The Portfolio Review (Feb-Mar 2015)

portfolio reviewChina
The year opens with China’s two successive cuts of interest rates in three months, which confirms market concerns of a “Chinese QE”. HSBC’s Global Research reports that The People’s Bank of China announced on 28 February that, effective from 1 March, the 1-year benchmark lending rate and deposit rate is to be lowered by 25bp to 5.35% and 2.5%, respectively. The pace of monetary easing in China has accelerated, as this move comes just 24 days after the Required Reserve Ratio (RRR) reduction announcement on 4 February. Still, HSBC believes that a resulting weakening RMB will not spur growth exports, as although “a weaker currency might help some exporters’ profit margins, any boost in exports is likely to be minimal amid still lacklustre global demand.” Therefore, an aggressive RMB devaluation seems unlikely. 2014 year also marks the “soft landing” of the Chinese economy, with a yearly growth of 7.4%, an all-time low in 24 years. The rate cut was widely seen as China’s attempt to address the so-called “New Reality”, as phrased by Xi Jinping, President of the People’s Republic of China, to shift the focus of the Chinese economy from export-centric to demand-centric. The newly introduced Shanghai-Hong Kong Stock Connect, launched in November 2014, will surely raise volatility of the stock and capital markets of both cities in the year to come, pushing yield for the offshore RMB market.

Oil
Over the course of 2014, the oil and energy markets worldwide were plunged by intensifying geo-political risks in the wake of rising political concerns in the Middle East and Europe. However, surging oil supply, due to a decade of higher oil prices, has brought oil prices to $60 per barrel, fuelled further by a slowing emerging market growth. Sarah Riopelle, Vice President & Senior Portfolio Manager at RBC Global Asset Management, says a price of $80 per barrel is expected, given the cost of major producers. She adds that although growth in emerging markets has decelerated materially over the past few years and fewer efficiency gains are available to corporations, this trend may near an end as these countries stand to benefit from falling oil prices, lower interest rates, weaker currencies and improving developed world growth. While she expects low interest rates to persist over the next year, a trend to a higher level of interest rate would be possible, depending on where oil prices settle. The Ukraine-Russia crisis, plus the ongoing political saga in the Middle-East, further adds to the geo-political fluctuation risks of the world commodity in 2015.

Europe
The EU28 unemployment rate reached 9.8% in January 2015. These figures are published by Eurostat, the statistical office of the European Union. For the Euro Zone, 2015 proves to be a year of significant changes. David Zach, Senior Vice President of the Franklin Templeton Fixed Income Group, says should a European Quantitative Easing (QE) happen as predicted in 2015, it could mark a significant change in the role of the European Central Bank and how the region finances debt. Despite this, the weakness of the German economy, with growth of just 0.1% in the 3rd quarter of 2014, will prevent any significant growth over the current stagnation in 2015. In addition, a European QE would also close the spread between peripheral and core European Bonds. However, the much anticipated US interest rate hike this year will certainly cause another hike in European markets. While the biggest banks have cut back on their positions in risky, speculative-grade debt, a Bloomberg report says that it has steadily migrated to large institutions, insurance companies and mutual funds. Such firms have boosted their holdings of corporate and foreign bonds to $5.1 trillion, a 65 percent increase since the end of 2008, according to data compiled by UBS. In a dramatic change of policy, on 22 January 2015 Mario Draghi, President of the European Central Bank, announced an ‘expanded asset purchase program’ to purchase €60 billion per month worth of euro-area bonds from central governments, agencies and European institutions. It is planned to last until September 2016 at the earliest, with a total QE of at least €1.1 trillion. On the other hand, a Reuters report indicates that Germany and Portugal sold debt at new record lows, in 5 and 10-year sales respectively, while Italy is aiming to raise a total of €8.75 billion through auctions of 4-year, 5-year and 10-year papers in the last week of February. Euro QE’s impact on the returns on national debts will surely be seen in the Pan-European economy, in particular in economies requiring a bail-out like Greece.

Dollar
After a brief period of US Quantitative Easing (QE), the ending of QE is in sight, as it is widely expected that the near zero interest rate policy will be ending as soon as the coming summer. However, due to the fact that the export sector constitutes a relatively smaller part of the economy of the US when comparing with other countries, the appreciating value of the dollar will be balanced against interest rate hikes, as the US does not need to maintain a low dollar just for the export sector, according to a report released by AXA Investment Research. David Page, Research & Investment Strategy for AXA Investment Research, said that as the US “is less sensitive to movements in its currency than other economies, reflecting a smaller international sector and the complication of the US corporate tax system,” he believes that the Federal Reserve will tighten policy for the first time in 2015 (possibly in September). However, a marked further appreciation of the dollar could reduce inflation soon enough to delay the first rise in interest rates. He further emphasises that since the US is less susceptible to rate fluctuation, the dollar appreciation‘s impact on the export market will be minimal. US exporters are themselves less susceptible to strong dollar gains. Balancing between the export and the interest rate factor will remain on stage throughout much of 2015.

China’s Property Market
After almost a decade as the country’s leading growth vehicle, the Chinese property market has been exhibiting signs of slowing down in 2014. According to data released by the PRC National Bureau of Statistics (NBS) on January 20, real estate investment in the country has dropped to a five-year low in 2014, rising 10.5 percent year-on-year to around 1.55 trillion USD. Real estate investment growth had slumped by 9.3% from 2013. Occurring concurrently with the further slow-down of Chinese economic growth, concern over the possibility of a property bubble burst grew, due in part to credit easing since the financial crisis of 2008 and the growth in the number of redundant flats in major cities. The NPC and CPPCC sessions, which began on March 5th 2015, will provide a glimpse into how Beijing chooses the most appropriate policy options to reduce property market overheating. For reference, the Chinese State Council has published a report by the country’s National Audit Office in December 2014, stating that the debts of China’s local governments had increased to RMB 17.9 trillion ($3.0 trillion) by the end of June 2013. This amount, including contingent liabilities and debt guarantees, represents a 70 percent increase from the RMB 10.7 trillion ($1.8 trillion) owed by the country’s local governments at the end of 2010. While experts agree that the debt level is not exceptionally high compared with the near 100% debt level of the developed economies, whether new financial instruments or national debts are to be issued to finance the debt level remains to be seen in early 2015. BM