W E A LT H ST R AT EG I E S

8 10 Aug Oct 2013

Looking past short-term market swings for potential returns

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 CONTENTS

02
Looking past short-term market swings for potential returns

06

Outlook for RMB bonds remains robust

Implications of rising US yields on credit markets

10 14 20
What would QE tapering do to the bond markets and what can investors do about it?
Aug 8 Oct 10 2013

Where will the market go?

Recent market selloff: A pause, not a reversal

24

01

WEALTH STRATEGIES


Looking past short-term market swings for potential returns

02

Global equity markets was on a wild ride in the second quarter as investors were caught off guard by Chinas slowdown and the Federal Reserves signal that it may reduce the pace of asset purchases, provided economic data continue to improve. The prospect of the tapering of quantitative easing (QE) in the US, which sparked a surge in the US Treasury yields, has also put pressure on the overall bond markets.
Despite tapering talks increasing short-term volatility, company earnings had supported the performance of US equity, which delivered positive returns of +2.6% over the quarter. The Japanese equity market also continued its rising trend with a 3.7% gain on strong economic data although losing some ground following a long winning streak in Q1.

2.6 3.7

03

WEALTH STRATEGIES

Aug 8 Oct 10 2013

Looking past short-term market swings for potential returns

7.68.1

An outflow throughout Asia and EMs

Asia ex Japan and emerging market equities, however, ended the quarter lower by falling 7.6% and 8.1% respectively as the Feds possible QE tapering had led to an outflow of money throughout the regions. In addition, Chinese and Hong Kong equities lost 6.8% and 6.6% respectively with a spike in Chinas interbank lending rates, though the Peoples Bank of China eventually intervened to stabilise the money market. Chinas recently released economic data, which pointed to a slowing economy, also added pressure to market sentiments. The countrys Q2 GDP growth fell to 7.5% from 7.7%, and the manufacturing purchasing managers index (PMI) readings for June also dropped from 50.8 to just above the 50 threshold at 50.1, weaker than expected. However, Premier Li Keqiangs recent pledge in July to put a floor under the current growth slowdown has led to market optimism that the policy maker may fine-tune its policies to support growth in the coming months.

6.86.6
7.7

7.56 PMI 50.850.150

7

Chinas recently released economic data, which pointed to a slowing economy, also added pressure to market sentiments.

04

Rising yields impacted credit performance

In terms of yields, the 10-year US Treasury yield rose by 64bps over the quarter to 2.49% on 28 June due to tapering talks, bringing negative impacts to both investor sentiment as well as the overall credit performance. Global emerging market bonds declined the most by 6.1%, whereas global government bond market and investment grade corporate bonds also lost 3.0% and 2.8% respectively. Despite widening spread due to risk averse sentiment, high yield bonds led the fixed income market (-1.3%), buffered by relatively higher yield income. While short-term volatility is likely to continue on QE tapering concerns, Chinas slowdown and unsettled Eurozone debt crisis, the medium to long-term outlook for risk assets remains favourable with improving economy, attractive valuations and better corporate earnings. A diversified approach and buying on dips gradually may help manage risk during a volatile market and capture long-term investment opportunities. The recent market pullback may also provide long-term entry points for those able to look through shortterm market swings.

10646 282.49%
6.1 3.0 2.8 1.3

2013
2013 Q2 market performance

Global Equity US Equity European Equity Japan Equity Asia Paci c ex. Japan Equity Emerging Market Equity China Equity Hong Kong Equity Global Emerging Market Bond Global High Yield Bond Global Investment Grade Corporate Bond Global Government Bond

-0.42% 2.58% -0.51% 3.72% -8.08% -6.76% -6.63% -6.06% -1.29% -2.79% -2.97%
Aug 8 Oct 10 2013

-7.61%

Morningstar2013630 JP Source: Morningstar. Data as of 30 June 2013 and in USD terms Global government bond refers to Citigroup World Government Bond Index; Global investment grade bond Barclays Capital Global Aggregate Bond Index; Global high yield bond Merrill Lynch Global High Yield Bond and global emerging market bond JPMorgan EMBI Global Composite. Global equity refers to MSCI World Free Index; US equity MSCI USA Index; European equity MSCI Europe Index; Japan equity Topix; Asia Pacific ex Japan equity MSCI Asia Pac ex Japan Index; Emerging market equity MSCI EM Index; China equity MSCI China Index and Hong Kong equity Hang Seng Index

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Implications of rising US yields on credit markets
Views from HSBC Global Asset Management

Julien Seetharamdoo

Recent comments from the US Federal Reserve (Fed), following intense market speculation, on plans to taper the US quantitative easing (QE) programme have led to a spike in US Treasury yields and caused a selloff in the broader market towards the end of the second quarter. Investors have become increasingly concerned about the impact that higher shortand long-term US interest rates could have on the global economy and asset markets, including the credit markets.

Senior Macro and Investment Strategist, HSBC Global Asset Management

06

While volatility is expected to remain high in the near term, it will not be enough to disrupt the medium- to long-term performance of credit markets or the outlook for the global economy. The key to riding through all these tides is to remain focused on long-term fundamentals such as corporate profitability and valuations which are still supportive.

5 6

Investors continue to grapple with the prospect of reduced Fed stimulus. What is your view on this?
Since May, markets have become increasingly concerned about the US Federal Reserves plans to taper off QE measures. Yields have spiked further following the Federal Open Market Committee (FOMC) meeting in June, causing heightened volatility in the credit markets.

5
Yields have edged higher starting early May
11% 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% Jan 2010 Jul 2010 Jan 2011 Jul 2011 Jan 2012 Jul 2012 Jan 2013

10
10-year US Treasury yield

30
US 30-year mortgage rates

US High Yield yield

JPMorgan EM Bond Index Global Spread 20136 Source: Bloomberg, HSBC Global Asset Management, as of June 2013

2014

its monthly QE asset purchases later this year and would continue to reduce the pace, in measured steps, to end purchases around mid-2014, if its economic projections prove broadly correct. The chances of QE tapering beginning this year have clearly increased. The key point is that QE tapering will begin only if the data, especially from the labour market, holds up and the Fed is convinced the US economy can sustain its recovery. The Fed will eventually have to reduce its extraordinary monetary accommodation but is likely to be cautious when tapering off QE, so the process of normalisation will be gradual.

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The Fed Chairman Bernanke said the central bank may scale back

Aug 8 Oct 10 2013

Implications of rising US yields on credit markets

What is the implication of the recent rise in Treasury yields on the credit markets?
After a period of stellar performance over the last year, the credit markets were recently hit by by the sharp rise in Treasury yields. Both investment grade and high yield bonds suffered as a result. In the short term, volatility is likely to remain high and credit markets could stay under pressure. However, we do not think it will be enough to disrupt the medium- to long-term performance of the credit markets or the outlook for the global economy. Monetary policy normalisation on the back of improving macroeconomic fundamentals should be positive for credit spreads. In the longer term, fundamentals such as corporate profitability and valuations will determine performance. Indeed, the Fed would not be contemplating tapering off the QE programme if it wasnt convinced the outlook for the US economy was improving.

Against the current backdrop, what is the outlook for credit markets, in particular high yield (HY) and emerging market (EM) bonds?

Overall, we prefer corporate bonds to government bonds, and we retain our overweight positions on investment grade and high yield debt. In general, credit selection is increasingly important but overall valuations dont seem overstretched, especially in less cyclical sectors in the high yield universe. Historically, there is only a loose correlation between rising US Treasury yields and HY credit spreads. Typically higher government bond yields are associated more with tighter HY credit spreads (i.e. a negative correlation) as US Treasury yields tend to rise when economic conditions are improving and therefore corporate default rates are low or falling and profitability is strong or increasing. In addition, any tapering of QE asset purchases and an eventual increase in policy rates is likely to take place only if the economic environment is improving. Hence profitability and credit quality should continue to be supportive of credit markets, even if Treasury bond yields continue to rise during the rest of this year and next. These positive fundamentals should limit the extent of any backup in HY bond yields, or at least provide profitable entry points for longterm investors, who are able to look past the short-term volatility.

08


High yield default rates are low
30

25

(%) Default Rate (%)

US high yield bonds

20

15

European high yield bonds

10

Emerging market high yield bonds 20136 Source: Bank of America Merrill Lynch, as of June 2013
May 2001 May 2003 May 2005 May 2007 May 2009 May 2011 May 2013

0 May 1999

In terms of the outlook for EM bonds, including Asian bonds, valuations are now more attractive, and from a longer-term perspective, we continue to favour this asset class because of improved credit fundamentals in many EM countries especially when compared to the developed world. Local currency bonds also offer exposure to many emerging market currencies that we expect to appreciate versus developed market currencies over the long term.

This article is provided by HSBC Global Asset Management (Hong Kong) Limited Investment involves risk. Past performance is not indicative of future performance. Please refer to the offering document for further details including the risk factors. The document has not been reviewed by the Securities and Futures Commission. The document is prepared for general information purposes only. All views expressed cannot be construed as an offer or recommendation by HSBC Global Asset Management (Hong Kong) limited (AMHK). AMHK and HSBC Group shall not be held liable for damages arising out of any persons reliance upon this information. Any person considering an investment should seek independent advice on the suitability or otherwise of the particular investment. AMHK has based this document on information obtained from sources it reasonably believes to be reliable. However, AMHK does not warrant, guarantee or represent, expressly or by implication, the accuracy, validity or completeness of such information.

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We expect appreciation potential in a number of emerging market currencies over the long term

Aug 8 Oct 10 2013


Views from HSBC Global Asset Management

Outlook for RMB bonds remains robust

Geoffrey Lunt

Director, Senior Product Specialist for Fixed Income, HSBC Global Asset Management

Concern that the US Federal Reserve may begin to withdraw the extraordinary monetary stimulus applied to the financial system in recent years has led to higher US Treasury yields and considerable volatility in asset markets.

10

 2.4%10.5%1

Throughout the volatility, offshore RMB bond markets have held up well, and returned 2.4% this year, while emerging market bonds have fallen by 10.5%1. Good credit quality, low duration, attractive yields, and geographical diversification of issuers are some of the major reasons why investors are increasingly drawn to this asset class, and should consider RMB bonds as a medium- to long-term opportunity.

How have offshore RMB bonds performed through the recent market volatility?
Offshore RMB bonds have held up relatively well. Yields have risen but returns overall have outperformed other emerging bond markets. This asset class has a relatively low duration, and is thus less sensitive to interest rate risk and the movement of US Treasury yields than other credit markets. In fact, US Treasury and offshore RMB bonds have historically displayed a negative correlation in price (-0.3 since the beginning of 2011)2. As a result, the recent concern about rising interest rates and Treasury yields has not had as much impact. This in itself has been a significant draw for international investors.

2011 -0.3
2

Yield comparison between Asian hard currency bonds vs offshore RMB bonds
6%

4%

JP Morgan USD Asia Credit Index (IG) Yield

3%

HSBC CNH Bond Index Yield

2%

20136 Source: HSBC Global Asset Management; as of June 2013

May 2011 Sep 2011 Jan 2012 May 2012 Sep 2012 Jan 2013 May 2013

1% Jan 2011

In addition, investors have been attracted by the asset class fundamentals such as good credit quality, attractive yields and potential currency appreciation.
1) Source: Bloomberg as of 25 June 2013, in USD terms; indices referred to HSBC Offshore RMB Bond index and JP Morgan EMBI Global Total Return 2) Source: Bloomberg as of 25 June 2013

1) 2013625 2) 2013625

11

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Aug 8 Oct 10 2013

5%

Outlook for RMB bonds remains robust

How has the recent credit crunch concern in China affected the RMB bond market?
The recent spike in interbank money market rates has compounded investor worries over a further slowdown in the Chinese economy. This phenomenon had a number of causes including seasonal factors, the impact of tightened supervision of interbank bond transactions and shadow banking activities, as well as a sharp slowdown in capital inflows/FX carry trades. While the liquidity squeeze has eased, helped by The People's Bank of China (PBoC)s pledge to maintain market stability, deleveraging will likely continue as authorities crack down on financial risks in the system and reduce reliance on credit driven investment. Tighter liquidity/credit conditions and higher funding costs could pose downside risks to growth and increase default risks. However, these should apply more significantly to the onshore market, where lending concerns are far more pressing. The offshore RMB bond market is still protected somewhat by the relatively strong credit quality of issuers, and we do not anticipate a significant rise in default risks in this market. Tighter lending practices by banks in the onshore market may lead to mainland companies seeking financing via debt capital markets. This may result in an increase in offshore RMB bond issuance. This could lead to greater diversification and the liquidity in the offshore RMB market, making the asset class a more compelling opportunity to global investors.

What is the outlook for this asset class and what are the benefits of investing in offshore RMB bonds?

The outlook for offshore RMB bonds has several positive drivers, including strong growth in the asset class. The offshore RMB bond market has grown considerably since its inception and now stands at around RMB 500 billion, compared to a market size of less than RMB 50 billion in 2010, representing a 10x increase in just two and a half years. As at 5 June 2013, the year-to-date gross issuance of offshore RMB bonds has reached RMB 185 billion, which is around 50% higher than the figure recorded during the same period last year. In addition, the asset class continues to be supported by the factors mentioned earlier: low duration, attractive yields, geographical diversification of issuers, good credit quality and potential currency appreciation.

5,000 2010500 10201365 1,850 50%

12

Currency appreciation continues to be positive factor, though it is likely to be gradual. The low duration nature of the market will continue to be a draw for investors worried about a rising interest rate environment. For international investors, the increasing diversification and credit quality of this asset class will be important too. Issuance of offshore RMB bonds is generally made up of Chinese and global issuers, with a skew towards the latter. The constituents include corporates, financials, sovereign and supranational entities. What this means is that the offshore RMB bond market is less correlated and thus less impacted by any negative news flow in China. It also has a relatively low correlation to other credit markets and asset classes. This suggests that an allocation to offshore RMB bonds can help diversify investor portfolios, which is valuable in light of trends that indicate market volatility will likely continue in the near term.

RMB bonds as a medium- to long-term opportunity

) ( ) ( This article is provided by HSBC Global Asset Management (Hong Kong) Limited Investment involves risk. Past performance is not indicative of future performance. Please refer to the offering document for further details including the risk factors. The document has not been reviewed by the Securities and Futures Commission. The document is prepared for general information purposes only. All views expressed cannot be construed as an offer or recommendation by HSBC Global Asset Management (Hong Kong) limited (AMHK). AMHK and HSBC Group shall not be held liable for damages arising out of any persons reliance upon this information. Any person considering an investment should seek independent advice on the suitability or otherwise of the particular investment. AMHK has based this document on information obtained from sources it reasonably believes to be reliable. However, AMHK does not warrant, guarantee or represent, expressly or by implication, the accuracy, validity or completeness of such information.

13

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Aug 8 Oct 10 2013


What would QE tapering do to the bond markets and what can investors do about it?

14

What is QE?
Quantitative Easing refers to the action taken by the US central bank to purchase bonds from banks and other institutions with newly created money, injecting a large amount of funds into the financial system. The bondbuying action raises the prices of bonds and lowers their yield. In theory, the goal of a greater amount of funds and lower yields is to promote increased lending, investment and consumption activity.

15

WEALTH STRATEGIES

10 20135 1.6% 201372.6%

Chairman Bernanke surprised the markets by his clear signal about the time table of the asset purchase tapering. The US 10-year Treasury bonds yield continued to rise and USD sustained its upward momentum. Market is concerned that the indication of QE tapering may lead to end of a low interest rate environment. US Treasury yield shot up from a low of 1.6% in May 2013 to 2.6% as of July 2013.

Aug 8 Oct 10 2013

What would QE tapering do to the bond markets and what can investors do about it?

3 HIBOR 19932013
HIBOR 3-month historical chart (1993-2013)
% 10

9.97

(6 June 30, 1998)

Average:

~ 3.42

Source: HSBC Research, Bloomberg

Recent reading

0.38357 0.14
(12 Dec 31, 2009)
2011 2012 2013

(6 Jun 24, 2013)

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

2008

What is the implication of quantitative easing tapering for Hong Kong investors?
Interest rates across the world have been at historical low level since the financial crisis in 2008, including Hong Kongs benchmark interbank rate, HIBOR. Since Hong Kongs monetary policy is correlated to the US, customers who are interested in hedging the value of their investments against a potential rise in interest rate could consider floating rate investments, such as those linked to HIBOR. Rather than paying a fixed rate of coupon, HIBOR floating rate investments offer interest payments which are reset periodically with rates tied to HIBOR.

(HIBOR)
HIBOR

HIBOR
HIBOR

16


The selloff in EM bonds has been moderating
4

USDm 0

Local currency bond flows

-2

Hard currency bond flows Total flows EPFR

-4

-6 7Jul 2012

Source: HSBC, EPFR

10Oct 2012 1Jan 2013 4Apr 2013 7Jul 2013

100 7

Fund outflows in the EM bonds

In the past month or so, emerging market bond funds recorded outflows of around USD10 billion, although the selloff seems to be moderating based on the figures in early July. Emerging Markets, both equities and bonds alike, have experienced fund outflows and much volatility due to the slower-than-expected pace of global growth and the timeline of the Federal Reserves likely changes to its current QE programme. until market stability returns. But if the Federal Reserves QE programme is to be wound up as the US economic growth becomes self-sustaining and the country resumes its consumption, this may be positive for emerging markets, especially those with certain levels of dependencies on the US consumers, their financial performance could improve in the long run. Valuations of emerging markets bonds have actually been lowered in many emerging markets, and could become attractive once volatility reduces. It is important to note that the long-term reasons that attracted foreign investors to emerging markets remain: emerging markets rising share of global GDP, favourable demographics, healthy balance sheets, and currency diversification are powerful forces. Last but not least, bond investment may experience short-term volatility, but investors will be paid back their principal investment upon bond maturity, as long as there is no issuer default. The volatility in
Aug 8 Oct 10 2013

emerging markets is likely to keep many investors on the side-lines

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WEALTH STRATEGIES

What would QE tapering do to the bond markets and what can investors do about it?

5 8.2%

Hard landing in China is unlikely

Two anchors that have supported emerging market assets for the best part of the past five years are gone: not only are investors concerned about US monetary policy, they now also need to worry about the potential of slower growth in China. HSBC has lowered its China GDP forecast from 8.2% to 7.4% for this year as the new leaderships preference for reform over stimulus to sustain growth may have a limited impact in the short term. While some investors worried over a risk of a hard landing, with growth falling below 7%, HSBC thinks this is highly unlikely. Beijings new leaders prefer to use reforms rather than stimulus to sustain growth. The reform agenda includes financial, fiscal, deregulation, and urbanisation reforms. HSBC believes that these reforms should invigorate the private sector and improve efficiency, lifting growth prospects in the medium to long term.

7.4%
7%

SOEs still dominate in many sectors

100% 90% 80% 70% 60% 50% 40% 30% 20% 10%

% State-controlled enterprises as % of industrial output

% State-controlled enterprises as % of services sector value-added CEIC

0 1992 2001 2011

Source: HSBC, CEIC

18

Reforms should invigorate the private sector and improve efficiency, lifting growth


Private enterprises is more efficient (return on assets)
16%

14%

12%

10%

8%

6%

Private enterprises

4%

SOEs

2%

CEIC
0 1996 1998 2000 2002 2004 2006 2008 2010 2012

Source: CEIC, HSBC

Once implemented, these measures should invigorate the private sector and improve efficiency, lifting growth prospects in the medium to long term, and few would disagree that financial and fiscal reforms are the only solution to local government debt, shadow banking and other structural problems. HSBC also believes that Beijings focus on speeding up reforms will, once implemented, improve efficiency as well as revitalise private business. This will put China on a sustainable and steady growth path in the medium to long term. However, it will take time for the impact of the reforms to filter through, so growth is likely to
Aug 8 Oct 10 2013

stay lower in the near term, especially given weak global demand. Breaking the monopoly of state-owned enterprises one of the biggest challenges for the reform process and lowering entry barriers for private investments should improve investment efficiency and speed up the technology advancement.

Private investment is likely to be increased in the following areas:

1)
Railways: Benefit from the split of Ministry of Railways and the subsequent investment system reform

2)
Infrastructure construction: With fiscal constraints and high debt burdens, local governments should invite private investment in urban infrastructure

3)
Service sectors such as education, finance and telecoms where there are huge potential consumer demand and the opportunity to create large numbers of jobs

19

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Where will the market go?
Views from Invesco Asset Management Asia Limited

Concerns that the US would taper quantitative easing policies sooner than expected have driven a heavy selloff in global equities. In addition, disappointing data out of China and concerns over financial sector risks following a spike in domestic interbank rates have also hit investor sentiment, leading to sharp falls in Asia Pacific ex-Japan markets.

20136
Asia Pacific ex Japan equities corrected in June 2013
10%

5% 0.2% -1.6%

0% -3.2% -4.9% -7 .9% -12.2% -15.6% -20% A China Philippines A-Shares Hang Seng (China) Hang Seng Thailand South Korea Indonesia Singapore India Australia Taiwan New Zealand -7 .1% -7 .1% -6.9% -4.9% -2.5% -2.3%

-5%

Factset2013 531628 Source: Invesco, Factset, data from 31 May to 28 June 2013. Local index returns in local currency terms. Note: Hang Seng (China) refers to Hang Seng China Enterprises Index instead of overall Hang Seng index

-10%

-15%

Malaysia

20

We believe that fundamentals in Asia ex-Japan are still relatively robust in the long run, but investors should be careful when they invest into the equity markets amid short-term volatility despite the attractive valuations.

Weaker Asian currencies

Overall risk aversion and outflows from markets have led to weaker currencies in many cases, adding to the extreme volatility seen in regional markets. In keeping with the drop in global commodity prices, declines have been seen in commodity-linked currencies such as the Australian dollar, Malaysian ringgit and Indonesian rupiah as well as in economies with somewhat weaker external positions such as India and Thailand.

2013628

Currencies one-month change as at 28 June 2013

10%

5%

1.7% 0% -0.3% -2.4% -3.2% -5% -4.5% -2.2% -1.9% -1.3% -1.1%

-0.2%

-0.1%

-10% INR AUD NZD THB PHP MYR IDR KRW SGD TWD CNY JPY

Source: Invesco, Factset, from 31 May to 28 June 2013

20142015

US growth is the key to quantitative easing

The introduction of a data-dependent path to US monetary policy changes has no doubt increased the volatility within markets, with investors assessing risks relating to a change in what had been presumed to be a low interest rate environment over the medium term. Nevertheless, Fed tapering is likely to be gradual, given the level of unemployment and soft pace of recovery in the overall economy. Market expectations are shifting to an exit from overall purchases in mid-2014, with rate hikes commencing sometime in 2015.

21

WEALTH STRATEGIES

Aug 8 Oct 10 2013

-5.0%

Factset20135 31628

 Where will the market go?

While adjustment to this policy shift is leading to dislocations in markets that have become frothy during the prolonged period of monetary expansion, the recognition that eventual rate hikes will be gradual should eventually help to stabilise sentiment. Moreover, the improved US growth prospects that would be the prerequisite for quantitative easing exit should ultimately support risk assets, including emerging market, Asian equities and currencies, not to mention a more positive backdrop for Asian exporters as currency weakens.

Issues to monitor in China

One issue that has been of particular concern has been the explosion of off-balance sheet and non-bank lending in the financial sector. While Peoples Bank of China (PBoC) officials have stressed that liquidity risks are controllable and that they will carefully monitor money market rates going forward, the market has interpreted the absence of liquidity provision by the PBoC as a sign of its determination to raise the cost of borrowing and to force deleveraging of the financial system in order to control risks from credit expansion. While all of this is weighing on equity sentiment in the near term, particularly within the banking sector, we believe that the government stance suggests that it is serious about rebalancing the sources of growth through structural reforms and deleveraging, which could carry long-term benefits for both the economy and for Chinese equities. Recent speeches from authorities have reiterated the commitment to reforms designed to open up the financial sector through interest rate deregulation and further exchange rate liberalisation, as well as reduce the role of state enterprise in the economy through the promotion of the private sector and services sector. All of this should be a long-term positive for Chinas economy, albeit creating short-term market uncertainty.

Fundamentals are still strong

Although we cannot rule out further volatility as investors adapt to the new monetary stance on the one hand and Chinas lower growth trajectory on the other, it is worth noting that fundamentals in Asia ex-Japan are still relatively robust. Prior to the onset of market fluctuations, most economies in the region were poised for a moderate recovery this year with lower inflationary risks. Asian governments are nearly free from external debts, following the lessons learned from the Asian financial crisis and are much better positioned versus selective counterparts in Latin America and emerging Europe, where asset prices and currencies have seen deeper slumps in response to the change in the Fed policy.

22

 Macro Assessment
* % % %

10

FX reserves (US$ bn)

Imports coverage* (no. of months)

Current account as % to GDP

Capital account as % of GDP

External debt as % of FX reserves

Credit growth % Minus nominal GDP growth %

China Hong Kong # India# Indonesia South Korea Malaysia Philippines Singapore Taiwan Thailand Japan Brazil Mexico Turkey

3,311.6 317.4 259.7 112.8 327.0 139.7 83.8 259.3 403.2 181.6 1,268.1 362.1 153.5 98.3

20 27 6 7 8 9 16 17 18 9 18 11 0.4 0.4

2.3 1.3 -4.2 -2.8 3.8 6.4 2.9 18.6 10.3 0.7 1.0 -2.4 -1.0 -6.1

-0.2 7.5 3.6 2.8 -2.8 -2.5 2.3 -10.2 -6.6 3.2 -1.8 -0.1 4.0 -0.0

0.2 3.3 1.3 2.2 1.3 0.6 0.7 N/A 0.3 0.7 2.6 121.7 149.2 342.8

4.3 9.9 6.0 5.3 -0.9 3.2 4.2 6.1 -0.9 4.1 -5.5 8.3 7.4 24.1

* Based on retained import for Singapore and Hong Kong given the significant re-export portion
2009-2012 2009-2012 average

2013620

Source: UBS, as at 20 June 2013

# Fiscal year

201310.8 15.4% 1.6 10 30 1.8

2013628

Another positive note we should take from the recent correction is that regional valuation remains accommodative versus its historical standard. On price-to-earnings (PE) terms, Asia ex-Japan is now trading at 10.8x 2013 PE, with consensus earnings growth of 15.4%. The region is equally supportive as measured by price-tobook (PB) metrics, at 1.6x trailing PB versus 10-year and 30-year average of 1.8x.

All data are sourced from Invesco dated 28 June 2013 unless otherwise stated The article provided by Invesco Asset Management Asia Limited This material has not been reviewed by the Securities and Futures Commission of Hong Kong. Investment involves risks. Past performance is not a guide to future performance. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. Any opinions contained herein, which reflect Invescos judgment at this date, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Invesco to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. This material is for informational purposes only and does not constitute an offer or invitation to anyone to invest in any Invesco fund and has not been prepared in connection with any such offer. Any research in this material has been procured and may have been acted on by Invesco for its own purpose. The results of such research are being made available only incidentally.

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Aug 8 Oct 10 2013


Recent market selloff: A pause, not a reversal
Views by Standard & Poors

6
24

Global equity markets sold off sharply in June, resulting in generally disappointing second quarter performances for Asian markets and in particular, Hong Kong and Shanghai. Although the first six weeks of the quarter were promising with US economic data improving and China looking to a pick up in growth from 1Q pace, market sentiment and China news flow deteriorated.

 (REIT)

On the US front, the Federal Reserves (the Fed) meeting minutes and Chairman Ben Bernankes indications that the Fed was looking to taper its bond purchases sent long-term Treasury yields higher and triggered a selloff in emerging market bonds. The rise in yields also sent investors out of high dividend yielding stocks, particularly REITs.

2013621
A difficult Q2 for Asian equities (as of June 21, 2013)
52 (%)

Returns based on main indices (%)

200 S&P/ASX 200 index 300 CSI 300 index Shanghai Stock Exchange Composite index Hang Seng China Enterprises Index Hang Seng Index CNX NIFTY S&P/CNX NIFTY Index Jakarta Composite Index 225 Nikkei 225 Index Malaysia KLSE Composite Index Philippines PSE Composite Index FTSE Straits Times Index South Korea Kospi Composite Index Taiwan TAIEX Index

QTD -4.6% -7.1% -7.3% -15.2% -9.1% -0.3% -8.6% 6.7% 5.0% -9.7% -5.6% -9.1% -1.6% -10.3% 1.5% -4.6%

YTD 1.9% -8.1% -8.6% -19.2% -10.6% -4.0% 4.6% 27.3% 4.0% 6.4% -1.3% -8.7% 1.2% 0.6% 11.7% 0.3%

Pullback fr. 52-wk High -9.2% -16.5% -14.8% -24.4% -14.9% -8.4% -13.4% -15.3% -1.8% -16.4% -9.6% -10.3% -7.2% -14.8% -9.7%
Aug 8 Oct 10 2013

SET SET Insex

500 S&P 500 Index 600 STOXX Europe 600 Insex (EUR)
S&P Capital IQ Source: S&P Capital IQ

-4.6%

(SHIBOR) 61012 SHIBOR SHIBOR

China added to monetary tightening worries when the Shanghai Interbank Offered Rate (SHIBOR) spiked up. The jump in SHIBOR rates has occurred on occasion triggered by events and also holiday periods where companies and individuals withdraw funds (this latest event coincided with the June 10-12 Duanwu festival holiday). However, this time round, with the fiscal-half year closing soon, and with authorities keen to clamp down on shadow banking activity, the jump in the SHIBOR could stay at relatively elevated levels for a few months. The Peoples Bank of China (PBoC) looks to be intent on punishing the provincial banks who are the net borrowers in the interbank market and who have not been managing risks and have gotten around lending restrictions through the shadow banking system.

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WEALTH STRATEGIES

Recent market selloff: A pause, not a reversal

GDP 2.4%

Rising interest rate worries are exaggerated

We had written in the prior Q1 note that monetary loosening was likely peaking in Asia and we continue to maintain this view. However, we believe the recent worries over a sharp rise in interest rates triggered by the Feds comments have been overdone. The reason for our view is that global demand growth remains sluggish and this is reinforced by the revision down in US Q1 GDP growth to just 1.8% q-o-q from the prior reading of 2.4% q-o-q. In addition, with ongoing sequestration in fiscal spending, there remains a downside risk to US GDP growth estimates. Given this scenario, we think that the Fed is likely to remain mindful of the fragility of US growth. In addition, inflation pressures are largely absent. With China slowing, this would seem all the more apparent with commodity prices down and energy costs contained. The fact that Chinas Producer Price Index (PPI) continues to fall (-2.6% y-o-y in April) shows that there is limited production price pressure on inflation.

1.8% GDP
4 2.6%

China price pressure remains largely absent

12.0 10.0 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 -8.0 -10.0 5May 2010 9Sep 2010 1Jan 2011 5May 2011 9Sep 2011 1Jan 2012 5May 2012 9Sep 2012 1Jan 2013 5May 2013

% y-o-y%

CPI

PPI CEIC Source: CEIC

Chinas banking sector reform experiences short-term pain

One of the key risks weighing on the Chinas banking sector is the uncertainty on where the cause of failure of some Chinas wealth management products (WMPs) lies. We see the PBoC targets a soft landing, hence we believe the recognition of non-performing loans may be spread over one to two years. While the government has the resources to recapitalise the small banks, we believe they will want to reinforce to bank branch managements that there will no longer be any free lunch.

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0.9 19%

Chinas big four banks have relatively cheap valuations at a weighted average PB of 0.9x vs. ROE of 19%, which reflects increased asset quality risks. While investors remain unconvinced by the low valuations, we believe the big banks remain best positioned to benefit from a potential upward rerating. This, we believe, will materialise as China cleans up its banking system risk and improves transparency over the next six months. The risk from deteriorating asset quality remains the key concern. Credit costs have averaged 50 bps for the large banks since 2009. Assuming non-performing loans (NPLs) jump to 2% (2008 levels) from the current 1% for the large banks, credit cost would need to rise to around 120 bps (2008 levels) to maintain provision coverage above 150% (it is 250%, currently). In this scenario, we estimate that large banks ROEs may decline to the mid-teens level from the current 19% average. Given that the large banks core capital ratios remain comfortable at above 9.5%, we do not expect any pressure on this front. Separately, assuming short-term rates remain elevated, we see minimal impact to net interest margins (NIMs) as lending rates are largely reset on an annual basis and given the short duration of their investment book, we expect market losses to be minimal.

2009 50
1% 2% 2008 120 2008

150% 250%
19% 9.5%

Shadow banking risk is manageable

16%

Shadow banking default rate

12%

10%

At assumed default rate of 9% (in line with recent experiences in emerging Asia), NPLs hit around 4% a manageable level.

8%

4%

2%

S&P Capital IQ Research Source: S&P Capital IQ Research

1 2 3 4 5 6 (%) System NPLs (%)

0%

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WEALTH STRATEGIES

6%

Aug 8 Oct 10 2013

14%

9% 4%

Recent market selloff: A pause, not a reversal

20%

We see a triple whammy for the small banks. Firstly, asset quality deteriorates faster than sector average given their higher exposure to small and medium enterprises (SMEs). Secondly, net interest margins continue to be under pressure, given their dependence on interbank assets (which account for 20% to 30% of their assets). Assuming rates stay elevated and we see a gradual winding down of their off-balance sheet book, we expect NIM pressure of 25 bps on a half year basis for H213. Hence, we expect the banks to limit off-balance sheet growth, going ahead. Lastly, as sales of WMPs slow, we expect fee income growth to slow to single digits.

30%
2013 25

MSCI AC 12.72013 11.8% 50014.9 6.9% Stoxx

Buy selectively for positive mid-term view

As a whole, global emerging issues have been sold off. A deteriorating earnings outlook and depreciating currencies have hurt global investor appetite for such issues. However, we think the earnings outlook in Asia ex-Japan remains positive as a whole and with the MSCI AC Far East ex-Japan trading on a forward PE of 12.7x and 2013 EPS growth of 11.8% (excluding outliers), valuation appears relatively attractive given S&P 500 forward PE of 14.9x and operating EPS growth of 6.9% and Dow Jones Stoxx forward PE of 12.6x and EPS growth of 7.0%. We think EPS growth in Asia exJapan is likely to be underpinned by relatively decent average GDP growth of 6%-7% in 2013 and 2014. We believe global demand will gradually stand firm and this will benefit externally-driven economies more. Given relatively low valuations, we think Korea, China and Hong Kong may outperform the rest of Asia ex-Japan in H213 as investors begin to look ahead to 2014. As we see a period of choppiness for equities, we think a balanced portfolio strategy for the near term is recommended. Hence, we favour defensive stocks in the healthcare and utility space, where cash flow is relatively stable but also note opportunities to pick up some better positioned cyclical stocks with relatively attractive valuations as share prices correct. Among these, we like energy and insurance companies and see potential in selective financials and industrials.

12.6 7.0% 2013 20146%-7% GDP

20142013

The article is provided by Standard & Poors Investment Advisory Services (HK) Limited (S&P) In the case of inconsistencies between the English and Chinese version of this report, the English version prevails. Neither S&P nor its affiliates guarantee the accuracy of the translation, Assumptions, opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not necessarily indicative of future results. This material is not intended as an offer or solicitation for financial instruments or strategies mentioned herein may not suitable for all investors. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only currents as of the stated date of their issue. This material is not intended for any specific investor and does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation of particular securities, financial instruments or strategies to you. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice.

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Aug 8 Oct 10 2013