Yun, who influences fund selection at BMO Private Bank, cited several risks that came into sharper focus in the second half. The first is expectations that the mainland’s annual GDP growth won’t fall below 6%.
“If China cannot reach 6% GDP growth that will be a huge problem. An unexpected sharp slowdown in China would change our views on the investment landscape.”
Another risk is in Japan, where Abenomics dominates the investment environment.
Japan's parliament recently approved a controversial bill that changes the country's security laws, allowing Japan to deploy troops overseas. As a result, the approval rate of the Abe government has fallen and if elections are called and Prime Minister Abe is not re-elected, “the whole theme of Abenomics may change, which may change our view on Japan as well”, Yun said.
The third risk is the price of oil. A large number of high yield bonds are tied to energy companies.
"In terms of leverage versus GDP, A-shares are the most highly leveraged compared to the markets in Hong Kong, the US and Japan"
“If there are continuously low oil prices below $40, there could be quite a number of US high yield issuers defaulting, which could affect the whole investment landscape in the US.”
Selective fixed income
Yun believes the US interest rate rise will be gradual, starting with 25bps. In the next 12 months, he’s expecting a maximum of 1% or about 75bps. The rate hike will likely have limited impact on markets.
“Equities may be slightly negative on the first hike but not thereafter. With bonds, we expect short-term price fluctuations but not a huge sell off. If we can, we go into funds that offset this interest rate hike.”
He declined to name funds the bank has selected for clients, but as an example of the type of fund he’s referring to he mentioned the Jupiter Dynamic Bond Fund. Multi-asset products can be another option that offsets the rate hike because they are not limited to long-only fixed income.
BMO has a neutral on US equities, and Yun sees the S&P index climbing only 5% in 12 months, largely due to a stronger US dollar.
“Almost half the revenue of S&P 500 companies is coming from overseas, and a stronger dollar makes them less competitive,” Yun said. “Wages are also starting to pick up and the profit margins of some US companies may start to narrow.”
Helping to offset that could be a pickup in consumer spending, which would result in earnings driven by consumption, he added.
European equities are attractive to the bank. “The weakness of the euro helps, particularly for exporters because they become more competitive globally. ECB policies are also continuing to be accommodative.”
A third factor is European bank balance sheets that are in better shape than a few years ago. Banks are therefore more willing to lend, Yun said. “If lending becomes more customer friendly, GDP growth will pick up as well. Not just driven by exporters but also domestically- focused companies. Europe’s equity market has better upside than the US in the next 12 months.”
Rising interest rates should benefit the banking sector through rising margins. US and European financial sector equities are appealing because they will likely have revenue growth, he added.
For the next 12 months, Yun likes Japanese equities, which he said are not expensive but not cheap in terms of price-to-earnings. “EPS growth still has room to expand.”
Japan equities are discounted by depreciation of the yen, he said. Reforms in corporate governance have prompted corporations to become more shareholder friendly by selling non-core assets and paying more dividends.
“That will help to drive earnings. We see inflation assets picking up already. The banking sector will benefit because when asset prices rise faster than the loan, banks are in good shape and could increase dividends to shareholders.”
A-shares, Yun said, remain volatile “unless you find a great stock picker and the client accepts that volatility. China is still a policy-driven market”.
H-shares, Chinese shares listed in Hong Kong, are slightly better because they have an institutional client base, he said.
China’s recent market volatility has raised client concern. “We highlight to clients that volatility will happen. It has happened in the past several times. In terms of leverage versus GDP, A-shares are the most highly leveraged compared to the markets in Hong Kong, the US and Japan. Due to high leverage, the drop is very fast.”
Yun said authorities are trying to make China markets more institutional. In Hong Kong, about 60% of the investor base is institutional. In China, the figure is 20-30%, he said.
“The stock connect will encourage foreign investors to invest in China’s market. More funds could be formed to make the market less volatile.”