thursday, up 20 points.

Next year, he said, non-performing loans (NPL) will rise across the board and especially in the commodity trading, oil and gas, and property sectors, offsetting net interest income gains by banks from higher rates.

"You can't buy banks, you can't buy commodities, don't do anything until June," said Mr Scully.

Due to deteriorating business conditions in the oil and gas sector, NPLs as a proportion of total loans had risen to 0.9 per cent for OCBC Bank in the third quarter, up from 0.7 per cent a year ago. Similarly, United Overseas Bank's NPL ratio had risen to 1.3 per cent from 1.2 per cent a year ago. DBS Bank's was unchanged at 0.9 per cent.

Those who are more optimistic say local banks are resilient, and Asian stocks are inexpensive.

"If you're going to buy when the glass is full, you're probably buying at the top," said Mark Matthews, Asia head of research at Julius Baer, a private bank.

"Emerging markets today are oversold and undervalued, absolutely. Asia has only been this cheap five times since the creation of the MSCI Asia ex-Japan index in 1987," he said.

Mr Matthews highlighted a "triple bottom" in China companies trading in Hong Kong. This technical analysis indicator suggests a short-term uptrend.

He is also cheered by the Fed's statement referencing "international developments" in determining the rate-hike path. This shows the Fed is aware of the risks of a strong dollar caused by rapid rate-hikes, he said.

Peter Sartori, Nikko Asset Management Asia's head of Asian equity, said that the rate rise appears fully priced into markets and "incredibly well telegraphed".

Looking ahead, his two most favoured markets are China and India. Stocks in the two Asian giants will benefit from reforms, he said. He likes the healthcare, insurance and tourism sectors.

"Lower oil prices give Asian central banks room to ease monetary policy, which should be supportive for stock prices here," he said.

The Fed announced, on Wednesday US time, a higher interest-rate target of 0.25 to 0.5 per cent, up from zero to 0.25 per cent previously. The change marks an end to the zero interest-rate environment after the 2008-9 global financial crisis.

Near-zero interest rates in the last seven years, along with the Fed's "quantitative easing" programme of buying long-term bonds from financial institutions, had encouraged investors to snap up Asian assets in pursuit of higher returns. This drove up asset prices in Singapore and in the region, and led to a rapid increase in borrowing by Asian corporates.

Now, some market participants fear money will flow out of Asia as rates rise in the US and make assets there more attractive. Capital leaving Asia will not only depress asset prices here due to lower demand, but will also cause the dollar to strengthen against Asian currencies.

A stronger dollar can result in borrowing costs increasing unsustainably for companies with US dollar debt. This happens if companies get operating cashflows from weaker Asian currencies, but repay interest in pricier US dollars.

On Thursday, bullish market participants cheered the Fed's apparent reluctance to raise rates fast.

The mid-point of the Fed's latest estimates for interest rates stands at 1.4 per cent by end-2016. This works out to one 0.25 percentage point hike every quarter. Looking further ahead, rate mid-point projections are 2.4 per cent at end-2017 and 3.3 per cent at end-2018, slightly lower than the September forecast.

Others had expected the Fed to make more significant downward adjustments to its rate projections to establish a "dovish hike" scenario.

According to Bloomberg, Fed funds futures imply that the market, on average, still expects two hikes in 2016 instead of four.

"Our concern is that the markets are underestimating the potential for a sequence of rate hikes over the next couple of years," said Bank of Singapore chief economist Richard Jerram in a Thursday note.

However, he does not foresee severe ramifications for Asian economies and markets. "Exchange rates have been weakening since the taper tantrum two-and-a-half years ago and equity markets have persistently underperformed," he said.

Those who are more sanguine say the global economy can handle higher rates, especially if they go up slowly. They point out that Asian currencies, unlike in 1997, are also less linked to the US dollar.

Historically speaking, markets are weak after the first hike, strong in the second and third, and decline after the fourth, said Goldman Sachs chief Asia-Pacific equity strategist Timothy Moe in a note.

"The 'narrative' that fits this fact pattern is that markets are wary of the 'sea change' in Fed policy, then embrace subsequent hikes if growth is improving, but again become concerned as the Fed continues to tighten," he said.

Mr Moe expects subdued regional markets in the coming months, partly also because China is going to slow further and corporate profit growth remains low.

Stocks such as Hong Kong's Tencent and AIA, and Singapore's DBS are worth buying as their sectors have historically traded well after the first rate hike, but have done worse than the MSCI Asia ex-Japan index in the past month, he said.

Mark Haefele, UBS global chief investment officer, said in a note that global economies and the US can cope.

"More relaxed monetary policy in the eurozone, Japan and China should also continue to support credit conditions. In addition, signs of economic stabilisation in China and a broadening recovery in the eurozone will promote economic and corporate earnings growth," he said.

Wong Yu Liang, co-founder of boutique fund Lumiere Capital, is staying invested mostly in Hong Kong and China stocks, such as companies in the car industry and new energy stocks involved in electric cars and solar panels.

While his fund was 30 per cent in cash in early August after raising new funds, it is almost fully invested now.

"Now, we have 30 core positions, the average price-to earnings ratio excluding cash is 4.6 times, dividend yield 4.5 per cent, trading at 1.1 times book, it's really very cheap. These companies are not your value traps, we deploy in areas where there's growth, with an average earnings growth rate of 10-20 per cent," he said.



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