BT: Worst may be over for equities (23 Apr 2008)

This article was printed in Apr08, good time to revisit the key points.

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Worst may be over for equities

Three of four fund managers and analysts polled also paint bullish picture for Asia and emerging markets, reports GENEVIEVE CUA

WILL it be a severe recession for the US or a relatively mild one? To what extent would Asia and the emerging markets suffer? Views gathered by Executive Money from fund managers and analysts reflect optimism for the medium term for Asia and the emerging markets. Valuations, they say, are looking attractive, and equity markets could resume their bullish trend before the end of the year.

As for the current market gyrations, three out of the four polled believe that the worst may be over for equity markets, even if volatility remains fairly high. Markets, after all, are a discounting mechanism and historically in past crises have recovered well ahead of an economic upturn.

If you are sitting on cash, price weakness is an opportunity to buy. Jim McCaughan of Principal Global, in particular, gives insights on some assets that offer value and attractive yields to boot.

Mark Mobius, executive chairman of Templeton Asset Management

The worst is over for credit and equity markets, say the man who oversees some US$47 billion in funds. 'The credit crisis is over,' he declares in a recent visit to Singapore. 'Markets - stocks, bonds and money markets - are leading indicators. Now, the rebuilding is taking place.

'Yes, you'll still hear of bad news, but in essence, the crisis is over. The worst of the market drop has happened.'

He said that emerging markets are looking attractive on a number of metrics, including price to book value, price earnings and PE to growth ratios. These include China, Thailand, Taiwan and even India, which until the recent correction, was seen to be overvalued.

'The support for emerging markets is based on fundamental factors. The most important is economic growth. Growth in these markets will be about 7 per cent compared to 2 per cent for developed countries. That will feed into earnings. We're expecting reasonably good earnings.'

Based on the Templeton Emerging Markets Fund end-February fact sheet, the flagship fund with US$1.54 billion in assets is 19 per cent invested in Brazil; 16 per cent in China and 13 per cent in Russia. In terms of industry exposure, it is 25 per cent invested in energy and 21 per cent in materials.

Yet, the fund has underperformed the MSCI Emerging Markets Index by a wide margin. Over one year, the fund returned 20.7 per cent, against the index's 33.6 per cent. Over three years, the fund returned 75.8 per cent, against the index's 114.9 per cent.

Mr Mobius says: 'We invest with a long-term framework. We can't change the portfolio so often . . . If you want to track the index, you can buy a tracker. Our purpose is to find good, safe stocks we can hold and that tends to deliver better results.'

Inflation, he says, is a concern for emerging markets. 'Inflation with strong emerging market currencies is something to watch carefully. If inflation expectations move up, it will be an incentive for central banks to raise rates. That's not good unless rates are lower than inflation, and real rates are negative . . . But we don't see this happening anytime soon.'

He says that one way to hedge the inflation risk is to buy consumer-oriented stocks which are able to pass on costs through higher prices.

Jim McCaughan, chief executive of Principal Global

He believes that yield-hungry investors will find lots of value in three types of assets that have suffered greatly in the current credit crunch. These are global real estate investment trusts; preferred securities - usually issued by financial and insurance firms; and commercial mortgage-backed securities (CMBS).

The other asset that he is positive about is emerging market equities, which until the recent bear market, have enjoyed a bull run for the last four years or so.

On global real estate, he says that the credit crunch has caused financing facilities to be withdrawn from the real estate market. 'Less finance being available means less development, and oversupply can't emerge. That's good for existing investors. I see quite a good medium-term strategic outlook for commercial real estate. It's not over-built in the US.'

In the fixed income market, de-leveraging by major institutions and funds have thrown up value in a number of segments. One of these is preferred securities, which are a fixed income type of asset, subordinated to other senior debt a company may issue.

Mr McCaughan says that a portfolio of preferred securities could yield 7.5 per cent, at a time when 10-year Treasuries are yielding 3.5 per cent. 'We think that (spread) overstates the risk. There is risk, but in a diversified well-researched portfolio, we think the yield more than compensates for the risk.'

Yet another depressed segment is CMBS, where spreads have widened significantly. 'The mortgages underlying CMBS have virtually no defaults. Higher quality CMBS have a loan to value ratio of 65 per cent and 150 per cent interest cover. Corporate America has to stop paying rent for a problem to develop . . . Those are high quality yields of 7-9 per cent. Investors can lock in the yield and get a good performance in the next two to three years.'

Mr McCaughan believes that the worst may be over for equity markets. He reckons that a US recession would be relatively mild, even if the credit crisis is as bad as any previous financial crisis. 'I doubt that the credit crisis translates into a severe economic recession. The developed economies are too diversified and competitive to see that happen . . . Productivity remains a strong underpinning.'

Christophe Caspar, Russell Investments chief investment officer (Asia-Pacific)

Markets could still retest recent lows, and that warrants some caution, he says. 'The reason I'm cautious is that when you look at the spread of Libor against the Fed rate, we're at 25 basis points. Banks are still not comfortable lending to each other.

'It may be true that the worst of the sub-prime news is behind us, but bad news may still shake markets. If banks were more confident to lend to each other, that would give confidence that there are no more hidden issues.'

He believes, however, in a V-shaped economic recovery for the US. This would be very positive for Asian markets, which could resume its bullish uptrend. The reason for his optimism is that the Federal Reserve is expected to cut interest rates further; the financial effects of tax rebates are still to take effect; and the weak US dollar is a boon to exports.

On a price-earnings basis, he says that Asia is now more attractive, although it now fetches a premium compared with developed markets. The PE has fallen from about 19 times six months ago to 12-13 times. The latter represents a premium of about 4 per cent over developed markets. 'Usually, Asia trades at a discount of about 20 per cent, so it doesn't look cheap.'

He adds: 'Asian markets are on a structural uptrend. Companies are better managed than they used to be. We're not having an Asian crisis but a global crisis, putting a temporary brake on Asia. I think people shouldn't give up on Asia. When the market rebounds, it's always difficult to know when to get back in, and you end up not getting back in.'

Paul Nesbitt, Fortis Private Bank technical analysis director

He looks for patterns in the market for an indication of the likely or most probable forward path of markets. Drawing on a number of approaches - Fibonacci series, the Dow four-year patterns, the 'decennial' pattern, among others - he believes that equity markets may have hit their 'corrective lows'.

'All the evidence suggests we've seen the corrective low and markets will rally from here and make new highs. On balance, the trend for next year should be up.

'It may not feel like that in the next month or two. But once we get into the third quarter, a lot of confidence will come back - unless there is a totally new problem. We'll still get bad news and downgrades.'

The exception to his reading is Japan.

Technical analysis examines the historical path of markets. The Fibonacci approach, for example, looks into the magnitude of market rises and falls to discern probable outcomes. Academics, however, say that there is little evidence that this approach to investing delivers outperformance.

For example, the Dow Jones four-year cycle approach posits that the index forms a low every four years, roughly in the second year of one cycle. In Mr Nesbitt's reading, the current cycle began around 2007, following an extended bull cycle between 2002 and 2006. 'In the first year of the cycle, if there are problems to be sorted out, tough decisions are made. That causes a dip in the second year . . . Sometime between now and 2010, we'll get a bull run and make new highs. Once the cycle low happens, the following year in every occasion is up.'

At the moment, he isn't making an outright call yet to buy the market. 'It's too early to be 100 per cent confident,' he says. 'You can pick up your favourite stocks on the bad days of the market. I don't think it's a buy-and-hold market yet. But ultimately, the stocks that will perform best will be the dogs. The financials have to perform if the market is to take a bullish outlook.'



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