“Lose the Headlines, Win the Details”app.pmgasia.com/InvestAsean2018/pdf/Investment... ·...

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Investment Strategy

Willie Chan, +852 2268 0631, [email protected]

Sadiq Currimbhoy, +65 6231 5836, [email protected]

“Lose the Headlines,

Win the Details”

Oh, the Cost of Capital is Going Up

mailto:[email protected]




Summary

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Six Ideas

1.China’s strategy could be “Lose the Headlines, Win the Details” in any US-China “Trade

War”

2.We are still Bond Bears, and think you don’t need higher inflation prints given growth,

history, real yields and the term premium. But Europe and Japan matter.

3.A Rising Cost of Capital could mean that valuations matter: Switch from Growth to

Value

4.Bonds v Equities: 2-year rolling correlations of weekly changes between yields and

equities shows the positive correlation over the past 15 years may be breaking down.

5.China’s inflation risk remains even as there is deleveraging: Long ASEAN, Short China.

6.Our strategy remains Defensive: i) Long ASEAN banks; ii) Long Indonesia, Short the

Philippines; iii) Positive Vietnam; iv) Long Consumer Staples, Short Consumer

Discretionary; and, v) Long Utilities.

Trade War or Skirmish?

US policy articulated by Navarro-Ross 2016 Economic Plan which argues that

the US is already in a Trade War and needs to re-negotiate deals.

With trade frictions ahead, we think China could respond in three broad

ways:

1.Full-scale retaliation - Unlikely

2.Satisfy most US requirements – Unlikely

3.“Lose the Headlines, Win the Details” – Most Likely

This scenario allows the US to “look good” with the “best deal ever” going into

mid-term elections but the details may be less severe.

Any deal may also take a long term to take into effect

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Remember the economy!

4

Source: Bloomberg

• US initial jobless claims have already returned to the lows in the 70s.

• With global synchronized recovery comes higher bond yields. The combination of

tax cuts and more government spending will further boost economic growth,

employment and salaries.

5-yr/5-yr USD & EUR inflation swap rates

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Source: Bloomberg, Maybank Kim Eng

• The 5-year/5-year forward inflation swap removes the short-term impact of

commodity prices and has been rising steadily from the lows in mid-2016.

• Under the current economic environment, the US core inflation is likely to be

above the Fed’s 2% target.

Higher bond yields

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• The US 10-year government bond yield breaking out from a 30-year downtrend

might increase market volatility in 2018.

US nominal GDP growth vs bond yield

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Source: Bloomberg

• Over a long history, average US nominal GDP growth is in-line with US 10-year

nominal government bond yield.

• Current nominal bond yields are still far below nominal GDP growth. And consensus

reckons the same for 2019…

US 10-year treasury real yield

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Source: Bloomberg

• Using TIPS, given where economic growth is, the real yield is too low

compared to history at 74bps vs around 2% before the GFC.

US 10-year treasury term premium

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Source: Bloomberg

• The term premium is currently negative 35bps – investors effectively pay to

hold a long-term bond compared to a series of shorter ones.

• As Central Banks pull back QE, and this includes the ECB, even a

normalization of the term premium can drive bond yields higher.

Real rates

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• Real rates are still negative in Developed Markets, and particularly in Europe.


The importance of QE elsewhere

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Source: Bloomberg

• European industrial production has been running at very high levels recently

and was even above 5% in Dec-17.

• With the global synchronized upswing still continuing, the unwind of the ECB

buying program is set to also be a key factor in driving up the cost of capital in

the US and globally.

YTM of European high yield bond

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• European high yield bonds yield about 3%...

Should we fear the Wealth Effect?

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Source: Bloomberg

• The Shiller PE is again at levels only seen in the Nasdaq Bubble.

• The period of QE in the US has resulted in Household Net Worth as a % of

Disposable Person Income at a record high. It’s unclear to us that if equities

retreat modestly, we shall see a significant wealth effect.

Rotate from bonds to equities?

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2-year rolling correlation of weekly returns between the S&P 500 & US 10-yr govt’ bond yield


• The 2-year rolling correlation of weekly returns between US 10-year

government bond yield and the S&P 500 shows that the positive correlation

could be breaking down.

• This could be due to higher equity valuations.

Correlation between Asia & US 10-yr govt’ bond

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2-year rolling correlation of weekly returns between MSCI Asia x Japan & US 10-yr govt’ bond yield


• Looking at Asia ex Japan, the correlation has just turned negative, but only

marginally so.

Inflation in China

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Source: CEIC, Bloomberg

• Inflation risks in Asia appear to be more China than ASEAN.

• The latest CPI in China was above market expectation at 2.9%. Both food and

non-food inflation have been rising but the upward pressure was mainly driven

by food inflation.

Soybean price

17

Source: Bloomberg

• YTD, soybean prices have increased 10% and recently broke the 200-week moving

average.

• If China restricts soybean from the US to retaliate against Trump’s tariffs, this

will add further pressure on food inflation in China.

Pressure on property prices

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Source: Wind, CEIC, Maybank Kim Eng

• Property sales growth has slowed down and government has tightened domestic

credit growth.

• Property prices in tier-3 cities have started to peak.

Spread between China corporate and gov’t bond

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Source: Wind, Bloomberg, Maybank Kim Eng

• Spreads between corporate bonds and government bonds have widened after the

government announced the draft issue of “The Guideline on Asset Management

Business” last year.

• Liquidity condition has improved a bit recently as the government injected liquidity

into market before CNY to prevent liquidity shock.

1-yr USD LIBOR and HKD HIBOR spread

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Source: Bloomberg

• The aggregate balance represents the level of interbank liquidity and it is also a

part of the monetary base.

• Currently, HIBOR is much below LIBOR. A narrowing of this spread equates to a

tightening of liquidity conditions.

• If HK needs to raise its prime rate, interest rate sensitive sectors will be under

pressure. Money will rotate to defensive sectors.

Hang Seng utilities rel Hang Seng index, dividend

yield

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• HK Utilities are getting attractive relative to the Hang Seng Index in Dividend

Yield terms.

MSCI Asia x Japan Utilities rel MSCI Asia x Japan

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Source: MSCI, FactSet, Bloomberg, Maybank Kim Eng

• Our strategy remains defensive.

• Relative performance and valuation shows that Utilities are attractive from a

historical perspective.

• And Regional Utilities are getting attractive in relative terms on a Dividend Yield

basis

Value vs Growth

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Source: MSCI, Factset, Maybank Kim Eng

• The Value index underperformed the Growth index in the past five years and has

returned to 1998 levels.

• If the cost of capital is set to rise, we believe money will rotate from Growth to

Value.

Listed Corporate Sector:

Asset turnover and EBIT margin

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ASEAN asset turnover and EBIT margin China asset turnover and EBIT margin

Source: Factset, Maybank Kim Eng

• Asset turnovers (defined as Sales divided by Average Total Assets) in ASEAN and

China have improved but EBIT margin recovery in ASEAN is stronger than China –

returning to almost 2007 levels.

Listed Corporate Sectors:

Gearing and RoE

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ASEAN gearing and RoE China gearing and RoE


• Gearing (defined as Average Total Assets divided by Average Total Equity) in ASEAN

is lower than China while their RoEs are similar.

Is China a Growth stock and ASEAN a Value stock?

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Source: MSCI, Bloomberg, Factset, Maybank Kim Eng

• Performance of China relative to ASEAN looks like Growth to Value.

• Rotate from China to ASEAN.

Long ASEAN banks

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• ASEAN banks have started to outperform the region and global banks. The PB

relative to the region is still near the GFC lows.

• With higher interest rates, improving loan growth, lower NPLs and potential

banking deregulation in the US, the market sentiment for banks should improve.

Long Indonesia, short the Philippines

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• Philippines’ gearing is at a record high while Indonesia’s gearing is falling.

• The RoIC in Indonesia is much better than the Philippines.

Indonesia relative the Philippines, PB

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• The PB valuation for MSCI Indonesia is attractive relative to the Philippines.

Positive on Vietnam

30

Source: Statista Digital Market Outlook, e-Commerce Report 2017

• FDI, exports and capex continue to grow.

• Growth in retail banking, digital consumption and infrastructure spending in 2018.

• The government is investing aggressively in infrastructure and government

infrastructure-related expenditure is high at 5.7% of GDP.

Source: CEIC

Construction GDP growth (in real terms) by country E-commerce penetration and growth by country

Long Staples, short Discretionary

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• Asia x Japan’s consumer staples EBIT margin and RoIC are much better than

consumer discretionary.

China’s household personal products rel auto, PB

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• PB valuation for China household personal products is attractive relative to China

autos.

Materials

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Source: MSCI, Factset, Bloomberg, Wind, Maybank Kim Eng

• PB valuation for materials is not expensive in relative terms.

• We think there is limited upside in absolute terms given our property and market

outlook for China.

Correlation of Asian markets & US 10-yr govt’ bond

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• Within Asia, MSCI China relative

the MSCI Asia x Japan has a

more positive correlation with

the US 10-year government

bond yield most of the time,

even though the correlation has

started to weaken.

• Many investors use Korea as a

leading cyclical indicator. However,

this correlation turned negative

after 2014 rapidly.

Correlation of Asian sectors & US 10-yr govt’ bond

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• Energy has the highest correlation

with the US 10-year bond yield while

consumer staples has the lowest

correlation.

Correlation of Asia small cap & US 10-yr govt’ bond

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• Over the past 20 years, the 2-year rolling correlation between the MSCI

Asia x Japan Small Cap index and US 10-year bond yield has been positive

most the time but it turned negative at the start of 2018.

Global Debt-to-GDP

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Debt to GDP distribution

2007

2017

Total household Total non-financial Total Govt Total

Total household Total non-financial Total Govt Total

US 98 70 61 228

79 73 99 251

Japan 63 98 145 307

58 102 213 373

UK 93 83 45 221

88 76 116 280

Germany 61 56 64 181

53 54 73 180

France 47 104 66 216

58 130 111 299

China 19 97 29 145

46 165 47 258

Indonesia 12 15 33 59

17 22 29 68

India 11 42 74 126

11 48 68 127

Korea 72 89 22 183

93 100 41 233

Malaysia 52 58 39 149

69 68 53 189

Philippines 2 37 54 93

9 39 42 91

Singapore 39 76 86 202

61 117 115 293

Thailand 45 46 23 114

69 49 32 151

Source: BIS, CEIC, Maybank Kim Eng

• In aggregate terms, there is more debt now in Developed countries than there

entering the Global Financial Crisis.

• China’s total is below Developed market but saw the largest increase in

percentage-point terms.

• ASEAN is largely under-leveraged with scope to expand Balance Sheets

APPENDIX I: TERMS FOR PROVISION OF REPORT, DISCLAIMERS AND DISCLOSURES

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Ong Seng Yeow | Executive Director, Maybank Kim Eng Research

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