If the US federal reserve does cut interest rates on 18 September, will that automatically make Asian equities a “buy”?
A cursory glance at statistics does seem to suggest such a correlation.
In the past 27 years, except on a couple of occasions, every time the Fed began paring rates, Asian markets, excluding Japan, were up—both in absolute terms and in relation to equities in other regions—nine months later.
This plain reading of the data may be both simplistic and misleading, according to a new study by Citigroup Inc. analysing the link between previous Fed rate cuts and Asian equity prices.
An important point of departure between now and, say, April 1980, or September 1998, is that equities in the region are much more expensive today, especially in markets such as China, Hong Kong, India, Indonesia, Singapore and South Korea, says the report written by Markus Rosgen, Citigroup’s chief Asia strategist, and his colleagues.
Their research shows that in the past when Asian equities rose in response to the Fed’s lowering of its target for the overnight federal-funds rate, they had an average price-to-book-value of 1.2; and on the two occasions the region’s shares slumped, the ratio was 2:3.
At present, prices are 2.6 times the book value.
“We are at a 116% premium valuation to periods when markets rose and a 13% premium to levels when markets historically fell by one-third,” Rosgen says.
To be sure, things could turn out differently this time. For instance, Asia could “decouple” from the US and continue to grow strongly even as the American economy slows down markedly, or enters a recession.
That could make investors more willing to pay a hefty premium to own stocks in the region.
Similarly, a Fed rate cut may stoke fresh appetite for risk. That will help emerging-market stocks, including Asian shares.
On a longer-term perspective, some other analysts are anticipating Chinese liquidity to become a floor supporting risky emerging-market assets, such as Asian equities.
The trade surpluses spawned by the undervalued Chinese yuan have so far provided an interest-rate subsidy to the US; now that more of this money is being allowed to exit the country through non-official channels, it may come to play an increasingly important role in Asian stock markets.
A case in point is Hong Kong, where mere anticipation of that liquidity has been enough to send shares into the stratosphere.
The benchmark Hang Seng Index has risen 11% since China’s state administration of foreign exchange, the currency regulator, announced a pilot programme two weeks ago allowing individuals to buy stocks in Hong Kong.
The Hang Seng China Enterprises Index, which tracks the so-called H shares of 41 mainland companies, jumped 31% in the last two weeks, the best performance among 89 global benchmarks tracked by Bloomberg.
“China matters in global finance, more than many people think,” says Joseph Yam, chief of the Hong Kong monetary authority.
Even as individuals in China wait for the pilot programme to start, institutions are already lining up new products to channel Chinese savings into overseas markets.
In recent weeks, four Chinese fund houses, one securities firm, one bank—Deutsche Bank AG—and one local insurance company has been given licences to join the qualified domestic institutional investor, or QDII, plan.
Unlike direct investments by individuals, the liquidity effect of QDII may not be limited to Hong Kong.
“While a number of companies are developing products that will focus on H shares and overseas-listed Chinese companies, some Asia-Pacific and global-concept funds are also in the works,” says Jing Ulrich, chairwoman of China equities at JPMorgan Chase & Co. in Hong Kong.
Then there’s China Investment Corp. (CIC), which, to begin with, will manage $200 billion (Rs8.2 trillion) of the country’s foreign exchange reserves. Part of the funding for the sovereign wealth fund was completed last week when the finance ministry sold 600 billion yuan (about Rs2.24 trillion) of bonds to the central bank.
“We expect CIC to grow into one of the world’s largest investment vehicles,” says Ulrich.
As a result, a chunk of the money that has so far been going into US treasuries and other “safe” fixed-income securities will now flow into emerging-market equities, including Asian shares, through private equity firms and hedge funds that might be selected by CIC to invest on its behalf.
China’s liquidity support for Asian equities, significant as it will be in the years to come, is not a force just yet outside of Hong Kong. For now, the Fed rate decision will be of immediate significance. A rate cut may not automatically mean a “buy” at the current valuations, but it will still be closely watched. BLOOMBERG
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