China Press Release
Subdued growth, low inflation and moderate returns could be expected for 2016. A high degree of diversification with an active tactical approach would be deployed against periods of volatility says Credit Suisse Private Banking
Putting that together, global growth would be subdued and not trigger a surge in inflation with prices of tradeable goods still seeing some price pressures. Commodities should see a year of normalization resulting from supply rebalancing on cutbacks in investments and production. The US and UK could see inflation rising towards the 2 percent handle whilst that in other parts of the developed world should remain low, even for the case of emerging markets and China.
Monetary divergence will remain pronounced with the US Fed to further tighten its reins but at a very gradual pace followed by the UK sometime in 1H 2016, according to John Woods, Chief Investment Officer Asia Pacific at Credit Suisse Private Banking. "The Bank of Japan (BOJ) is expected to remain on hold whilst the European Central Bank (ECB) may be compelled to be more assertive. Within the emerging markets where interest rates are high whilst inflation start to taper off or where disinflation persist, paths to more cuts could be paved for China and some other Asian countries as well as Brazil," said Mr. Woods.
Credit Suisse Private Banking expects China's economy to continue to grow at a steady pace of 7 percent in 2016 versus the consensus 6.5 percent. Consumption, property sector prices, infrastructure spending, and bank lending should remain on a recovery path, while trade and industrial oriented sectors could remain weak. "Disinflation is likely to persist. China's monetary policy support is set to continue in 2016, with policy rate cuts rather than competitive currency devaluation. However, the rest of the region is likely to experience a modest recovery in growth in 2016 due to base effects. Inflation is likely to surprise on the downside in the region. China is likely to be the most aggressive in the region in terms of policy loosening," said Mr. Woods.
What does the above mean for asset classes across the world? More of the same witnessed in 2015, with the need to have an active tactical investment strategy against periods of volatility and an overarching emphasis on diversification.
Yields across the board to gradually rise in 2016
Essentially, a normalizing US Fed would mean gradual rise in yields across the board, thus, some downside potential for core government bonds. But the 2015 trend of higher risk premia in corporate credit could present opportunities in 2016, said Mr. Woods. "Corporate bonds should perform better as the credit spreads could overcome the slow drift up in underlying yields. Floating rate notes should come into play as an alternative to fixed rate bonds' duration risk and inflation-linked bonds would be a good hedge against accelerating inflation. We would forewarn that tightening of global credit conditions would lead to the emergence of the corporate default cycle, most notably within the US high yield sector, thus, ensuring the need for more discernment. However, we are more constructive on European high yield bonds as the underlying macro backdrop is more favorable. Lastly, convertible bonds are also an appealing source of yield and capital gains for the year ahead."
Prefer equities over the major asset classes
With that backdrop, Credit Suisse Private Banking favors equities over the major asset classes, coming from an elevated but not extreme price-to-earnings ratio of 15 times and price-to-book ratio of 1.9 times and dividend yield of nearly 3 percent for the global average. Although attractive versus bonds, outsized returns may be capped given that valuations are about fair where economic growth is moderate whilst interest rates are on the rising path. This is where within equities, an active tactical approach would be necessary-deploying capital in times of setbacks and rising volatility coupled with a clear focus on themes, regional plus sectoral selection for outperformance.
Markets correlated to unconventional monetary policies would likely outperform, notably Eurozone and Swiss equities, with an emphasis on domestic European consumers in areas of discretionary spend. The surge in money supply in Eurozone resulting from the ECB's policy is expected to lead a recovery in earnings from a topline perspective. The European real estate sector and REITs should also benefit from the positive underpinning of loose monetary policy.
Favor Asia Ex-Japan among the emerging markets
Within emerging markets, Credit Suisse favors Asia Ex-Japan on the region's geared exposure to US and Eurozone as well as benefits derived from low commodity prices helping many of the importers, namely China, India and Taiwan as well as Korea. Mr. Woods believes the massive downgrade in earnings since early 2015 should hit a bottom and start to recover, leading to a rerating for the regional equities. However, a complex interplay of risk-on, risk-off catalysts will ensure investing in the region remains challenging. Having said that, the current valuations are more reasonable compared to those in the prior US Fed rate hike cycles since 1982.
The sector bias from a global viewpoint would favor healthcare and technology compared to the more traditional industrials or capital goods and the interest sensitive ones such as utilities and telecoms. Themes that Credit Suisse would recommend include cash-rich corporates for stock buy-backs and growing dividend payouts, mergers and arbitrage as well as Asian tourism.
Over the longer run, the USD is expected to stay strong as the US economy recovers.
But in previous FED tightening episodes, after the first hike, there is a short term consolidation in the USD against the G4 currencies, i.e. EUR, CHF, GBP and JPY. This is due to temporary decoupling of interest rates and FX, as well as the overbought nature of the USD heading into the FED hike. For investors that are substantially overweight in USD, particularly against the EUR or CHF, a temporary reduction in existing USD long positions is advisable.
Continue to stay cautious Asian currencies in first half of 2016
Asian currencies are expected to stay on the defensive, at least in the immediate first half of 2016. In line with the recovery in the US economy, rising US interest rates, further weakening of the CNY post special drawing rights (SDR) inclusion announcement. "We remain negative on most of the Asian currency block. Further weakness and improving valuations may well offer a temporary respite but, until growth in the region starts to accelerate meaningfully, and various current account deficits narrow, these currencies remain vulnerable. The notable exception would be the MYR, which we see significant undervaluation offsetting the prevailing cyclical risks, leading to a neutral overall view," said Mr. Woods.
Specific to the CNY, People's Bank of China (PBoC) made a recent statement highlighting the launch of a series of CNY trade weighted currency indices. The PBoC highlighted that going forward, market participants may shift their focus from bilateral USD/CNY exchange rate to an effective exchange rate based on a basket of currencies. In addition, the PBoC also highlighted that the CNY trade weighted currency index is overvalued. This announcement added to prevailing weakness in the CNY, which had already weakened post SDR announcement past 6.45 to the USD. The SDR inclusion will have little immediate benefit for the currency. Rather this latest move by PBoC to focus instead of an overvalued trade weighted currency index for the CNY will add more depreciation pressure.
High degree of diversification is advisable
Investors should maintain a high degree of diversification, but be selective on sources of yield with a tactical bias for deployment of capital, Credit Suisse expects pockets of volatility may emanate from Fed tightening, economic shocks, illiquidity or geopolitics, but an underlying picture of ongoing growth is expected to see investors' patience rewarded. "We have been advising our clients to invest in a thematic approach where we have been introducing the concept of "Themes in Portfolios" since July 2015 to better enhance returns via the selection of the securities, investment vehicles or mutual funds to benefit from these themes," said Mr. Woods.
One of the topics in the features segment of the investment outlook relates to the phenomenon of shrinking liquidity post-Global Financial Crisis for many major asset classes. As a result, it may not be always possible to buy or sell stocks, bonds or even currencies as easily at a quoted price as before, according to Mr. Woods. "Some assets now have wider bid-ask spreads or smaller dealing sizes making the risk of illiquidity real and with the potential to deteriorate further in future. The reasons are many fold – rising capital costs and need for shrinking trading books amongst banks, lack of market depth, changing trading patterns with clustering of trades around the most "liquid part" of the day and policy normalization by the US Fed, for instance."
The implication for investments means greater volatility with large price movements even for traditionally liquid assets. Extreme price falls can create value and entry levels where it is important to have sufficient cash from prior asset sales during periods of ample liquidity and deploy them to benefit from exaggerated price swings. Matching clients' future cash needs with a sound portfolio approach of diversification from dividends, coupons receipts and redemptions and less reliance of outright sales of large blocks would be important to consider.