Asia Outlook for 2010 – a 20% return year
MRE expects that, for 2010 as a whole, Asia ex Japan will return around 20%. Although far from cheap, Asia’s equity markets are not excessively expensive and the macroeconomic backdrop is, broadly speaking, supportive of healthy equity market conditions. Specifically:
Growth (in both the G3 and emerging markets) is either healthy already (China, India) or improving (the G3)
While there are very valid and understandable concerns about the strength of the recovery, the worst is clearly behind us, and a recovery in global growth is in train.
Global monetary conditions are likely to remain very loose for a long period of time
Most of the tightening in policy (in the developed world) that does come this year will come
from fiscal policy, because that’s where the imperative lies. The consequence is that monetary policy will have to be kept looser for longer to ensure a self-sustaining recovery takes hold. The lower discount rate that this implies means that equity market multiples, and asset price multiples more generally, could be higher than historical averages for quite some time.
Fund flows are likely to remain healthy
Offshore emerging markets and global fund managers do not, yet, have enough exposure to Asia ex Japan. From discussions during MRE’s marketing trips in Europe and the US, it is very clear that these investors are only part the way through the process of increasing their exposure to Asia ex Japan. This is also supported by official data on fund flows which shows money continues to flow into the region.
Importantly, though, MRE expects most of these returns to come later in the year, rather than right now. The reason is simple: key cyclical indicators that MRE follows are falling.
Main downside risk
The main downside risk to this view is to margins and earnings. Margins in Asia correlate closely with global nominal GDP growth. Doing a simple linear regression of this relationship, and plugging in the IMF's forecast for global (nominal) GDP growth for this year, suggests analysts' current bottom-up margin forecasts are too high.
Leverage up to two years: long-dated warrants
Macquarie has a range of call warrants over blue chip stocks that expire in 2011 and 2012. The following warrants have exercise prices close to their respective last traded underlying share prices:
CapitaLand: CapitalaMBLeCW120103 (JA7W) exercise price $4.10.*
Cosco: CoscoCorpMBLeCW120103 (JA4W) exercise price $1.30.*
DBS: DBS MBL ECW120103 (JA6W) exercise price $13.80.*
DBS: DBS MBL eCW111003 (IL6W) exercise price $15.50.*
Genting: GentingSMBLeCW120402 (J2UW) exercise price $1.15.*
SGX: SGX MBL eCW110901 (IL4W) exercise price $9.00.*
SingTel: SingTelMBLeCW110404 (HJ5W) exercise $2.90.*
UOB: UOB MBL ECW120103 (JA8W) exercise price $17.80.*
Long dated warrants versus shares or margin instruments
With long dated warrants, you pay only a fraction of the share price up front and get exposure to the capital movements in the underlying share over the life of the warrant. Your losses are limited to your investment capital, and under normal circumstances, you will not face margin calls or forced selling.
One of the concerns of longer term investors is the time decay of warrants. The shorter dated a warrant, the higher the rate of decay. Hence longer term investors should actually look for warrants that have a lifespan of 1 to 2 years, as the rate of time decay is much less than the shorter dated warrants.
Longer dated warrants tend to have lower effective gearing compared to shorter dated warrants. Thus longer term investors who may not have an aggressive or high risk profile tend to prefer longer dated warrants.