Market
US - Valuation at a 10-year Low, But Risk to Growth and Earnings are to the Downside
- US stocks edged down by 1% during the month, but this masks a volatile market dominated by concerns over the survival of Fannie Mae and Freddie Mac, until news of supportive legislation in mid-July helped stocks rebound.
- Given the fair valuation of US equities, we remain neutral on US equities relative to other developed markets due to growth and earnings risks, and the threat of further credit write-downs.
Europe - Economic Slowdown Appears to be Lagging US Data by About Six Months
- We see much pessimism priced into UK equities. At a forward P/E multiple of 10, the valuation of UK equities is at almost a 10-year low.
- However, we maintain our neutral stance on European equities versus local bonds and other developed market equities because of the uncertainty on the growth risks. In fact, there is risk that if there were deeper contraction in the US economy, than our central scenario of soft-landing, then this would affect Euro exports, with more negative consequences for domestic growth.
Japan - Expensive Valuation, Slowing Domestic Growth, Inflation, and External Risk
- The perception is that Japan is insulated from the slow-down in the US and emerging Asia, but further external shocks could cause a contraction in Japanese equities.
- We will continue carefully monitoring the developments in Japan, as the combination of expensive valuations and risks to growth may lead us to take a more cautious stance in the near future.
Asia ex Japan - Strong but Slowing Consumption, and Central Banks will Continue to Combat High Inflation
- At 15x P/E, valuation is attractive from an historic standpoint.
- The region continues to benefit from a strong structural growth story, albeit economic slow down, exports risk, and active central banks due to high inflation, both remain overhangs.
Emerging Markets - Still Expensive, and Slowing Growth Meets High Inflation
- Emerging-market stocks as a whole were among the worst equity market performers last month as the oil price receded. But despite the sharp stock corrections, valuations are still expensive relative to developed markets.
- We favor Emerging Asia over Latin America, on relative valuation grounds. A decline in oil price would also exert more risk to Latin America than to Emerging Asia, as the former has more exposure to oil exports.
- We remain bullish on long-term prospects, but are cautious in the short-term.
Hong Kong & China - Eased Inflation and Attractive Valuation are Supportive
- The easing in commodity prices reduces inflationary pressure and is positive for Chinese equities in the near term. Also, valuations are back to attractive levels relative to its historical average, which is supportive. However, as we expect that global equity markets will remain volatile and range bound over the coming months, it will be difficult for Chinese markets to decouple from these trends. On a 3-month view we maintain a neutral recommendation. On a 12-month basis we remain positive as we think the growth in China will be the dominant medium-term driver of the market.
Commodity
Oil - Volatile Month, as Reduced Consumption Data Pinched the Recent Oil Price Rise
- The oil price fell 11% during the month as concerns over excess demand have waned with reduced global growth. Additional risks to the oil price, which could cause it to increase, include acceleration in supply depletion, and ongoing geo-political tensions. We continue to believe that slowing global growth will cause oil prices to gradually weaken.
Interest Rate/Fixed Income
US Government Bonds - Benefits of Continued Risk Aversion, Offset by Inflationary Pressure
- Bond yields continue to be very low relative to history, and do not compensate for higher inflation. US interest rates are expected to remain on hold in the near future.
- While continued risk aversion is positive for the asset class, inflation remains a negative factor, especially for long-date bonds, as it could lead to higher yields. Thus we remain neutral on this asset class.
Eurozone Government Bonds - Target Interest Rates Move Higher as ECB Remains Hawkish on Inflation
- Although high inflation remained a concern at 4.1%, bond investors chose to focus on economic growth concerns.
- High inflation could push yields higher, but high volatility gives the asset class some support, as investors perceive government bonds as safe haven assets. Thus we maintain our neutral view on this asset class.
Asian Bonds -Cautious on Credit Markets
- Asian bonds continue to be correlated with movements of credit in the US as well as overall emerging market bonds. Asian bond spread is currently slightly above its historic average. We regard the spread as being within the fair-value zone. Overall Asian bond spreads are unlikely to decouple from the global trend. Our global house view is still very cautious on all credit bonds. We therefore expect limited returns in the near term.
Emerging Markets & High Yield Bonds- High Inflation & Credit Crisis Continues to be a Concern
- Spreads for emerging market debt remained unchanged. We maintain a negative stance on the asset class, mindful that high inflation, persistent market volatility, and poor valuations continue to exert a negative influence for emerging market debt over the medium term.
- Pan European high yield continued to suffer more than their US peers. Credit concerns and the economic slowdown suggest a cautious stance. Hence, we remain neutral towards high yield bonds.
Currency
US Dollar (USD) - Attractive Valuation, but Penalized by Interest-rate Differential
- The USD gained slightly against major currencies last month and continues to be attractive versus the GBP and Euro, on valuation grounds. "Strong dollar" rhetoric is a mild short-term positive.
- But the interest-rate differential continues to suggest cautiousness. And if the Fed is seen as "behind the curve" on raising rates to combat inflation, this could also be negative for the USD. On balance, we stay neutral.
Canadian Dollar (CAD) -Driven By Capital Flows and Commodity Prices
- The general backdrop of solid economic growth, firm commodity markets, narrowing interest rate differentials with the US and broad USD weakness are supportive for the CAD. With the currency having appreciated strongly over the past 3 months, some consolidation should be expected. However, major pullbacks are unlikely in the near term.
Euro (EUR) - Risk to the downside, but there is no immediate catalyst for change.
- Poor economic data could start to penalize the currency. If inflation persists, and the ECB does not raise rates rapidly enough so that is perceived as "behind the curve", this could be negative for the currency. Given no immediate catalyst for currency depreciation, however, we keep a neutral position.
Sterling (GBP) - Overvalued, but Supported by Interest-rate Differential
- The GBP continues to be overvalued against the USD, and economic growth is clearly deteriorating. However, the currency is supported by a favorable interest-rate differential. As there is no clear catalyst for depreciation in the GBP, on balance we keep our neutral position on the GBP.
Japanese Yen (JPY) - At Fair Value, with Upside Capped by Weak Macro Picture
- The JPY is broadly at fair value relative to the USD. But the macro picture continues to deteriorate and does not support a long-term appreciation of the currency. The unsupportive interest-rate differential is another negative factor. Therefore, we maintain our neutral view on the currency on a 6-12 month period.
AUD & NZD - Negative on Falling Commodity Prices and Possible Rate Cut
- The decline in commodity prices has caused a reverse in the direction of the AUD. Whilst it is difficult to say whether commodities will decline significantly further, the pressure for now looks to be down. We thus believe there is more downside risk in the medium term. As the NZ economy is weaker than Australia and rates are likely to be cut in H2, we expect the NZD continues to underperform.
Investment involves risk, value of investment may move up or down, and may become valueless.
For more information, please call HSBC Premier Investment Phonebanking Services on 2996 6888, PowerVantage Investment Phonebanking Services on 2996 6000 or Unit Trust Investment Phonebanking Services on 2233 3733.
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