Buy Japan: Shifting Fund Flows Are LIke a Balancing Act

The Japanese stock market fell by 20% in the last 2 weeks. I went in to buy several ETF CFDs, the Schroder Japan Equity Fund and call options. Now I am up by 8%. I put in about SGD 20k, but because I leverage 5x, my exposure is around SGD100k. The rebound has already rewarded me with 8k, with an ROE of 40% in 3 days. Very good reward.The Japanese disaster was truly a heartache for all of us. My prayers are with them and I will contribute 10% of my returns to a charity of my choice, perhaps connected to helping the Japanese.

I don't think the bull cycle is over. I always thought this was a mid cycle correction and the disaster in Japan and the unrest in the Middle East triggered the sell down.

MONEY MATTERS


Shifting fund flows are like a balancing act

Flows from emerging to developed markets present good opportunity for long-term investors

By HAREN SHAH

THE tide of fund flows into the emerging markets is receding. The reverse is happening to the benefit of developed markets, which have experienced strong growth in recent months. But does this reversal of fortunes signal a long-term trend, an uncanny aberration or a necessary market correction?

We believe the recent fund flows out of the EMs and into the DMs are more a balancing act rather than a structural shift away from EMs. Inflationary pressures, rising interest rates and political uncertainties in the EM underpin the flowback.

For investors with a medium to long-term view, the flowback may represent good buying opportunities in select equity markets such as Hong Kong, South Korea and Taiwan in Asia. Brazil and Russia, too, particularly for commodity plays.

Fund flows

It was just last year that emerging market (EM) governments were lamenting the prospect of large fund flows into their economies and how these would distort their economies and affect their financial markets. It is only the first quarter of 2011, and how it all has changed. Rather than receiving inflows, EMs have experienced outflows, and most of the funds are reverting to developed markets (DM) like Japan, the US and parts of Europe.

This begs the question, is this the start of a new trend or is this just a normal adjustment to the vagaries of fund flows looking for value and safety?

In the last couple of years, EMs have been attracting inflows mainly due to the more robust growth prospects of these economies relative to DMs. The financial crisis further exaggerated the flows as interest rates remained low and investment prospects were not as attractive in the developed world.

Between 2008 and 2010, EMs saw significant inflows to the tune of US$130 billion while DMs saw outflows of US$350 billion. Moreover, with QE2 announced by the US Federal Reserve late last year, the expectation was that these funds would continue to flow into EMs as their growth prospects remained stronger, interest rates were heading higher and currencies were appreciating.

Inflationary pressures

A primary cause of the reversal in fund flows has been concerns about the build-up of inflationary pressures in the emerging economies. Many of them, especially in Asia and Latin America, have seen inflation surge due to strong growth and high commodity prices, especially food and energy.

This has resulted in interest rate hikes and property curbs to rein in these sharp price appreciations. Recent political tensions and events in Northern Africa and the Middle East have also not helped as risk aversion has further fuelled outflows from EMs. The risk premium on EM assets has risen as investors are concerned that the political problems could spread and affect growth prospects and ultimately corporate earnings. Oil price spikes and food inflation remain key concerns as these could lead to more unrest in EM countries.

EM equity markets attractive

EM equity markets have underperformed DM equity markets by about 10 per cent in this recent move over the past few months. Considering that EMs underperformed DMs by more than 31 per cent in their last period of underperformance in 2008, this raises the question of whether we could see such a magnitude of divergence this time around.

We suspect not, as the underlying fundamentals are currently much better. It should be noted that previous big pullbacks in EM equities occurred when global growth expectations were falling.

On the contrary, we are currently seeing global growth expectations being revised upward on the back of improving prospects in the US, Japan and core European countries.

Also, EM stocks are showing sharp improvements in earnings. So, from a valuations and 2011-12 earnings perspective, the recent underperformance and pullback in EM equities has increased their overall attractiveness.

Tighter monetary policies in Asia

Looking at Asia, the main concerns for investors have been inflation and the prospect of tighter monetary policies. So far, we have seen policy tightening across most Asian countries as governments try to cool price pressures. The fear here is that policymakers will misstep and cause growth to slow dramatically, thereby affecting corporate earnings.

This is of most concern in the region's two largest economies, China and India. Inflation in China, especially property prices, has resulted in the implementation of three policy rate hikes and significant banking reserve tightening measures. With signs that overall inflation is on an uptrend, the government appears very worried about social unrest.

Similarly, with inflation close to 10 per cent in India, there have been six policy rate hikes, with potentially more on the way. Such moves have made global investors nervous and prompted them to reverse their investment flows out of EM economies back to DM economies, where growth prospects and earnings outlooks are beginning to brighten. Nonetheless, we believe this is merely a short-term shift and that Asian stocks are likely to rerate once some of the uncertainties subside.

Against this backdrop, we believe the recent fund flow movements out of EMs and into DMs represent more of a rotation rather than a structural shift away from EMs. Macro concerns stemming from inflation, rising interest rates and political uncertainties will continue to resonate in EM economies.

But for investors who are taking a medium to longer-term view, this pullback may represent good buying opportunities in select markets such as Hong Kong, South Korea and Taiwan in Asia, while Brazil and Russia look like good prospects for the commodity play.

The writer is senior investment strategist, wealth management, Citi Asia Pacific

Disclaimer: Opinions expressed herein should be regarded solely as general market commentary, and may change without prior notice. Past performance is no guarantee of future results.