MONEY is flowing back to the US, drawn by improving confidence in the world’s largest economy. It can be seen in the ever-strengthening US dollar and a stock market that continues to seek new highs. But a stronger economy may not translate directly into corporate earnings, says BlackRock Asset Management North Asia Ltd director Oisin Crawley.

In fact, he is much more bullish on equities in Asia, particularly China, India and Thailand, as they stand to benefit from leadership-driven reforms as well as lower oil prices that will ease inflationary pressure.

“I’m not especially bullish on the US stock market, but I am bullish on the US economy. Some of the things going right for the US economy could put pressure on the US stock market. Rising wages would be good for consumption but it will raise costs for corporates,” explains Crawley.

At the same time, rising bond yields would raise borrowing costs for corporates, even if it does indicate that the country’s economic growth is improving. Simply put, he is more confident in the US economy that he is in corporate earnings.

“I think the US is still one of stronger economies, if not the strongest economy. People still want to invest there. If you expect the US dollar to strengthen, you tend to have your money in US assets. However, we see the US might have quite a flat year. The market might be very volatile — it would be up a lot at one point and down a lot at another,” says Crawley, who expects a mid-year interest rate hike to cool the bull market.

The Dow Jones Industrial Average closed at 18,019.35 points last Monday, just shy of its all-time high and almost 11.71% higher from a year ago.

While the US has performed admirably in the past few years, Chinese equities have taken centre stage in the past few months with the Shanghai Composite index gaining 50% in six months to close at 3,246.906 points last Monday.

“We were constructive on Asian equities last year and the oil price change has now made us bullish. Asia is really one of the prime beneficiaries of the weaker oil price,” says Crawley, whose top pick is China — a contrarian view, he points out.

Lower oil prices will reduce inflationary pressure on Asian countries, giving them more room to cut interest rates and in turn boost liquidity, he says, “It is one of the few places left in the world where there is room to cut interest rates.”

To cap it all off, Crawley is optimistic that the leadership changes and subsequent reforms in the region will be able to address many of the structural issues in Asian markets like China, which have been worrying investors.

“China is the one market that generates the most debate, but it is the cheapest,” he says. He points out that there has been too much fear surrounding China’s opaque financial system that has kept many investors away but he is confident of the reforms led by President Xi Jinping.

Today, Chinese equities listed in Hong Kong, or H-shares, are being valued at roughly 9.9 times forward earnings, notes Crawley. In comparison, the S&P 500 is going for 17.5 times for the same period.

Over the years, there has been a divergence between Chinese growth and the performance of Chinese stocks, says Crawley. China has seen growth but the stock market has been falling.

“Now growth is slowing, but the stock market can go up again. That kind of sounds counter-intuitive, but really, it is because the quality of growth is improving. It is less reliant on heavy industry and credit. It is less polluting and hopefully becoming less corrupt as well,” he explains.

In particular, Crawley’s fund is looking into China’s banking and financial stocks, which stand to gain the most if the government’s reforms are successful.

China’s big four banks — Bank of China Ltd, China Construction Bank, Corp, Industrial and Commercial Bank of China Ltd and Agricultural Bank of China Ltd, which are listed on the Hong Kong Stock exchange — are all trading at less than six times earnings, and only around one times book value. (See table)

“There is a lot of fear around Chinese financials and there is good reason for that. The debt situation in China is a little unclear. Banks are not being transparent about their non-performing loans (NPLs),” says Crawley.

On the flip side, most of these risks have already been priced in. In fact, the market appears to be pricing in a highly negative event like a disorderly default, a scenario that he feels is highly unlikely to play out.

“China will not allow its big four banks to fail,” he says. The Chinese government has time and a strong balance sheet on its side to spread these risks over a number of years, reducing the risk of a major event, he explains.

“We see an orderly progression where the banks admit they have more NPLs and the government supports them through local government projects , then it lets a few bad local government projects go bust. But overall, I find it very hard to believe China will allow its financial systems to collapse,” explains Crawley.

Nonetheless, investors appear to be very fearful of Chinese banks, not unlike the sentiment about Spanish and Italian bonds about two years ago. Yet today, those same bonds that used to have yields in excess of 7% are now trading on par, if not lower than, US bond yields, notes Crawley.

“Fear can be very transformative. When people go from fear to less fear, or even greed, that is what you get,” he says, referring to the European bonds.

“I think now that you are starting to see China cut interest rates and that it is starting to impact liquidity. Interest rates are still high, so it is difficult for people to delever, for them to pay all of their debts. But if you follow the rest of the world and cut interest rates to very low rates, then people have time to restructure and work through their debt issues. But, I think we’ll still have periodic flashes of fear,” he adds.

Other than banking, Crawley is also more optimistic on sectors that are still undergoing restructuring like cement, steel and aluminium that have been struggling with overcapacity and slowing demand. The cement industry has already seen its share of consolidation.

“The strong will take over the weak. It happened in sectors like cement. And you saw those companies become healthier and do better. It is going to take longer in steel and aluminium. Because it is not just Chinese overcapacity, it is global overcapacity,” he explains.

Not Malaysia’s year

Beyond China, other markets that Crawley are eyeing includes India, Thailand, Taiwan and South Korea, primarily because these economies will benefit from lower oil prices.

His fund, however, has very few positions in Malaysia, which will instead be adversely affected by low oil prices.

“In Asia, with other countries benefiting from cheap oil, it isn’t really Malaysia’s year. We have very few positions in Malaysia, and from an investment point of view, that is right. Malaysia isn’t one of the beneficiaries of the low oil and gas prices. The good news about Malaysia’s market is it used to be expensive but it has become cheaper,” he says.

Economically, Malaysia performed well, he notes, but corporate earnings were only mediocre. For the moment, BlackRock is only dabbling in a few defensive stocks in sectors like telcos, as well as construction, which stand to benefit from ongoing infrastructure demand.

However, Crawley is even more bearish about Hong Kong’s prospects.

“Why did Hong Kong do so well? It had Chinese growth and US interest rates. Now there is slowing Chinese growth and rising US rates. It is sandwiching Hong Kong and similarly Singapore. We are more cautious in those markets,” he says.

Further abroad, he is also bullish on India, which stands to benefit the most from falling inflation.

“We are looking at economically sensitive and cyclical sectors. What has done well in India historically has been expensive high growth. Pharmaceuticals, IT services, consumer staples. What we see slowly happening in India is the economy returning to the 7% to 8% growth it used to be capable of. Compared to the recent 4% to 5% growth, which was a result of government paralysis, India is the opposite of China. It has a lack of capacity and infrastructure capacity,” he says.

Going ahead, he anticipates more investment into the power sector, general infrastructure and materials.

“Those are the cheapest stocks in India and their earnings acceleration from an economic rebound in India will be phenomenal,” he opines.
Closer to home, Crawley is most positive on Thailand among the Asean countries.

“The political situation is a risk but a lot of it has already been priced in. Coming from a low base of economic position, it looks like the government has been fairly pro-business. I think life can go on,” he says.

Meanwhile, he is neutral on Indonesia and feels that Philippines is still too expensive.

“[South] Korea is also a beneficiary of oil. Everybody hates it but also very cheap, and generally does better than you’d expect when global growth starts to do better,” he explains.

More volatiliy ahead

Going ahead, the combination of liquidity and volatility in the market will see even more violent swings when the market chooses to move, he notes.

The quantitative easing by the European Central Bank and the Bank of Japan has definitely stepped in to fill the void that the US Federal Reserve left when it withdrew its bond buyback programme in October last year.

However, the money will still chase hot assets and right now, it has been chasing fixed income assets, says Crawley.

“Painful as it is for us in equities, there is a bull market in bonds and maybe a bubble. Any bull market or bubble eventually crashes. The most likely catalyst would be an interest rate increase. Just as people are worried about deflation, we take the opposite view. Oil price falling is reflationary. And rates will rise and growth will increase and therefore, I think the biggest financial risk for equities is a big swing in the bond market,” he says.

Going forward, Crawley advises investors to take a medium term view and stick to the position, instead of reacting to volatility, where “you tend to lose money changing your portfolio constantly”.

This article first appeared in The Edge Malaysia Weekly, on February 23 - March 1, 2015.

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