Opportunities arise in stocks and bonds amid easing of risks

15 April 2014   Category: News, Asia, Global   By Herve Lievore*

The United States' continued withdrawal of quantitative easing did not have any tangible effects on the performance of asset classes in the first quarter of 2014, though global stock and bond markets recorded gains. In contrast to the market fluctuations seen during 2013, particularly in the second and third quarters, the sell-off seen in this first quarter is systematic in nature, and was primarily caused by changing market predictions of upcoming monetary policy in the US, which exerted an influence across all asset classes. In the first quarter of 2014, fluctuations in the market were driven by events occurring in individual nations, such as the dramatic devaluation of Argentina's currency and the Ukrainian crisis. Non-systematic market swings are generally temporary in nature, and indicate that market adjustments may bring opportunities for long-term investors to enter the market.

Recent macro data from developed nations, and particularly the US, further demonstrate signs that the economy is recovering. The latest labour data indicate that, driven by the substantial growth in productivity, the US economy is continuing to recover. At least 75% of companies included within the S&P 500 index announced fourth-quarter profits higher than predicted. Earnings growth continues to increase, leading to greater profitability for companies.

Although increasing yields and interest rates concern investors, monetary conditions remain eased. Traditionally, if monetary conditions remain eased during an economic recovery, this often benefits all kinds of risk assets, and, in particular, stocks. On a value-orientated basis, we favour Asian equities in the long-term. Firstly, risk-adjusted valuations, in comparison with other regions, are particularly attractive. Secondly, global economic growth will benefit Asian cyclical stocks. The rebound in global exports and continued economic recovery will also become the catalysts that drive outstanding performance in Asia.

In addition to stocks, investors may also consider bonds. Withdrawal of the third round of quantitative easing may allow yields to return to past levels, and for real yield to return to the long-term average trend. If investors worry about climbing interest rate, bonds with a shorter duration and higher yield such as high yield bonds are less sensitive to changes in interest rates, and will help diversify risk.

Currently, high-yield bonds demonstrate impressive investment value, with a very low default rate that shows no signs of increasing. In terms of yield, global high-yield bonds provide a yield of approximately 5.4%, which is more attractive than that of sovereign bonds in developed countries. In addition, current high-yield bond spread stands at approximately 381 basis points, higher than its lowest level of 221 basis points in 2007 (Source: Bloomberg, as of April 4, 2014).  This indicates room for the spread to narrow, which would be attractive to investors looking for yield. For investment opportunities in the high-yield market, the prospects for Asia are promising. Credit fundamentals are strong, and yields are more attractive than bonds of similar types in other developed markets, which should be able to partially compensate for interest risks brought by the tapering of quantitative easing programme in the US.

As investors reassess risks and weigh up the impact of the United States' debt reduction on different asset markets, there will continue to be market fluctuations in the short term. Diversification is an effective way of mitigating the potential risks caused by current volatility. At the same time, fund managers with substantial long-term experience and reliable professional knowledge can help seize opportunities and exploit investment values.

*Herve Lievore is senior macro and investment strategist at HSBC Global Asset Management