News analysis

Will the bull market trample the risks?

Uncertainty over China and Europe could slow the good times

Equities worldwide are on a tear. US (S&P 500), Asia ex-Japan (MSCI) and Singapore stocks (MSCI) have roared to life, climbing nearly 6 per cent, 9 per cent and 10 per cent respectively since the year began. And the good times look set to keep rolling: The momentum signal of UBS' World Equity Model has been higher on only around 13 per cent of occasions since 1995.

This is good news for our portfolios. Still, there are fears that the bull market could be derailed by political events in key countries, including France, the Netherlands, Britain, China and the United States. Outside of the Trump presidency and Brexit, two key risks deserve attention: renewed concerns about China's economy and rising populism in Europe. If these risks materialise, the consequences would certainly shatter the positivity now coursing through the financial system.


The continuing fall in China's foreign exchange reserves, which slipped to their lowest level in nearly six years in January, and US Treasury holdings has fuelled concerns about the adequacy of the reserves. This in turn has raised worries about the health of China's economy. So how low are the forex reserves, and does their relentless fall pose a big risk to the economy? 

China's forex reserves are comfortably above the minimum threshold prescribed by the International Monetary Fund (US$1.75 trillion or S$2.47 trillion, with capital controls, and US$2.82 trillion with no capital controls). Assuming China maintains its current pace of forex reserves drawdown of around US$30 billion to US$35 billion a month, the level should not fall below US$2 trillion for another 21/2 years. In addition, China has several policy tools (for example, activating its current account surplus more fully, speeding up its efforts to attract capital inflows and restricting capital outflows by Chinese nationals) at its disposal to bolster its forex reserves and ensure stability.

Market concerns about China's economy will hinge on the pace of economic reforms: a too-slow pace poses the risk of an unsustainable build-up in public- and private- sector leverage, while a too-fast pace poses the risk of a hard landing.

A military band conductor at a rehearsal before the opening of China's "two sessions" - meetings comprising top legislative and consultative bodies. The policies made at these meetings aim to facilitate tax, finance and state-owned enterprise reforms
A military band conductor at a rehearsal before the opening of China’s “two sessions” – meetings comprising top legislative and consultative bodies. The policies made at these meetings aim to facilitate tax, finance and state-owned enterprise reforms, while promoting growth initiatives, to allay market concerns about China's economy. PHOTO: EUROPEAN PRESSPHOTO AGENCY

China's annual "two sessions" - plenary meetings of the country's top legislative and consultative bodies - took place in Beijing from March 3 to 5. The policy decisions made at these meetings aim to facilitate tax, finance and state-owned enterprise reforms while promoting growth initiatives such as One Belt, One Road. 

The reforms that were announced during the two sessions are expected to be supported by a mix of fiscal and monetary policies. Stability will remain a top priority for policymakers, thus preserving the required reform balance.

Hence, China's economy is expected to continue along its gradual, yet manageable path of deceleration, with GDP growth likely slowing to 6.4 per cent in 2017 from 6.7 per cent in 2016. This should allow Chinese equities to rally; the Internet sector, which offers growth at a reasonable valuation, the insurance sector and Chinese banks are our preferred picks for this year.


The European Union is facing an unprecedented threat from populist parties. Once considered a fringe candidate, France's Ms Marine Le Pen has staged a comeback in the country's presidential election not entirely unlike Mr Donald Trump in the US. Her rise in popularity has rattled the financial world as she has vowed to pursue France's exit from the EU. We believe Ms Le Pen has a 40 per cent chance of winning the presidential election, but the likelihood of "Frexit" is much lower at 10 to 20 per cent due to parliamentary and constitutional hurdles.

Still, a Le Pen win would likely confound European equity markets, given her attitude towards EU membership and France's involvement in the single currency. If she wins the presidency, she is expected to call for a referendum on these issues unless Europe meets her demands. Regardless of the legal complexities about holding a referendum and the odds of a public vote to exit the euro zone, investors will likely fret that a Le Pen presidency may trigger an existential crisis for the EU and the euro.

Meanwhile, the anti-EU Freedom Party (PVV) is set to win the highest share of votes in the Dutch general election on March 15. The Netherlands, long a bastion of EU stability, has hit media headlines globally, thanks to the PVV's pledge to hold an EU referendum. However, all key parties in the country have shut the door to a coalition for now. So an EU exit looks highly unlikely, especially considering the Dutch legal framework for referendums - the public is not allowed to call for a binding or non-binding vote on EU or euro membership.


A landslide victory for EU-sceptic populists such as the PVV and Ms Le Pen's National Front party could set a strong precedent in a year of landmark elections in France, Germany and potentially Italy. Consequently, it may result in a further widening of French and Italian government bond risk premiums. The risk momentum will likely persist rather than ease in the run-up to the elections.

French equities, meanwhile, are also likely to lag the wider euro zone in the coming months because of the political uncertainty ahead of the presidential and parliamentary elections. In contrast, German equities, which should benefit from the uptick in global growth, are poised to outperform.

Overall, investors are better off with global equities than with high-quality government and corporate bonds. Equity markets should rise on robust earnings growth, especially in the US. With over three-quarters of S&P 500 companies having already reported, fourth-quarter earnings per share (EPS) is on track to post growth of around 6 per cent as around two-thirds of companies have beaten EPS estimates. In 2017, EPS growth of US companies is expected to be about 11 per cent, making US stocks more attractive than European ones.

Current market conditions warrant a moderate risk-on stance. Global economic numbers so far this year have been beating consensus forecasts by the most since May 2010, and reflation appears to be on track.

Markets can scale a wall of worries so long as fundamentals in corporate earnings, economic growth and central bank support remain intact. Still, political risks are significant, and investors should brace themselves for renewed volatility in the spring.

With the strong year-to-date gains in Asian equities, we have reduced our tactical overweight position in Asian equities in favour of EM (emerging market) corporate bonds in our asset-allocation portfolio. However, we continue to retain a cyclical and reflationary bias in our regional equity exposures through our overweights in China, India and Thailand, and our preference for regional materials, energy, financials and Chinese Internet stocks.

•The writer is the 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 06, 2017, with the headline 'Will the bull market trample the risks?'. Print Edition | Subscribe