This article first appeared in Personal Wealth, The Edge Malaysia Weekly on September 18, 2017 - September 24, 2017

With the winding down of unconventional monetary policies in many of the advanced economies, the time has come for investors to focus on the growth opportunities that have arisen. Many of these opportunities are in this part of the world, say money managers.

“On the one hand, we are looking at a reduction in liquidity. But on the other, investors are scouting for growth prospects,” says Lim Tze Cheng, CEO of Inter-Pacific Asset Management Sdn Bhd.

“From a growth perspective, emerging markets look better at the moment. The liquidity impact on emerging markets will depend on how factors such as liquidity flow or growth pan out. Personally, I think the growth angle is a more important factor.”

Investors do not have to look far for such opportunities. Malaysia, for example, looks very attractive at the moment, says Lim. “We are still keen on local equities. However, this is due to our investment philosophy of being company and business-centric. We are seeing a lot of companies post stronger growth.”

His assertion is backed by the fact that global growth is picking up pace, with corporate earnings looking rather positive. He also stresses that central bankers are much more communicative about their monetary policy decisions, which leaves little room for panic.

“The market is a collective mind of investors. If things are predictable, then there will be market order. As the central banks’ intention to taper has been well communicated, there is minimal shock factor,” says Lim.

“We are pro-tapering as cheap money cannot last forever and a prolonged cheap money environment encourages speculative activities. As for investors, our view is that global economic growth is still on track, thus corporate profits are generally positive.

“We cannot say that all corporates will perform well. Investors can get good returns by picking the right companies to invest in.”

Kelly Chung, senior fund manager at Hong Kong-based asset management firm Value Partners, says the firm is positive on emerging market equities. “We believe the global economy will remain strong in the near future as economic activities, employment and consumption continue to pick up in both the developed and emerging markets.

“We are also positive on emerging market equities in the next 12 months as fund flows have begun to return to emerging markets. Also, corporate earnings have continued to deliver positive surprises.”

The iShares MSCI Emerging Markets ETF is up 30.39% year to date (as at Sept 13). However, the valuations in emerging markets are no longer considered cheap after the last rally, although they are relatively cheaper than those in developed markets, says Chung. “Valuations have now reached the historical average level and the rally going forward will be more moderate than it was in the first half of the year.”

The US Federal Reserve started phasing out its quantitative easing (QE), or bond buying, programme in 2014 and began normalising interest rates in late 2015, ending the near-zero interest rate environment that was deemed necessary after the 2008 global financial crisis. As a result of the QE, the central bank has amassed a great amount of assets and its balance sheet now stands at US$4.5 trillion.

The Fed has decided to reduce its balance sheet, which has been dubbed the “Great Unwind”. The concern is that if the unwinding occurs too quickly, it would result in soaring bond yields or falling bond prices, higher borrowing costs and economic stagnation.

The European Central Bank (ECB) has indicated that it will be making adjustments to its monetary policy and phasing out negative interest rates next year while the Bank of Canada and Reserve Bank of Australia have signalled that interest rate hikes are on the horizon. The Bank of Japan and Swiss National Bank, however, are expected to be the only central banks maintaining their unconventional monetary policies.

OCBC Bank Singapore’s vice-president Vasu Menon says that since the intentions of the major central banks have been well communicated, the shock factor will depend on the speed of the interest rate hikes. “With the increase in interest rates in the US and tighter monetary policies elsewhere, the bond market will be affected more than the equity market. The reason for the tighter monetary policies is better economic data, so this may not be all that bad for the equity market because it will benefit from the economic recovery.”

Chung believes that the Fed is likely to announce its balance sheet normalisation plan at its upcoming meeting this month and begin rolling out the plan next month. “The market has only priced in a very gradual pace of normalisation. The reduced liquidity will definitely have some impact on emerging markets, but the effect should be moderate as a lot of money has been pulled from emerging markets in the past five years and the flow has just started to return to the emerging markets this year. Also, Europe and Japan are still in an easing mode, which will continue to add to global liquidity,” she adds.

“For Malaysian investors, the more significant impact will come from the movement of the US dollar. However, unless the Fed takes on a much more hawkish stance towards either rate hikes or balance sheet normalisation, the US dollar will likely stay in the current range. The Trump effect that drove up the US dollar has almost diminished as the market does not expect any aggressive reforms to take place in the near term.”

As Janet Yellen’s term as Fed chair ends in February next year, Chung believes that this will set the pace for the balance sheet shrinkage and start before the end of her term. “Therefore, we don’t think the balance sheet normalisation will wait until interest rates reach a higher level. We believe that if the US has full employment and its economic data remains strong, the Fed will continue to hike interest rates over the next few years. However, there will be a ‘new normal’ for eventual interest rates, which will be lower than what historical normalised interest rates suggest,” she says.

Maybank Islamic Asset Management Sdn Bhd CEO Ahmad Najib Nazlan says the ECB’s plan to begin tapering its QE programme may not drastically affect the growth trajectory as Europe is already showing signs of economic recovery and the current liquidity may be able to absorb the reduced demand from the tapering exercise.

“Synchronised global growth is possible in the next 12 months as the US, China, Europe and Japan are expected to deliver decent GDP growth within expectations. Central bankers around the globe are more careful with their actions to ensure sustainable growth and low volatility from less speculative activities by providing clearer and more precise guidance to the markets,” says Ahmad Najib.

The decisions made by central banks should not affect the decision-making of investors, says Franklin Templeton’s emerging markets group executive chairman Mark Mobius. He points out that there has been no proven correlation between the central banks’ decisions and the belief that they will push the prices of debt instruments down or result in a decline in asset prices.

“There is a feeling that by reducing its balance sheet, the Fed will, of course, need to sell its assets and thereby push the prices of those assets (primarily bonds and other debt instruments) down. The theory goes that this will generally result in a decline in asset prices, including equities. Such a connection has never been definitively proven, so it is not something that we can rely on,” he says.

“The other theory is that as the Fed reduces its balance sheet — by not only selling assets but also ceasing to purchase assets — interest rates will rise and this will be bad for both the bond and equity markets, resulting in a decline in the prices of those instruments. For the three years before January 2016, the Fed was purchasing assets aggressively and pushing interest rates down. But emerging markets still underperformed the developed markets.

“Furthermore, if we go back 10 years, we find that the relationship between the Fed funds rate and emerging markets equities is non-existent. There is no direct correlation. Sometimes, interest rates go up and the MSCI Emerging Market Index rises. But other times, interest rates go down and the MSCI rises or even falls. A clear pattern that we can rely on to predict market behaviour simply does not exist.”

Thus, any subsequent action by the Fed will not have a sustainable impact on emerging markets. On the other hand, other variables, such as earnings growth and geopolitical events, will be the determinant factors, says Mobius.

“All the central banks — the Fed, ECB, Bank of Japan — are whistling in the dark. By their own admission, they do not know what impact their actions will have. Hence, as investors, it would be a mistake for us to rely on the Fed’s actions to make investment decisions apart from trying to determine the overall psychological impact its actions and pronouncements will have on investors and the markets. Malaysian investors should not rely on such predictions and invest for the long term in good solid companies and industries with substantial long-term prospects.”

He adds that the global economy, particularly the emerging markets, is doing well and growing at an average of 4% while China and India are growing at more than 6%. Corresponding growth is also seen in Europe. “Although the US growth is not what we would like to see, there will continue to be growth in the economy, but at a slower pace,” he notes

“Most [local] investors are very underweight on emerging markets, so they need to increase their weightage to at least 30% since that is the portion of what makes up the world market’s capitalisation. Of course, investors in Malaysia already have exposure to their own emerging market, but that is not sufficient. The country may not always be the best performing market in the world, so it is necessary to diversify their holdings in emerging markets globally,” says Mobius.

Chung says Asia will continue to benefit from positive fund flows and the continued pickup in economic activities globally. “We continue to overweight equities over fixed income as we remain positive on equities. However, as valuations have become more expensive, we will not be as overweight on equities as before.

“Global bond yields remain at a low level as the market only expects a very moderate pace of interest rate hikes in the US. It is not likely that bond yields will go much lower unless crisis-like events happen. Thus, we do not recommend being overweight on government bonds and prefer corporate credit.

“Besides equities and fixed income, we suggest including some alternative investments in your asset allocation, such as gold and absolute return strategies, for hedging and diversification purposes.”

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