News analysis

Just a bounce, or are markets ready to leap ahead?

Major hurdles to growth are the glut of China's industrial and housing excesses and the region's mature credit cycle that stymies lending

Plato once poignantly acknowledged: "Courage is knowing what not to fear."

A task easier said than done as a wobbling global business cycle, US Federal Reserve ambiguity and China's growth risks continue to shake investor sentiment in the region. But if the Greek philosopher was alive today, we think he would be tactically bullish on Asian equities.

This summer was a tumultuous period for Asian markets, but the current market rebound has started to disperse the shroud left over from lingering cynicism. While anticipation of a Fed tightening delay certainly contributed to this respite, improved macro data also deserves some credit.


Successive rounds of policy stimulus are beginning to stabilise China's sputtering economy, a major source of regional turmoil. Sequential improvements are now evident in credit, money and even select industrial indicators - including PMI and exports. China's accommodative monetary and fiscal policy is proving to be efficacious.

The People's Bank of China slashed interest rates again, the sixth cut since November last year, and lowered the reserve requirement ratio (RRR) to further grease China's growth engines.

Meanwhile, rising political consensus to keep "ahead of the curve" in managing decelerating growth is likely to prompt additional easing. The one-year deposit rate could fall another 50 basis points to 1 per cent by early next year, whereas the RRR may drop another 300-400 points next year from the current 17.5 per cent.

As China races ahead in its economic evolution, slower growth should be expected as the economy shifts from an investment-dominated market towards a more sustainable model steered by growth in consumption and services. The nation's will to reform can be found in its commitment to restructure the highly inefficient, yet politically sensitive, state-owned enterprises. A greater focus on higher-value industries and consumption will permit China to sustain medium- to long-term stability.

Singapore, not unlike China, was surprised on the upside recently, thanks to stronger performance in its service sector, averting a widely anticipated technical recession when third-quarter GDP eked out a 0.1 per cent quarter-on-quarter growth, up from minus 2.5 per cent in the second quarter.

The Monetary Authority of Singapore (MAS) opted to reduce the appreciation rate of the Singapore dollar trade-weighted index, but only just. The MAS seeks consistency with its policy focus on the medium-term narrative of labour market restructuring and industry upgrading.

Across Asia, strengthening trade balances are helping to thwart the risk of a liquidity crunch. Asean and North Asian governments are also turning up the heat with loosened monetary policy and increased fiscal support.

With continued strength in consumption and services in the United States, Europe and China, a moderate rise in Asia GDP momentum into year-end is likely, as activity indicators also stabilise.


Markets are certainly bouncing, but are they ready to leap ahead? We believe further reforms are critical to plug the holes that are draining global optimism on the region.

While we believe markets are oversold relative to near-term fundamentals, worries over tepid growth are not going away any time soon - significant structural challenges to growth exist, for which a quick fix is not the answer.

Notable impediments to growth are the glut of industrial and housing excesses produced as a by-product of China's economic metamorphosis and the region's mature credit cycle that stymies lending.

We expect Asian growth to drudge through these factors next year, at best matching the 5.3 per cent pace of 2015 and clearly down from the past-decade average of around 7 per cent.

Yet, the light at the end of the tunnel is beaming brighter than before.

The recently concluded Trans-Pacific Partnership (TPP) trade deal and strategic initiatives such as the Asean Economic Community (AEC) and China's "One Belt, One Road" are potential game changers that could reinvigorate investment beyond the typical domestic channels and boost future growth in Asia.

If the TPP is implemented - still a big "if" as it requires ratification by national governments, including a prickly US Congress - it would transform trade, increase foreign direct investment and accelerate supply-side reforms in Asia for years to come.

The smaller and less developed Asian markets, especially Vietnam and Malaysia, are poised to benefit the most, while Singapore as a regional hub too will gain from increased trade and capital flows.


A leap appears imminent, notwithstanding the long-term headwinds. So we are eyeing near-term opportunities.

We observed early last month that the market's overly bearish view on Asian equities has helped to produce a fertile market environment where value has emerged for select quality stocks.

With valuations of Asian equities at major correction lows - 23 per cent below the 10-year trading mean - and favourable macro forces encouraging a broader market recovery, we are expanding our opportunity set to encompass Asia ex-Japan equities as a whole, which we fund against Asian credit.

We believe Japanese, Indian and Singaporean equities hold the most upside. By sectors, we like insurance, Internet, healthcare and telecoms. Thailand and Malaysia, however, still appear to be held hostage to a relatively weak trade cycle and idiosyncratic issues.

We also see value in Asian high yields, which are now trading at a spread of 580 points. Chinese property bonds, in particular, will benefit from China's housing recovery, and crucially, improved domestic liquidity where developers can now issue three- to five-year yuan-denominated bond domestically at 4-6 per cent, compared to 7-10 per cent for US dollar bonds.

Meanwhile the Fed, the elephant in the room, will inevitably hike interest rates, likely next month if not March next year. From history, the average return for Asian equities in the 12 months following the first Fed hike is in the high single digits. This trend should endure so long as the rate is gentle - exactly the Fed's intention.

Despite this, we think Asian currencies are poised to weaken as we get closer to the hike date, and investors should look to re-establish US dollar hedges.

While we are most negative on the Indonesian rupiah and Malaysian ringgit which we think could drift back to recent lows, we expect the Indian rupee to perform the best in the next three to six months given India's solid structural journey.

The US dollar-Singapore dollar is poised to weaken to 1.45 over six months alongside regional peers as growth moderates further in Singapore amid continued economic restructuring.

In short, this tactical opportunity in Asian markets stems not from how good conditions have become, but how bad the situation is not. Plato would likely agree that an assertive investor strategy in Asia is now warranted.

•The writer is Apac regional head, chief investment office, at UBS Wealth Management

A version of this article appeared in the print edition of The Straits Times on November 02, 2015, with the headline 'Just a bounce, or are markets ready to leap ahead?'. Print Edition | Subscribe