Rebound in the offing for equities this year

  • Markets
  • Monday, 28 Jan 2019

Manpreet Singh: Equity and bond markets are showing signs of stabilising after a rather rough 2018

EVERYBODY wants to say goodbye to 2018. It turned out to be a year when stocks were battered and most major indices across the globe finished red. However, this now offers opportunities in 2019.

So, what about the outlook for 2019?

Investors are understandably concerned following the global uncertainty that continues to roil the market daily.

Manpreet Singh Gill, head of fixed income, currencies & commodities investment strategy Standard Chartered Bank gives StarBiz his view on why he is still positive on the market, why energy is still attractive, and how a matured cycle bull market behaves.

2019 is here. What is your market outlook now and how would you position yourself/your fund? What is the strategy going forward?

Our theme for 2019 is to “Prepare and React”. Equity and bond markets are showing signs of stabilising after a rather rough 2018, but the upside of market weakness is that we’re seeing much more value emerge. This signal is strongest in cash and bonds, where higher yields are looking increasingly interesting to us, especially in emerging market dollar bonds. On the equities side, we see the US adjusting to a more “normal” level of earnings growth after two years of a fiscal stimulus sugar rush. This means we still expect equities to rise (and have a small preference for the US over other regions), but those returns may come with much more volatility than what we’ve been used to over the last few years.

Is the trade war something you are still concerned about or do you feel it has been fully priced in?

The market most likely priced quite a considerable risk of rising trade tensions in late 2018. This is most evident when you see the extent to which Chinese equities have fallen. However, we do believe it is possible for the US and China to cool tensions in the short-term. The ongoing trade talks are a positive sign and the market may need “less negative or do we want to say more positive news” to rise.

Beyond a short-term cooling, though, trade tensions may be here to stay long-term. While there is room for the two countries to reach an agreement on many industry-specific disagreements, it is not clear how an agreement will be reached in areas like Made-in-China where disagreements are more structural in nature. This is one of the possible volatility triggers through the year.

Do you feel that the huge market fall over the last three months now presents an opportunity to buy, especially with valuations previously being quite high?

In specific areas, yes. One example of a buying opportunity is in bonds, particularly emerging market (EM) bonds. Market volatility in the last few months means EM US dollar bond yields are now approaching 6.5% to 7%, which we believe is quite attractive both on valuation grounds and relative to high yield bonds in developed markets. In equities, US equities may have over-reacted over the past three months as economic growth indicators (such as the Purchasing Manager’s Index) have not fallen as much as the market suggests.

We like the energy sector in the US as we also think oil prices have overshot on the downside given demand has not slowed as much as markets suggest. We also see onshore Chinese equities as an attractive way to position for a short-term rebound in Asian equity markets, especially if trade tensions calm.

What are some of the catalysts that you foresee for our FBM KLCI? Do you feel most of the kitchen sinking has been done with, and it will soon be time to focus on how to grow the economy?

We would focus on two main drivers for Malaysian equity markets. The first is regional flows – we do believe Asian equities have been excessively punished in 2018 so a rebound is in the offing, in our view. Greater flows into the region are likely to be beneficial to the equity market, in our view.

The second is energy prices. Oil prices have over-reacted on the downside, in our assessment, as the market has been much too focused on the risk demand for oil might slow. However, we still see supply as the key, and efforts by major producers to limit supply growth is likely to push Brent oil back into a range centred around US$70/bbl, in our view. That should also offer support to the market.

Which part of the cycle are we in? A matured bull market or do you feel, the end is near and the big fall is coming? Or do you feel the volatility in 2018 was indeed the ‘bear’ everyone was anticipating for?

We see global markets as still being in the late-stages of the economic cycle. This means three things for investors. First, some strong equity market gains could yet be ahead of us, making it important to ensure one stays invested. Second, these returns are likely to be more volatile in nature; equity markets tend to become more volatile in both directions as the cycle matures. Third, it is very important to stay diversified; while reaping late cycle returns is important, preparing for volatility is also key and a well-diversified approach is often the best first line of defence.

What are some of the indicators you look at, to guide you of an impending bear market?

Equity markets tend to top out about six to nine months before the start of a US recession. Hence, we spend a lot of time focusing on how likely it is for the US to tip over into a recession. Specifically, we prefer three indicators. One is the US yield curve. This is perhaps one of the more reliable indicators in the sense that post-World War II recessions have always been preceded by the 10-2 yield curve (for example the gap between 10-year and two-year US Treasury bond yields) turning negative.

A second is US corporate margins – signs showing margins are beginning to shrink can precede a recession. Finally, we watch the US Lead Economic Indicator – a sharp turn lower here can also signal the possible onset of a recession.

At the moment, none of these three indicators are flashing red yet. This, together with expectations of positive earnings growth, give us confidence that the cycle may yet have further returns to offer. Having said that, these indicators can turn relatively quickly so we do watch them closely.

How do you advise your clients when they ask you what sort of assets/stocks they should hold on to, to protect against sharp drops in the market.

There is no one single “hedge” that can protect against all types of uncertainty. Hence, in our 2019 Outlook, we outline several possible transitions for the global economy and markets, which helps focus on which risks may be worth building some protection against. The first risk is that of the US business cycle coming to an end. US Treasury bonds are usually a good asset class to hold going into a US recession. The second is that of a sizeable jump in inflation. Real assets (such as gold, or even real estate) can be more effective ways of building in some protection against this type of risk. Finally, further bouts of volatility remain possible. The Japanese Yen is another asset class that tends to strengthen when markets face a wobble.

What about inflation? Do you see it rising this year? As the Fed intends to raise interest rates, do you feel that is fully priced in, and will it still affect the market?

We are not expecting a massive jump in inflation in the US or elsewhere in 2019. The US could face moderate inflation pressure coming from both rising wages and a rebound in oil prices back to a range around US$70/bbl, but we believe the Fed is likely to continue to raise interest rates gradually to lean against this. Europe and Japan face far lower inflation pressures, in our view. Emerging Markets are a mixed bag – with many countries that raised interest rates over the past couple of years likely to consider pausing, or cutting rates, as inflation remains reasonably well-controlled as long as oil prices do not rise excessively.

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