NEWS ANALYSIS

Don't let fear get the better of investment approach

There are select opportunities even amid an overly bearish financial environment

Former US president Franklin D. Roosevelt famously stated: "The only thing we have to fear is fear itself." Proclaimed at the height of the Great Depression, this quote has recently resurfaced as a rallying call to calm investors panicking over the state of global markets. We knew 2016 would be a bumpy transition to a new normal, but the year has had a rougher start than anticipated. The current level of fear, however, is exaggerated.

FROM ZERO TO NEGATIVE INTEREST RATE POLICY

Investors are understandably feeling rattled about the future - talk of a sharp Chinese yuan devaluation, worsening European credit and even a US recession have markets on edge.

For China, in particular, the sense of crisis is unlikely to fully recede unless capital outflows and currency expectations stabilise. Growth prospects are looking weak, particularly in the US, which was supposed to be a stalwart supplier of positivity for the year.

But disappointing data aside, a US recession is highly unlikely, with housing and employment remaining robust and lower household debt fuelling consumption. And in Singapore, economic activity has faltered since the year began, as headlined by the 9.9 per cent tumble in non-oil domestic exports (Nodx).


An ad for a US currency deposit financial product at a commercial bank in Beijing. For China, the sense of crisis is unlikely to fully recede unless capital outflows and currency expectations stabilise. PHOTO: REUTERS

Central banks are responding to such ominous headwinds with even easier monetary policies. The European Central Bank just recently announced a "comprehensive package" of monetary easing, including cuts to its deposit, refinancing and marginal lending rates, an expansion in the size and scope of its quantitative easing programme, and a second round of targeted long-term refinancing operations for banks.

Bank of Japan governor Haruhiko Kuroda recently adopted a negative interest rate and additional easing is possible to help the economy's struggle to spur inflation. And the US Federal Reserve, long the lone voice for tightening, has likely paused its normalisation schedule. We anticipate no more than two rate hikes of 25 basis points each in the latter half of 2016, and see the US 10-year bond yield at 2.2 per cent by year end.

Interest rates in the region should soon follow suit: we now expect Asian ex-Japan policy rates to fall rather than rise in 2016, with seven Asian central banks either cutting rates or standing pat. A slower Fed hike path will also mean slower rate rises in Hong Kong and Singapore, where the respective three-month interbank rates are now likely to stay around 2 per cent over the next 12 months.

As for China, benchmark deposit rates could well fall towards 1 per cent, with the reserve requirement ratio (RRR) down another 250 to 450 basis points in 2016 (the People's Bank of China slashed the RRR by 50 basis points on Feb 29).

THE EQUITIES AND CREDIT DISCONNECT

Slower global growth naturally weakens Asian prospects - the impact will be most apparent on trade figures. January exports remain dismal across the region, with year-over-year declines reported in all key Asian markets.

While this will impede a broader earnings recovery, it doesn't disrupt our key investment thesis for Asia: investors should exploit excessively cheap valuations to add quality stocks with dividend sustainability, particularly amid expanding pro-growth policies.

Tellingly, outside of energy and high-yield cyclicals, Asian credits are showing few signs of stress. Average credit spreads are stable at 320 basis points versus the height of over 800 basis points from 2008 to 2009.

In contrast, Asian equity markets are in the doldrums, down 18 per cent the past year, notwithstanding the recent bounce. The region now trades at 1.2 times trailing price-to-book, nearing the averages of both the global and Asian financial crises.

While earnings forecasts are likely to edge lower, we see growth in the mid-single digits and still healthy return-on-equity ratios. So, we see select opportunities amid an overly bearish financial environment.

ENTICING YIELDS BRING DIVIDEND INVESTING BACK IN VOGUE

Just as domestic liquidity has underpinned performance of Asian credit, the current low-bond-yield environment could renew the focus on dividend investing. Quality income stocks - those enjoying stable cash flow and a track record of dividend sustainability across economic cycles - should perform better this year, now that the yield gap for Asia ex-Japan equities is at its most attractive level since the 2008 global financial crisis.

Markets with attractive high-yield gaps include Singapore, Hong Kong and China. Traditional high-yielding sectors include Singapore and Hong Kong Reits, Singapore and China banks, and major companies in transportation and telecoms.

This said, investors should remain highly selective in their stock picks, especially in sectors where fundamentals are deteriorating - Singapore office properties, Hong Kong's retail sector and Chinese banks.

We would broadly avoid high-yielding stocks in cyclical industries such as energy and manufacturing where challenging fundamentals raise the risks of dividend cuts.

While the macro environment will likely remain fluid and volatile, it's critical to not let fear get the better of our investment approach. In times of apparent crisis, stay nimble and opportunity will often arise.

•Tan Min Lan is Apac regional head at the chief investment office of UBS Wealth Management. 

A version of this article appeared in the print edition of The Straits Times on March 14, 2016, with the headline 'Don't let fear get the better of investment approach'. Print Edition | Subscribe