EMTA HONG KONG FORUM
HONG KONG INVESTOR PANEL: PROSPECTS FOR THE EMERGING MARKETS
EMTA presented its first forum in Hong Kong on November 3, 2006. Hosted by ING Wholesale Bank, the lunchtime forum was held at the Ritz Carlton Hotel. In contrast to the almost universally positive outlook expressed by EMTA panelists over the past couple of years, one of the Hong Kong forum participants expressed some strong notes of dissent and caution.
Moderator Tim Condon of ING Wholesale Bank introduced his co-panelists, Qing Q. Wang (Bank of America), Ken Hu (First State Investments) and Eugene Kim (Tribridge Capital Management), and led off by asking them to comment on whether the current sustained period of global economic stability would continue. Wang cited three main reasons for the stability of the asset class: global economic strength, abundant liquidity, and the excessive savings glut in Asia, which has been recycled into EMs. Wang addressed the likelihood that each of these factors would continue to be supportive, stating that a “soft landing” in the US could decrease support, while US rate cuts and large current account surpluses in Asia could continue to promote liquidity and recyclable funds.
Condon next asked Hu to comment on whether, in light of the current low US yields being the rule of the day, market expectations on EM credit yields should be readjusted. Hu replied that he saw the “very long disinflation trend,” which he attributed to productivity gains such as outsourcing to low-cost countries, as supportive; he also predicted that real interest rates will be lower due to slowed growth in the US, China and Europe in the future, but emphasized that any slowdown will be very moderate.
Condon asked Kim if the recent history of market dips proving to be buying opportunities would continue. “Partially yes…and no!” Kim replied, explaining that “the weighting of EM in global portfolios will increase going forward, and that will support the asset class.” However, Kim warned that spreads are currently at levels not “necessarily supported by fundamentals,” but are more likely attributable to the “global carry trade.” Kim continued, “There are companies that are coming to market which really should not be able to,” and advised attendees that “the internet bubble has taught us to be wary of talk of new paradigms.”
Condon pressed Kim to describe what could precipitate a turn in the market, to which the portfolio manager replied that a rise in US rates could serve as the catalyst for a bear market. Kim underscored his point by reminding the audience that the May “tremble” had been set off largely by a BoJ rate hike.
How robustly would EM stand up to a contraction in liquidity or a correction in commodity prices? “Overall the asset class should be OK, especially those countries with strong economic policies,” according to Wang. He specified that, based on their strong fundamentals, Asian EMs were better positioned than others to withstand a global downturn.
FOCUS ON LOCAL MARKETS?
Condon also polled panelists for their thoughts on the drivers of the move into local markets. Hu indicated that much of this has been sparked by the decreasing supply of external debt. Condon pressed further, “but has “original sin” been absolved?” According to Kim, the attractiveness of local market investments was more a reflection of dollar weakness than anything else; local markets remain underdeveloped as well. “Again, things are overdone. At some point, the music will stop; the Fed will raise rates and local markets will lose their appeal,” he predicted.
Following up on this, Condon asked if CDS might replace sovereign issuances, and asked for comments on the implications of current explosion of interest in credit default swaps. Kim again voiced concern at market developments, and identified increased counterparty risk as something investors should consider. Hu then raised the issue of political risk, pointing out that despite political upheaval and disruption in many EM countries, investors have tended to look beyond those events to the underlying fundamentals. Kim later cautioned that the market is probably underestimating the possibility of war due to North Korea’s nuclear actions.
ADDRESSING THE GORILLA IN THE ROOM
Condon directed the panel’s attention to China. Wang observed that China’s reserves are very high but that its exchange rate policy is a “policy of last resort”. He noted that while Chinese officials recognize that the country would benefit from a more flexible exchange rate regime, they are loathe to make a drastic move; current policy could continue for two or three years. Wang voiced his opinion that “this issue has gotten more attention than it deserves; equally undervalued is the Japanese yen.”
Condon described the lower “LBO risk” in Asia issue, noting that it is low in Asia because of the number of significant family-owned businesses— in contrast to Europe, where the risk is higher. Condon raised the topic of the impact of newer types of investment vehicles entering the market, predicting that hedge funds and private equity investment will increase their presence because mutual funds will not be able to perform like hedge funds.
TOP PICKS AND TOP RISKS FOR 2007
To conclude the discussion, Condon asked each panelist to share his top pick and his top risk for 2007. Wang reiterated his bullish outlook for EM in Asia, based on a soft landing scenario in US. Currency plays will be less interesting in 2007, and he did not see much opportunity for currency appreciation in Asia, with the possible exception of the Indonesian rupiah. He targeted the Chinese renminbi at 7.148 in 2007.
Hu identified the 2007 risk as inflation. He remains overweight on inflationary countries, and agreed with Wang on the potential for Asian currency devaluation. Hu noted he is more optimistic on the Korean won than on Indonesia rupiah. Kim, echoing his earlier concerns, sees the contraction of global liquidity as the major theme of 2007. The focus of the market will be safe havens such as South Korea, Singapore and Hong Kong, at the possible expense of current “high flyers” Indonesia and the Philippines.