Cushla Sherlock: “China reforms re-accelerate” is one of Credit Suisse’s top investment ideas for 2014. However, underlying growth momentum in China has weakened so far this year. Is this still an attractive investment opportunity?
Michael Strobaek: The latest economic data has surprised to the downside, so risks have clearly increased. Looking forward, deleveraging and the war on pollution will also present increasing growth risks. At Credit Suisse, we have downgraded our outlook for Chinese stocks to neutral and expect widening divergence between the winners and losers of structural reforms. We believe the winners will be the internet, technology, consumption, healthcare and new energy sectors.
Does tapering in the US risk slowing China’s reforms?
As a matter of fact, China's reform efforts have significantly increased recently, despite Fed tapering. The CNY trading band has been widened and economic stability has been moved even further up on the agenda. Efforts to fight corruption and pollution have also been stepped up. The Chinese government is putting more emphasis on job creation instead of a fixed GDP growth target. Therefore, if anything, reforms are accelerating.
What other economies in the Asia Pacific region could have a strong effect on regional growth this year?
We think that countries like South Korea or Taiwan – where the economy is closely linked to the business cycle in the Western World – could see accelerating growth dynamics. There are also more locally driven economies such as Indonesia that still have fairly solid growth rates, but are unlikely to accelerate this year.
Geopolitical risks in some parts of the world have increased recently. The situation in Russia and Ukraine is the most prominent example. What do these risks mean for financial markets?
It is true that risks have increased. However, this is not reflected across all asset classes. Risk indicators such as implied volatility have mainly increased in equity markets. Risks in fixed income and currencies have not moved much. We therefore think the situation for financial markets is still rather benign. Recent events have isolated effects in individual markets, such as Russian equities, but there is only little indication for contagion across asset classes.
What are the specific effects of this increase in risk for equity markets?
The cyclical high beta markets are mainly affected. For example, the German DAX and Japanese equities. Here, technical momentum and trend have also deteriorated, which is a warning sign. However, fundamentals such as earnings growth and valuation (in Japan) still look very strong. As a result, a good buying opportunity should present itself once fundamentals improve.
Given the negative economic surprises, has the outlook for fixed income investments improved?
We still have a negative bias for fixed income as bond yields are at the lower end of their ranges. So, a lot is already priced in. It's also important to highlight the fact that increased risks are mainly confined to equity markets. In the fixed income space, riskier bonds – such as those from peripheral European countries – are still doing quite well. In particular, we like Italian, Spanish and Portuguese bonds amid improving fundamentals there.
What are your views on the major currencies?
We believe that the USD has some appreciation potential given Fed tapering and our expectation of further economic recovery in the US. Against the EUR, the USD also appears undervalued. Risks of further geopolitical tension could temporarily support the CHF and the JPY. Longer-term, the USD should also gain against these currencies given diverging central bank policies.