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Market Outlook 2013

"Of course there is a bubble in the bond market, but I don't think rates are going to go much higher...the Fed is blowing lots of air -- some say hot -- and constantly inflating the bubble." – King of Bond, Bill Gross.

Just to illustrate the ‘power’ of these ‘hot money’ – after the Fed announced QE3 in mid September 2012, the Hong Kong Monetary Authority (HKMA) had in total intervened 27 times, pouring a total of HK$102.16 Billions to maintain its peg to the US at US$1 = HK$7.75; on 2013-01-03, according to Barclays indices, average yields of US Junk bond fell to a record low of 5.89%.  Average high yields below 6% is something markets have never seen…  

Meanwhile, the equities market appeared to done well for this year.  But is it really the case?  The chart below illustrates the Year-to-date performance of key MSCI indices performance against selected bond and gold funds:

Source:  iFast Financial Pte Ltd

Interestingly, bond’s performance is comparable to MSCI Asia ex Japan, however, at a lower volatility.  The table below compares the 1 Year, 2 Year and 3 Year performance of key MSIC indices performance against selected bond and gold funds:

Source: iFast Financial Pte Ltd

For the past 3 year, based on the above comparison, Bond had consistently outperformed equities at a low volatility.  To be fair, high yield bond and emerging market bond funds had performed even better. The reasons for the outperformance may attribute to low interest rate environment, the central banks’ support, and investors hunting for yield.  Past performance may not be a good indicator of future performance.  Moving forward, one of the key factors driving the bond prices up might change – on Jan 3, 2013, for the first time since the financial crisis started five years ago, the Fed has at last made its first signal that its extraordinary loose monetary policy will start to get tougher.  What does that mean?  The central bank would be able to slow or stop the bond purchases well before Dec 2013.. We might see some volatility in bond market, however, we don’t think it would be a “rush to exit” situation, as the other key attribute of bond price – interest rate is yet to revise upward yet.  The Fed indicated that the interest rates shall remain low until unemployment falls below 6.5%.  The unemployment rate as of December 2012 stood at 7.8%. 

On the equities front, in the last review, we are ‘right’ on China that the valuation is relatively ‘cheap’ – China stocks market had shot up to 2,277 on January 4, 2013 , more than 16% since its low at 1,960 on December 3, 2012, within a month!.  We believe South East Asia is ‘expensive’.  MSCI Southeast Asia Index is only 2% of the global index but it has outperformed its global peer by a resounding 3 times over the past three years.  The ‘irrationality’ might further support its rally.  But we believe that there are better alternatives such as China which has underperformed for the past years for various reasons.  Based on the past 100 years of the stock market historical records, there were only 2 incidents where the market fell consecutively for four year:  the first was in 1929, the Great Depression, however, in reality, it was down consecutively for only 3 year; the second one is the Thailand market which was due to the collapse of its exchange regime during the Asian Financial Crisis in 1997.  If China stocks were to underperform (generating negative return) in 2013, it would be the third. 

US Equities would be another interesting country to observe. Apart from the weak dollar (there is no good reason for US to adopt strong US dollar policy) which would give US’s product a competitive advantage in global trade, there are signs that more and more US manufacturing companies are returning to US. It would not be a surprise if one day your iPad is a Made in USA product. Ever since the Global Financial Crisis which took place in 2008, American workforce are more willing to accept significantly lower pay package. For instance, the Worker’s Union of US car manufacturers are willing to reduce its worker’s pay package range from 35% to 45%! The net effect is the manufacturing cost of a similar car category in US is even now cheaper than that of Japan!

Gold futures ended 2012 with a 7% gain, a 12th-consecutive yearly gain.  With the Fed signal ‘end of bond buying’, would it mark the end of gold rally?  Recently, CNBC interviewed Jim Roger and he said “Most things correct 30% every year or two, even in big bull markets – 30% corrections are normal and yet gold has only done that once in the past 12 years.  Gold on any kind of historic market basis is overdue for a nice correction.”  As a matter of fact, comparing to developed countries such as US, Germany, Italy and France, which hold more than 70% of their reserves in gold, most developing countries’ have relatively small percentage of their reserves in Gold, for instance China is only 0.8%!   As such, there is a good reason to believe that central banks from the emerging markets are likely to support the gold price.  For instance, Brazil boosted its gold reserves for a third month in November 2012 to double the country’s holdings; Bank of Korea increased gold reserves 20% in November 2012 to diversify investments…

Reference:

    1. 中国经营网, 2012-12-20, “香港金管局第27次狙击热钱 累计超千亿港元”
    2. Bloomberg, Glenys Sim, 2012-12-21, “Brazil Doubles Gold Reserves as Central Banks Buy Bullion”
    3. Financial Times, Lex, 2012-12-23, “SE Asian Economies – Size Matters”
    4. MarketWatch, First Take, 2013-01-03, “Fed says it’s running out of bullet”
    5. Financial Times, Vivianne Rodrigues, 2013-01-03, “US Junk-rated debt yield dip below 6%”
    6. MarketWatch, Polya Lesova, 2013-01-04, “US Stocks close at highest level since 2007”
    7. 21世纪经济, 杨琳桦 , 2013-01-04, “ ’中国制造’潜危机:生产外包回流美国”