Time to look for an entry point

Boscher: ‘Markets are underestimating the positive benefits of low oil prices. It is a strong support for consumers.’

Asset manager Amundi says there’ll be a rebound in emerging markets and developed world

THE world is not coming to an end. In fact, with such widespread fear and massive depreciation in emerging market currencies and commodities, the time to look for an entry point rather than an exit point is now close.

There will be a rebound in emerging markets and the developed world like the eurozone. Most are starting to look attractive, as their currencies have adjusted. For those who feel the economy has long ago normalised, the world is in fact far from a normalisation phase as there are still deflationary pressures and recovery is sluggish.

These are some of the insights shared by Romain Boscher, the global head of equities for Amundi Asset Management.

Amundi Asset Management group as a whole oversees about US$1 trillion fund.

Boscher adds that with the Fed committed to tapering and only doing a mild tightening, this means the Fed will maintain the size of its balance sheet and continue buying, thus this isn’t a contraction.

In layman terms – stop sweating. Although the US is now undergoing its eighth year of expansion, 2016 will still see upside in the stock market as there is no outright tightening measures.

He also feels that oil prices are very close to capitulation point as there are a huge amount of short positions out there.

“It is true that the world economy is very US centric. And it is also true that the US economy is losing momentum. But the good news is that we are very much ahead of that cycle. The US cycle is very much matured in both economic and financial conditions. Right now, we are talking about tapering and very mild tightening,” he explained.

Why is it just a mild tightening and not an outright tightening? Well, the Fed is still maintaining the size of its balance sheet. When their bonds mature, the Fed will not let the balance sheet reduce in size. They will continue buying.

“If markets are really going to have a risk of tightening, then yes it would be very risky. However, we are foreseeing an environment of very low short-term and long-term interest rates.

“We are far away from a normal cycle. We still have deflationary pressures and a sluggish recovery. This is not normalisation,” he said.

He feels that people obsess too much about what happens in the US, although for the rest of the world, it is far from the end of the cycle. He sees the world now in a modest and sluggish recovery, especially in Japan and Europe. However, there will be a lot of support coming from central banks.

Boscher feels that the concerns that are now being played out are late cycle concerns.

In the beginning of quantitative easing, there was a very clear convergence of stocks rising. Volatility is now higher and there is more down the road, but this is normal in a late cycle expansion.

However, the concerns are overemphasised simply because it is coming from the US.

“The US sends a very important signal because we are talking about the US. But they are not very consistent with what you are seeing elsewhere.

“Since 2007, the central role has been played by central banks. They always said don’t fight the Fed. Well since 2007 it has been the Fed taking that central role. In 2012, it was the Bank of Japan (BoJ) and in 2015 it was the European Central Bank (ECB).”

He adds that BoJ has been the main buyer of Japanese stocks, sovereign bonds, equities and risky assets. While markets are driven by market forces, it has also been very much driven by central banks.

“Who knows which central bank will be the next taking the driver’s seat? Probably the PBoC (People’s Bank of China) could be taking a bigger role in the future. Don’t underestimate the effects of central banks,” he said.

Thus Boscher remains positive on equities in the developed and emerging markets.

He says that this year is going to be about domestic consumers, particularly in the developed world. He also favours countries that are oil importers, as opposed to countries like Brazil and the Middle East.

On another trend, while the Fed may be tapering, the ECB and the BoJ are injecting liquidity at a much higher pace than the Fed is tapering.

The ECB and BoJ are injecting US$130bil into the system a month as compared to US$40bil by the Fed previously.

So the only difference now is that money is not coming from the West but from the East. Liquidity is still in abundance.

Amundi expects interest rates to remain very low. It anticipates only a rate hike of 25 to 50 basis points in 2015.

With interest rates remaining low, this is an invitation to riskier assets as markets are starving for yields.

Boscher likes stocks with high dividend yields and will avoid materials, mining and service petroleum sector.

“No one is now thinking of massive bull market returns because markets are now toppish. People are looking for yields,” he says.

With investors starving for yields, there will still be appetite for equities. Thus for this year, Boscher still foresees upside while 2017 and 2018 will become more challenging.

On oil, Boscher feels that too much emphasis has been given on the pessimistic side of things.

Oil is a headwind for those that are selling but is a tailwind for consumers.

So, for example, the US which is still marginally an oil importer, will be a beneficiary.

In Europe, for example, consumers are benefiting from low oil prices.

“The benefits of the current oil prices are better than any fiscal policy that has ever been implemented,” says Boscher.

He says that while people see low oil prices as giving the market a demand shock, it also gives a supply shock.

“Markets are underestimating the positive benefits of low oil prices. It is a strong support for consumers. Typically there is a lag effect for the benefits of low oil prices to be seen. You usually see it six to 12 months later.

“For the negatives, you see it almost immediately because the oil producers sell oil on a daily basis. For the consumers, once they know that the discounted oil price is going on for more than a few weeks, then they will start to adjust their habits accordingly,” he says.

Boscher adds that in Europe, the economy is bottoming out. While it is still very patchy, value is emerging, particularly with profit growth still 30% lower than what it was 10 years ago.

He likes the laggards in Europe, for example the countries that are last to implement reforms such as Italy and France.

On the emerging markets, he reckons that it is now undervalued and that he is looking for entry point opportunities although higher level of volatility is expected to intensify.

Emerging markets had seen capital flight from equity and debt since end-2013 due to currency weakness, falling oil prices, prospect of tighter monetary policy in the US and deficits concern.

Boscher suggests that although currency and commodity markets will be the main source of volatility this year, the depreciation of emerging market currencies is “nearly completed”.

“But of course we will be selective ... we are favouring countries that are oil importers and than oil exporters,” he says.

Although Malaysia is an oil exporter, he is not that pessimistic with the country’s prospect.

He says Malaysia does not have visible and massive weakness as well as political turmoil like in countries such as South Africa, Brazil and Turkey, which are also oil exporters.

“In relative terms, in this category, Malaysia is a defensive play,” he says.

The commodity and oil exporter emerging countries have been prone to boom and bust of oil price movement.

“We have a constructive opinion in Malaysia than other oil producers because they have deeper-pockets, stronger financial institutions, big pension funds that reduce the dependency on foreign and retail investors, and do not have a massive debt-to-GDP ratio and significant budget deficit like Saudi Arabia,” Boscher explains.

“That is why we are not worried and remaining significantly investing in Malaysian stocks,” he says.

Boscher says his investment approach in emerging markets will heavily depend on currency volatility because it influences investment returns.

“We are paying high attention to currency volatility risk than commodity volatility risk because we are in the low return environment. This is because you can lose very easily from currency depreciation more than one year of expected return,” he says.

However, he does not expect the US dollar to continue its 2015 rally this year.

“The only major adjustment we will see this year is China’s economy that could impact emerging economies’ currencies,” he says.

Nonetheless, stocks preference in emerging market will be driven by price-earnings (PE) ratio and dividend yield companies because at the current sluggish market, investors are hunting for yield, according to Boscher.

In most cases, PE expansion is because investors are anticipating earnings expansion in the long run.

“Thanks to the market correction that there are values in emerging markets ... valuation has becoming more attractive such as single-digit PE,” Boscher says.

Meanwhile, stock performances in the developed markets such as Japan and Europe will be supported by earnings and dividend yield.

Although markets around the world have been rocked since the beginning of the year on bleak economic outlook in China, Boscher reckons that the Chinese stocks look attractive.

This week, China announced its economic growth for the fourth quarter slowed to the weakest level since 1990. China reported that its economy notched 6.9% growth in 2015.

“We have anticipated the slower economic growth in China, which is at the low end of the consensus estimate,” Boscher says.

He sees the global economic growth likely to slow down to 3% this year from 3.1% in 2015, with prices of commodities to remain soft.

Romain Boscher’s views:

AS the Fed is rising its rates late in this cycle (after the US dollar has already tighten the monetary policy for an equivalence of about 200 basis points of Fed rates hikes), this raises the question of a Fed mistake, which usually put an to the cycle.

As inflation is not a real threat and the positive effect of the counter oil shock on GDP growth will already fade in 2017, the number of hikes in this cycle will be very limited.

Moreover, as the Fed is committed not to surprise the markets, we expect an upmove on the US dollar and bond yields to be limited. The current setback on equities could even turn to be a buying opportunity for entering 2016.

2 On the implication for developed market equities:

For sure the cycle is mature in the US : Toppish capital expenditure/GDP, low unemployment rate, toppish margins, fading earnings growth, expensive valuation even if not excessive yet, buyback thematic receding.

Thus, a balanced equity or bonds positioning is warranted. Look for quality style first when buying US equities. We prefer to take our risk in the European Economic and Monetary Union (EMU).

EMU equities generally outperform the US when the Fed rises rates.

This is the best risk-reward area. Play momentum-style first (EPS downgrades are probably over).

Japan is ahead of EMU in the cycle, but we keep it without hedging the yen, which has now turn to be a macro hedge in case of a tail risk. Do stock picking there, or look at the NIKKEI 400.

3 What to do with emerging market equities?

Emerging market equities are in a secular bear market since 2011, which has probably not come to an end yet (declining RoE while deleveraging has even not started). Our position has always been not to come back on them until currencies stabilise, which is still not exactly the case yet. But at the same time, oil prices are now below the US$40- US$60 range on the Brent, M1 growth rebound in China is a first (fragile) sign for a stabilisation of industrial commodity prices.

Emerging market and value style in general are largely oversold. We’d like not to be underweight in a counter trend rally and move tactically from underweight to neutral before the turn of the year.

4 On European sectors

In Europe, the cycle being less advanced than in the US, the allocation should remain more offensive while recognising the slowdown of emerging markets. Therefore, we will continue to count on momentum and domestic reflation via media, software, consumer services and food retail. Since interest rates are expected to stay low, we will round things out with insurance, real estate, telecoms and energy.

We remain overweight on banks but keep them on negative watch as the slope of the interest rates and the strengthening of the regulations have mitigated the impact of the Domestic recovery. Furthermore, the recent net-up and third-quarter earnings per share beats were disappointing. As regulatory issues could soften, we might find a better timing to eventually reconsider our opinion.

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