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Investment Outlook Review and Changes to Star Ratings – 1Q 12 April 5, 2012
Following strong market performance in 1Q 12, we have adjusted ratings on several markets to take into account the normalisation of return expectations
Author : iFAST Research Team

Investment Outlook Review and Changes to Star Ratings – 1Q 12


Our Forecasts:

In December last year, we highlighted several key investment themes and our outlook for 2012. Our forecasts were for a strong year for equity markets, predicated on improving investor sentiment amidst low stock market valuations, along with our expectation that the Eurozone would remain intact, avoiding a full-blown financial crisis. We also highlighted our preference for emerging market equities, which we believed would find increasing favour with global investors in the context of moderating global economic growth, especially given our expectations that the Eurozone would fall into recession in 2012.

Key investment ideas we highlighted included China, where we believed an eventual shift towards more accommodative monetary policy would spur an equity market recovery from depressed valuation levels, while within the fixed income space, we reiterated caution on developed sovereign debt in preference of higher-yielding albeit riskier bond segments like high yield and emerging market debt, and urged investors to seek short-duration exposure to minimise interest rate risk.

With the first quarter of 2012 now behind us, let us review and reiterate some of our key investment themes for 2012.

1. Equities to outperform bonds

Following the strong performance of individual equity markets so far this year (see “Equity Market Review 1Q 12: A Positive Quarter for All Markets”), global equities have delivered stellar returns of 12% in 1Q 12, significantly outpacing the 0.7% return for global bonds (returns in USD terms, on a total return basis). As with our expectations, investor sentiment has certainly taken a turn for the better in 2012 so far, with yields on peripheral Eurozone sovereign bonds declining from their 2011 highs (suggesting that the Eurozone will ultimately avoid a messy break-up), while improving economic conditions in the US have also boosted investor confidence. Even following the strong gains by equity markets so far this year, valuations remain supportive, especially in the context of historically-low bond yields and we maintain our “overweight” stance on equities vis-à-vis fixed income.  

See also:
A Bond-Beating Formula: Earnings Growth + Dividends + Valuation Expansion
Market Valuations as of 30 March 2012

2. Maintain Preference For Emerging Markets

Following the underperformance of emerging markets in 2011, the segment has posted a healthy rebound, with key markets like Russia and India gaining 18.7% and 12.9% (in USD and INR terms respectively) in 1Q 12, helping emerging market equities deliver a 14% year-to-date return, outpacing the 12% return for global equities on the whole (returns in USD terms, on a total return basis). Helping to boost the performance of emerging market equities is the return of foreign investor interest, with markets like South Korea, Thailand, India and Indonesia all seeing net foreign investor inflows on a year-to-date basis. While emerging markets have made up the bulk of top-performing markets in 2012 so far, a combination of low valuations, higher sustainable earnings growth rates as well as a general underrepresentation in most global investor portfolios should see emerging markets continue their outperformance over the longer-term.

See also:
2 Sectors to keep Brazil's Growth Beat Going!
Global Emerging Market Equities – 3 Key Themes

3. China equities poised for strong returns

While we identified China as a market poised to deliver extremely strong returns, the market has marginally underperformed the Asia ex-Japan equity benchmark so far in 2012, albeit still delivering a decent positive return. Even as the People’s Bank of China appears to have placed interest rates on hold (with a bias towards a more accommodative stance), investors have fretted over the latest announcement of a lowering of the official long-term economic growth rate from 8% to 7.5%. Our interpretation of the latest announcement is less pessimistic – in addition to the Chinese government’s track record of “low-balling” economic growth rates, the move is a necessary trade-off in a move towards more consumption-driven (and hence, sustainable) growth for the China economy. With the market at just 9.2X 2012 estimated earnings (as of 30 March 2012), valuations are near 2008-2009 crisis-lows, representing an extremely attractive opportunity for investors at this juncture.

See also:
China: What are the implications of a 7.5% Growth Target?
Prepare for a Chinese Rally!
The Fate of Chinese Banks if Non-Performing Loans Increase – A Stress Test (Part 1)

4. Riskier fixed income segments still remain more attractive

Riskier segments of the fixed income market have outperformed safer segments in 1Q 12, with Asian High Yield, Global High Yield and Emerging Market Bond funds delivering some of the strongest returns within the fixed income space as investor risk aversion declined. In contrast, yields on safer bonds like US Treasuries rose (over 1Q 12, the yield on the 10-year US Treasury bond rose 33.26bps to 2.2088%), hurting the performance of funds invested in the developed sovereign bond markets. Even as yields have risen for safer bond segments this year, they still remain near historically-low levels which are indicative of poor long-term returns to be expected. Within fixed income, we continue to prefer High Yield bonds and Emerging Market bonds where yields are significantly higher, but these come with higher associated risk. For lower-risk bond funds, we continue to maintain a preference for short duration offerings which are less susceptible to increases in interest rates.  

See also:
Top Funds 1Q 12: Aggressive Funds Lead The Way
Bonds Weekly: Managing Duration and Currency Risk [22 March 2012]
Bonds Weekly: Consider Short Duration Bond Funds As Yields Rise [15 March 2012]
Income Investing Series: Developed Sovereign Bonds

Lowering ratings for several markets following strong performance

At the end of each quarter, we review our calls on the various regional and single-country equity markets under our coverage to assess each market’s attractiveness as an investment proposition both on a standalone basis, as well as with respect to other markets.

Since we made a host of changes to our star ratings at the end of August 2011, several equity markets have delivered substantial double-digit returns, sufficient to warrant changes to our star ratings at the end of 1Q 12. We have long held a favourable view on the Technology sector, having upgraded the market to 4.5 stars “very attractive” in late August 2011 on the back of a positive growth outlook and attractive valuations. Since then, the sector has delivered a hefty 24.1% return (as of 30 March 2012, in USD terms including dividends), and while valuations remain modest due to high sustained earnings growth for the sector, we have adjusted down our rating on Technology stocks to 4.0 stars which still represents our positive view on the sector.

Brazilian and US equities have also posted healthy gains since our last upgrade in August 2011 (Brazil from 3.5 stars to 4.5 stars, and US from 3.5 stars to 4.0 stars). Since then, the benchmark Bovespa index has delivered a 17.6% return (as of 30 March 2012, in BRL terms), while the benchmark S&P 500 index has gained 17.9% (as of 30 March 2012, in USD terms). On the back of lowered return expectations for both markets, we have adjusted down our rating on Brazil equities to 4.0 stars, and our rating on US equities to 3.5 stars.

Growth forecasts for Singapore earnings remain muted in 2012 as a series of transitory issues (low domestic interest rates, delayed real estate development profit recognition and high oil prices) weigh on various sectors, and while earnings are expected to post stronger growth in 2013 and 2014, lower forecasted earnings has brought down our projected returns for Singapore equities, warranting a lowering of our rating on the Singapore market to 4.0 stars, still representing a “very attractive” rating. Indian equities have delivered a strong performance in 2012, gaining 12.8% year-to-date as of 30 March. While valuations remain at a hefty discount to the historical average, projected returns for Indian equities are not as strong as before, and we have adjusted down our rating on Indian equities to 3.5 stars “attractive”.

Our latest series of downgrades represents a normalisation of return expectations for several markets under our coverage, rather than a change in our positive outlook on equity markets.

Table 1: Star Ratings as of end March 2012
Markets Star Ratings Our 3 year view
Emerging Markets 5 Very Attractive
Asia ex-Japan 5 Very Attractive
Europe 3 Attractive
US 3.5 (Downgraded) Attractive
Japan 3 Attractive
Technology 4.0 (Downgraded) Very Attractive
Single-Country Markets Star Ratings Our 3 year view
China 5 Very Attractive
Hong Kong 5 Very Attractive
South Korea 5 Very Attractive
Taiwan 5 Very Attractive
Russia 4 Very Attractive
Singapore 4.0 (Downgraded) Very Attractive
Australia 4 Very Attractive
Brazil 4.0 (Downgraded) Very Attractive
India 3.5 (Downgraded) Attractive
Thailand 3 Attractive
Malaysia 3 Attractive
Indonesia 2.5 Neutral
Source: iFAST Compilations
Data as of end March 2012

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Top Funds 1Q 12: Aggressive Funds Lead The Way
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