Scottish-based Aberdeen Asset Management is positive about the outlook for US small caps in anticipation of improving corporate earnings from expected lower taxation, but reckons investors should be mindful of China’s credit market.
Speaking with Asia Asset Management, Irene Goh, head of multi-asset solutions for Asia Pacific at Aberdeen, shares her views on the company’s equities rebalancing in current market conditions, central banks’ interest rate policies, and market uncertainties.
AAM: From a regional perspective, how are you realigning your equity strategies over the next six months to a year?
We know quantitative easing has distorted asset prices, we know debt-driven buybacks have fuelled US equities and that valuations are elevated. At the same time, US business confidence has shot up. Mere talk of less regulation and lower taxes has raised hopes for earnings. The weakness remains in investment and spending. We like small caps, but the risks over trade protectionism and the targeting of industries make us wary of the main market.
On the other hand, we like Japan. Equities there are relatively cheap, the soft yen is good for exporters and the march to relocate closer to customers in Asia and beyond is as good a way of playing global recovery as any. Plus, high corporate cash levels should prolong the share buyback trend, which is typically market positive.
We’re more cautious on Europe. Sterling’s post-Brexit fall on the other hand will continue to help UK exporters and multi-national companies there broadly.
If nothing much happens in China, that should underpin growth in Asia and emerging markets, creating opportunities for relative value trades. Corporate earnings are recovering. This, together with resurgent commodity prices, bolsters exporters. Emerging markets still trade at a wide discount to developed peers. They are also better placed than previously to cope with fallout from exclusionary US policies.
We like India because of structural reforms, the falling cost of money and the quality of companies. We need a pick-up in investment to justify current prices, but in the medium to long term, that is not an issue. Last, in Latin America, Brazilian stocks look set to remain buoyant on hopes the recession has bottomed out with inflation under control.
How do you expect major central banks to adjust their interest rates and monetary policies this year?
The US is tightening but the rest of the world is not. The pace of that tightening is the issue, both in itself and for the effect on existing global imbalances.
Following the latest rate increase in March, we anticipate at least one more hike this year. If the new administration expands spending, then rates might have to go up more quickly, putting upward pressure on the dollar. This makes for a mixed outlook for emerging markets.
In China, cutting debt is the priority. But economic stability comes first, so the People’s Bank of China has stopped short of hiking headline rates, choosing only to raise short-term repo rates and longer-term money-market rates. Once the National Congress is over this November, we expect a renewed focus on structural reform.
Elsewhere, the European Central Bank will likely maintain its asset purchase programme before tapering in 2018; the Bank of England will hold until growth prospects improve, which we don’t foresee in coming quarters; and the Bank of Japan is committed to yield-curve control – although its 2% inflation target is a figment. Japan’s consumers are spending less, not more.
What are the major uncertainties global investors are facing right now?
China gives investors cause for concern because of its own version of ‘kicking the can down the road.’ It has a non-performing loan problem, but we don’t know how big. Somehow, policymakers have to rebalance the economy while appeasing the casualties – laid-off workers, those who can’t afford housing, etc. Having a closed capital account buys time, provided money does not leak abroad. You need to pay attention to Chinese credits.
Emerging markets are very sensitive to Chinese demand, not just for commodities but for intermediate and finished goods. China’s move up the value chain is changing labour and capital distribution. The sweatshop jobs have gone; Chinese brands are coming to prominence. This is all exciting.
It sounds odd to say so, but the US is a worry. (President Donald) Trump is exhausting. Some companies have publicly given up guessing what his trade policies are. Tariffs are a possibility, but we doubt all-out retaliation. The more interesting events may turn out to be at home. Should the government spend more, causing growth to improve, inflation may accelerate. That could be healthy in the short term…but deal a death blow later given debt levels. The price, then, is of delayed ‘normalisation.’
Last, we suspect weakness in the European banking system is more likely to derail economic recovery than politics, which will default to muddle-through if the Continent makes it through elections. Peripheral European economies are dependent on bank credit, and non-performing loans remain a problem, especially in Italy. And don’t forget: Greece is still bankrupt in all but name.
