With global growth expected to improve in 2014 led by developed markets, Bank of Singapore remains overweight in equities, underweight in investment grade bonds and cash, whilst downgrading high yield bonds to neutral. The Fed’s upcoming tapering will not result in a big reaction from markets given they have had plenty of time to discount the news.
On the macro-environment, Bank of Singapore anticipates growth prospects to be moderately brighter in 2014 as the policy environment in developed economies becomes more supportive. Bank of Singapore forecasts global GDP growth to accelerate from 3% in 2013 to 3.7% in 2014.
On the back of an improving economy, the Fed announced its plan to reduce its monthly asset purchases. Richard Jerram, Chief Economist of Bank of Singapore does not expect a huge impact on financial markets for two reasons.
“The first reason is that the decision is data dependent - recent strength in labour market indicators convinced the Fed that the situation is now robust," explains Jerram. "The second reason is that markets have already had plenty of opportunity to respond to the shift in policy. Most notably, US bond yields are up from lows in May. They might push a little higher as Fed purchases reduce support for prices, but we would not expect a sharp sell-off as the yield curve is already unusually steep.”
With regards to Japan, the exchange rate-driven side of the country’s recovery is easy to see (in exports and industrial production) and understand after a huge boost to competitiveness from the weaker yen. The domestic recovery is harder to judge. Although business confidence is higher across all sectors and plans for capital investment are improving, wages are still weak.
“It looks unlikely that the Bank of Japan will hit its inflation target of 2% on schedule and we expect to see pressure for further policy easing around the time of the sale tax increase. Structural reform remains a hope rather than expectation, and the lack of material progress is a cause for concern,” Richard Jerram notes.
Wary of Singapore’s and HK’s real estate market
Bank of Singapore is wary of the outlook for Singapore and Hong Kong. Both cities have a real estate boom, with a bubble only averted by a flow of macro prudential policy tightening measures. A stable economic environment and another two years of accommodative US policy means that real estate prices are unlikely to drop substantially, but as the market softens it will also subdue some areas of domestic demand.
“There is also an implicit warning from the Fed to real estate buyers in these two markets. Even though short-term interest rates will stay at zero for another couple of years, the Fed sees the equilibrium interest rate at 4%. Purchasing long-term assets funded by borrowing at short-term interest rates always involves some hazards and buyers need to take care that mortgage payments are manageable even after interest rates have normalized,” Richard Jerram continues.
Mixed outlook for emerging markets with continuing concern over China
The outlook for emerging economies is expected to be more mixed, with some rebounding from sluggish growth, while others face increasing problems.
“The “fragile five” of Brazil, India, Indonesia, South Africa and Turkey are in the spotlight as their current account deficits imply a vulnerability after the Fed starts to taper. But we should note that the “fragile five” have taken measures to protect their currencies in recent months, including structural reform to cut the deficit and interest rate rises to encourage capital inflows. Another large forex drop seems unlikely.” Richard Jerram says.
In China, policy-makers remain torn between sustaining growth over 7% and rebalancing the economy. Despite the optimistic spin from the Third Plenum, these objectives are inconsistent because rebalancing will require a drop in the wasteful investment that is currently being financed by a credit expansion. Ultimately government action will be needed to deal with the rising bad debts in the system and public finances are healthy enough to permit this.
Overweight in equities with developed markets favoured to emerging markets
Against the macro backdrop, Bank of Singapore expects the hunt for return to intensify in 2014, after investors come to realize that short-term interest rates will stay near zero for longer, even as the tapering starts.
However, with US Treasury bond yields rising, albeit at a gradual pace, the trend direction of higher yields has turned more challenging for credits. Bank of Singapore stays underweight investment grade corporate bonds and downgrade high yield corporate bonds from overweight to neutral.
“We prefer equities to credits," says Hou Wey Fook, Chief Investment Officer of Bank of Singapore. "While there is potential for further price earning multiple expansion and the Fed’s tapering means less additional liquidity, some of the existing liquidity pool will find its way into equities. In their search for return, investors will be incentivized to deploy more cash into equities, as global growth and earnings improve. The Great Rotation will also continue, supported by attractive equity relative valuations vs. bonds. Therefore, we look to increase our overweight in equities on pullbacks.”
In the equity space, Bank of Singapore continues to favor developed markets where growth is picking up rather than emerging markets, which face policy headwinds, growth concerns in some cases and are more vulnerable to tapering. China is favored within EM.