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It is prudent to avoid Asian equities at a time when US-Chinese trade tensions become even more virulent, regional currencies get slammed by King Dollar, global fund managers flee emerging markets and Trump's threats to choke Iran's oil export and move Brent closer to $80. My salad days trading currencies and financial futures have neurologically programmed me to seek out the 'capitulation trade', that ideal entry point when trends magically reverse and the trade then mints money on the path to Valhalla/Shangri La/Elysium. So where do I go in this quest for the elusive 'capitulation trade'. Asia. Why?
One, the MSCI Asia ex-Japan index has derated and now trades at 1.5 times book value. This is 'near capitulation' 16th percentile since Asian equities bottomed in the global recession and the Opec oil boycotts in 1974. I caution that valuation is a lousy timing indicator but this modest valuation suggests Mr Market expects the trade war to culminate in a global recession.
Two, Asia ex-Japan expected earnings growth of 15 per cent. Naturally, a protracted trade war would gut earnings growth in the region.
Three, Bank of America's Risk Love index, a metric of risk appetite, is now the lowest since 1995. As long as there is no recession (a big if), this is the time to increase exposure, not reduce it, to Asia ex-Japan. However, I will not heed the BofA Risk Love indicator for now. China, Japan, South Korea and Taiwan are in the cross hairs of Trump's tariffs. Asean markets face elevated financial and foreign exchange vulnerability to King Dollar, rising oil prices and a hawkish Federal Reserve. Note the rising scale of outflows from even India's Dalal Street, the consensus overweight in Asia.
Four, credit risk premia in the lowest investment grade US corporate bonds have begun to rise to 200 basis points, their highest levels since the failure of Lehman Brothers and onset of global recession in 2008-09. This means the smart money on Wall Street has raised its odds of a US recession even though the US Treasury yield curve has not yet inverted (but it will!). So it is essential to watch the Uncle Sam 10-year note/Moodys Baa spread before making a go/no-go call.
As I scan Asia's stock markets, I have to concede some amazing bargains, especially in China and the Philippines where a US dollar investors can get a 25-35 per cent discount given the scale of Chinese yuan and kabayan peso depreciation. There is definitely value in certain megacaps in Manila and Hong Kong's H shares. I have a bias for healthcare shares or domestic consumption proxies in Southeast Asia, primarily in Thailand and Indonesia but only in companies with low financial leverage.
Saudi Arabia has been one of the world's best-performing stock markets in 2018, up 17 per cent at Tadawul 8,750 points. Saudi Arabia's liquidity cycle has turned positive at the same time as oil prices rose to $77 and the kingdom borrowed epic amounts in the global debt market. The state budget is the most expansive in the history of the kingdom at almost SR1 trillion. While the easy money in Saudi stocks has been made, there are specific opportunities in banks (Al Rajhi, Saudi Fransi) and fertiliser/petrochemical shares (Sabic, Safco). Religious tourism is a winner theme in Saudi Arabia as the government prepares for a quantum increase in Umrah visas and revenue per available room in the holy city of Makkah for branded four star-hotels surge.
The election of Dr Mahathir Mohammed on an anti-corruption platform and the arrest of prime minister Najib Razzak for looting the 1MDB sovereign wealth fund is a game-changer in Malaysia. However, I believe Malaysian equities are expensive and the ringgit can easily fall below 4.25 as Bank Negara will not resist the pressure of King Dollar.
I had originally recommended Alibaba's New York ADR at 100 several years ago. The shares have been slammed down to 187 as I write, well below its 211 high due to yuan softness. I remember the same thing happened in 2015 and 2016 (yuan tanks) and Alibaba rebounded both times with vengeance. True, a deceleration in Chinese growth warrants a hit to Alibaba's valuation, this is fundamentally an e-commerce market place. Big Data and cloud play with 552 million active users and a Gross Merchandise Value that will hit $1 trillion next year. Alibaba is a classic put selling candidate in New York.
The writers is a global equities strategist and fund manager. He can be contacted at mateinkhalid09@gmail.com.
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