A Brief on Global & Local Markets, Investment Strategy.

Week in Review | 8 – 12 January 2018

Global risk-on sentiment continues, whilst US CPI hints on improving inflation

Strong performance across global financial markets stretched into the second week of 2018, as the “Goldilocks” environment of low inflation, accommodative central banks, and synchronised economic expansion remains in play.

In the US, headline CPI (Consumer Price Index) released last Friday came in slightly above consensus estimates at 2.1%; while core CPI – which figures are adjusted for seasonality as well as moving food and energy prices – came in at 1.9%. Although the data may not be the preferred measure of inflation for the US Fed, the CPI numbers may well indicate an improving inflation.

To shed some light, the US Fed relies on the core PCE (Personal Consumption Expenditure) price index to identify inflation trends. Core PCE accounts for shelter, medical care, and education among others that is more reflective of the prices that US consumer pays for – which currently stands at 1.5%.

Nonetheless, with the impending inflationary signs, our view is that the US Fed is likely to remain on course in its rising rate cycle of 3 hikes in 2018 as compared to market expectation of 2.5 hikes. However the US Fed may be pressured to revise its dot plot upwards should inflation shoots above its 2.0% target.

On Treasuries, we expect the 10-year UST yield to tread within the 2.4-2.6% range. The 10-year UST yield have actually touched 2.6% last week – from 2.4% at the start of 2018 – before easing back down to 2.5% to close the week. The minor sell-off was likely due to the effect tinkled from Japan, as BOJ announced to trim its buying programme of long-ended bonds; which also moved Japanese government bond yields upward.

While BOJ had previously dismissed the possibility of withdrawing stimulus any time soon, markets took the announcement as a hint that the Japanese central bank may gradually tighten their monetary policy on the back of a robust economic growth recorded. The revision in growth have also been reflected in the Japanese Yen; which strengthened from 113.0 to 110.5 against the USD last week.

As it stands globally, risk-taking continues to be the course of action for many investors. This smooth sailing will likely be challenged as we move into 2H2018 on the perspective of how the central banks will react when inflation does eventually picks up. While we intend to capitalise on the current lifted sentiment, we remain mindful of liquidity concerns that may arise from monetary tightening; hence our stance to remain tactically cautious moving forward.

Europe: Healthy data points despite upcoming political events

The recent barrage of data points coming out of Europe continues to point towards a healthy economic expansion – PMI, industrial production, and retail sales among others have recorded solid showings on the macroeconomic front.

In particular, the 10-year German Bund yield saw a sharp rise of 14 bps to 0.57% last week – likely driven by the robust economic data mentioned, rising speculation of a more hawkish ECB in early 2018, as well as a stabilising German government. Albeit the four-month wait since the 2017 federal election, there is increased optimism that a German government can finally be formed; as German chancellor Angela Merkel of the Conservatives will look to form a coalition with the Social Democrats, led by Martin Schulz.

The proposed agreement between both parties emphasised on EU’s prominent role in Germany; further fortifying the case for EU in the region. Nonetheless, political uncertainty still looms within the region – given the ongoing Brexit negotiations between UK and the EU; and the election lined up for the Eurozone’s third largest economy, Italy, in March.

China: A well-managed slowdown

Coming from a high-based effect, we’re expecting to see a softer headline GDP growth for China in 2018. The Chinese government’s endeavours of deleveraging continues to be evident as focus is shifted towards quality growth – in which impact is believed to be felt more eminently this year.

Nonetheless, this slowdown is expected to remain gradual and well-manged by policymakers as seen throughout 2017; hence any adverse impact on regional markets is unlikely.

In terms of currency, the RMB – which currently stands at 6.4 against the USD – is expected to remain within a stable range. Given the current bearish USD trend, we think that the RMB will be a strong anchor for EM and Asian currencies in the interim.

Strengthening regional currencies paves momentum for Asian equity

Alongside the Japanese Yen and Euro, the upward momentum for the EM currency basket continues to be evident against the USD.

From a technical standpoint, the low positioning in terms of EM investments by global investors – about 9.0% as compared to the MSCI World Index that comprises a weightage of about 13.0% – indicates that there is still room for potential inflows into the region. With the impending appreciation of EM and Asian currencies against the greenback, global investors will likely be tempted to neutralise their positions. In the past week alone, EMs including Asia saw a net inflow of approximately USD4 billion – further boosting sentiment for stocks within the region.

Reflective of the positive vibe for EMs and Asia, cyclical sectors such as the commodity space have also done well across the board; where copper, aluminium and zinc prices are seen to be on an uptrend. In addition, oil prices have also begun to surface and looks well on its way to hit the USD70 mark – likely driven by the upcoming listing of Saudi Aramco, one of the largest O&G companies in the world.

Despite the rebound in oil prices, we expect it to trade within the range of USD60 to USD70 per barrel – given that fundamentals are still somewhat wobbly, and the kick-start in shale production will likely cap further upsides.

Regardless, the overall improvement in the broader Asian economy remains undeniable. Earnings data from the region continues to be healthy – depicting a +5.0% revision on a 3-month rolling basis. In terms of valuation, Asian markets on aggregate stands at 13.8x forward P/E which is slightly above its historical average of 12.2x. Although current valuation isn’t the most attractive, we believe that the healthy earnings revision well justifies the investment case for Asia.

Positioning wise, we remain quite fully invested at about 95.0% across our regional portfolios. While our focus tilt toward financial names within North Asia remains, we have positioned some of our funds into cyclical names like POSCO (Korean steel company), as well as SINOPEC and CNOOC (Chinese O&G company) to leverage on the current commodity play and improving oil and gas outlook.

Malaysian market update & positioning

The domestic equity market continues its decent run with the FBMKLCI gaining around 2.0% thus far in 2018. It was boosted by strong foreign inflows mainly into index bellwethers. The oil price strength and MYR appreciation also added extra impetus to the market.

One notable company news flow was CIMB Group trimming its Asset Management arm stake from 60% to 40%. The deal valued at RM470 mil gives an implied valuation of 25x P/E. We are positive on the news flow and will remain invested on cheap valuation, better asset quality and improving margins in the event of a rate hike.

In terms of our strategy, we are maintaining our high equity exposure of about 90.0% to leverage on the positive market momentum. Nonetheless, we will look to take profit ahead of elections – which is expected to happen some time in March/ April.

A separate note on monetary policy developments, BNM is slated to meet next week (25 Dec) for its upcoming monetary policy meeting. Views are split on whether BNM will hike the OPR but the majority believes that a hike will only take place after the GE14. We however believe that the hike will push through this month on the basis that BNM has already indicated back in October 2017 that they will reassess their monetary policy stance, hence there is no need for the central bank hold rates steady. In any case, the majority expects BNM to only hike once throughout 2018.

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