One of the more notable policies enacted in the EM sphere was the unexpected corporate tax cut in India, amounting to more than US$ 20 billion. This has created a short-lived euphoria in the India markets, rising almost 8% over 2 days. Similar policy stimulus and structural reforms are taking place across the globe, such as the recent pension reform bill in Brazil, to counteract against the effects of the receding global economy via boosting confidence and investment. This is positive for EM going forward as the structural reforms offers great opportunities for their markets.

Yet warning signs continue to exist. The ongoing trade war remains one of the biggest threats to the EM economy, represented by the falling global manufacturing PMI, being in the downtrend and remaining in the contraction zone for 5 consecutive months. A recent regional outlook report released by the Asian Development Bank has scaled down the growth forecasts of most of the economies in the region, citing a more intensified impact from the trade war fallout. The Bank expects the effects to persist well until 2020, cutting forecasts by 0.3% for developing Asia in 2019 and 0.1% in 2020

Despite the shaky fundamentals globally, we believe that the trade war beneficiaries like Vietnam and Taiwan should continue to benefit from the effects of the trade war as production lines move out of China. Caution is needed before investing in EM due to the higher systematic risk.

The economic data of Eurozone remains poor, Markit Eurozone manufacturing PMI worsened to 45.7 in September, staying in the contraction zone for 8 consecutive months. The leading indicator of Eurozone economy, Economic Sentiment Indicator in Eurozone, worsened by 1.4 to 101.7 in September, continuing the downtrend from late 2017. Growth stays sluggish and shows poor signs of improvement, domestic demand is expected to be limited reflecting the continued stagnant economy in the Eurozone.

As for the never-ending Brexit matters, UK prime minister Boris Johnson claimed he has prepared a plan to resolve the “Irish Backstop”, though sources say the EU authorities are going to reject the proposal as it does not actually solve the issue. With the deadline for Brexit closing in, although the Benn Act is in place to force Johnson to request for an extension from the EU in the case of a “No-deal” Brexit, we are still not yet certain how the events will unfold. We have no idea if Johnson will be able to strike a deal with the EU, will he try to push for a hard Brexit, or if there will be a no-confidence vote alongside a caretaker government to delay the Brexit deadline. With all the uncertainties, we suggest investors to stay vigilant and prepare for all possibilities.

Moving on to the monetary policy, while the ECB’s rate cut of 0.1% from -0.4% to -0.5% was widely anticipated and mostly priced in over the month, the restart of asset purchase was a pleasant surprise, with the total amounting to EUR 20 billion per month starting from November. The central bank also introduced a tiered deposit rate to help out European banks. That said, while additional liquidity could provide support to the market, geopolitical factors and the sluggish growth in the Eurozone would likely continue to drag the market down in the last quarter of the year.

 China's overall economic data was still somewhat mixed. In September, both the official manufacturing PMI and Caixin China Manufacturing PMI posted positive surprises, coming in at 49.8 and 51.4 respectively. Yet, growth in the manufacturing industry in China is still expected to be relatively muted. While the August PPI of -0.8% was slightly better than market expectations, it remains in the contraction zone, together with the falling export figures of -1.0% YoY in August, this could mean further weakening in the exporting sectors.

After raising the currency manipulation controversy in August, it was reported that the White House is considering limits to fund flows into China or Chinese related entities via 3 major measures. The measures include limiting Chinese company’s weighting in various Indices, limiting pension funds investment in China, and limiting or even delisting ADRs currently listed in the US exchanges. While these measures do seem farfetched at the moment, the reports could possibly outline future US actions to be taken in order to further pressure China in the trade war.

As the downward pressure continue to mount, the Chinese government has once again introduced policies to stimulate the economy. The People's Bank of China announced further lowering of reserve ratios in early September, releasing RMB 900 billion to the system. While the act is likely going to provide support to the markets, many question the incremental benefits of further cuts. With the large level of cash released back to the system, some experts are also concerned over the rising inflation as the CPI is currently on the higher end. The Premier of the State Council Li Keqiang reiterated the importance of “Six Stabilities” at the State Council, and further supported the local government bond issuances as means to boost the local economy. In light of the recent developments, we continue to suggest investors to stay cautious with regards to the possible economic growth drop off.

Source: Bloomberg, Harris Fraser, Data as of :7-10-2019

While the Nikkei Japan Service PMI was 52.8, Manufacturing PMI further worsened and stayed in the contraction range. Japanese corporate confidence remained weak, machine tool orders fell 37.1% YoY in August, and industrial production went negative YoY once again. Overall, the Japan-wide manufacturing sector’s outlook continues to stay negative. Although CPI, household spending and cash earnings figures remained low, retail sales is surprisingly strong as the sole saving grace, which could be further bolstered by the ongoing Rugby World Cup held in the country. That said, the underlying issues with the Japan economy still exist, the existing trend continues and we have yet to see significant recovery in the Japanese economy, thus we retain our neutral rating for the market.

Sources reported that Japanese Prime Minister Shinzo Abe will not hold a meeting with Korean President Moon Jae-in during the ASEAN conference later this month, further plunging the relations into deep freeze. On the other hand, US president Trump claimed that he had reached agreement with Japan on a “mini trade deal” with agricultural products in focus. While the “deal” was not an official document, the gesture does show further improvement in relations between the two countries, with possible further amendments to be made to the “deal”. This does come in timely as Japan faces stronger headwinds in the economy, not only from worsened relations in Korea, the ongoing trade war, but also the increasing value-added tax from 8% to 10% starting in October. It is expected that the economy, especially industrial and retail sectors, will be more impacted in light of the recent events. Thus, investors should reconsider the situation more carefully and could consider reducing exposure to the region.

Economic figures continue to show warning signs in the US economy, as Markit and ISM PMI figures continue their downtrend in September. ISM manufacturing PMI missed expectations and remained in the contraction zone at a low of 47.8, which is the second contraction in a row, and the lowest point since July 2009. ISM non-manufacturing was 52.6, which missed the expected figure of 55, and marks the continuing downtrend for non-manufacturing figures. This is important as the US economy is dominated by the service industry. The weakening consumer confidence figures in September, coming in at 125.1 which missed the market consensus by 9 points, further shows a possible faltering economy.

As for the latest trade war development, September has been a relatively calm month as both sides are waiting for trade talks to recommence. Although Chinese trade parties have cancelled planned US farm visits earlier in September, causing a brief panic as the markets were concerned over the strained relations. Still, the scheduled trade talk in mid-October will continue as planned, we might see a positive but limited rally early in October. Overall, we expect limited progress in the trade agreement as fundamental differences remain. Even though the US market remains the most robust equity market from a global perspective, as complex existing issues remain, alongside with the weakening global economy at hand, we do not expect the US markets to sky rocket, investors should continue to stay cautious when investing.

Source: Bloomberg, The Conference Board, Harris Fraser, Data as of: 30-9-2019

United States

US economic data unexpectedly weakened. NASDAQ fell nearly 2% over the past 5 days ending Thursday, while S&P 500 and the Dow fell more than 2%. The US ISM manufacturing PMI released this week surprisingly fell to a 10-year low. In addition, the World Trade Organization lowered its global growth forecast for this year and the next, worsening market sentiment and causing US equities to fall sharply for two consecutive days over the week. The US ISM non-manufacturing PMI released afterwards also brought bad news, falling to the lowest level in three years. The weak economic data drove market's expectation of two Fed rates cuts in 2019 up, driving the 10-year US bond yield back down to the 1.52% level. The market will focus on the non-farm payroll figures released later tonight.

Europe

The WTO authorized the United States to impose tariffs on up to $7.5 billion of EU products, goods such as aircraft will face up to a 10%-25% tariff. The French finance minister said that the EU will make a firm response over the matter. The incident worsened market confidence, causing large drops in European equities on Tuesday and Wednesday. Over the past 5 days ending Thursday, the FTSE 100 and CAC fell more than 3%, while the DAX also dropped more than 2%. The UK Prime Minister Boris Johnson requested the EU to make concessions on Brexit, claiming that the UK is well prepared for a case of “No Deal Brexit”. The European Parliament on the other hand is concerned about the details of UK's Brexit plan. It was reported that even if the EU rejects Johnson’s proposal, the UK administration still has a backup plan. As the Brexit deadline approaches, market uncertainty rose, and GBP/USD is fluctuating between 1.22 and 1.44.

China

Due to the National Day holiday in China, the Shanghai and Shenzhen stock markets will be closed from Tuesday until next Tuesday, Hong Kong markets was closed on the National Day. Due to drop offs in international markets, Hong Kong equities performed poorly this week, but still outperformed the global markets. The Hang Seng Index fell 0.85% in the week while the H-Share Index fell 0.64%. In terms of economic data, Hong Kong retail sales in August recorded the largest year-on-year decline ever. As for the Sino-US trade relations, US soybean exports rebounded to the highest level in seven months as the tension between the two sides eased temporarily. On the week ending September 26, total sales increased from 1.04 million tons to 2.08 million tons week-on-week. China will release figures on foreign exchange reserves and Caixin Services PMI next week.

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Harris Fraser Group Limited released the latest “Hong Kong Property Market Outlook” (“Outlook”), an in-depth study on the property market trends from 2019 to 2022. The Outlook anticipated property demands in Hong Kong to continue outstripping supply, and the property market to remain in an uptrend. However, as the demand-supply imbalance subsides, the growth in property prices is expected to soften in the next four years. The Outlook also noted that, as Hong Kong faces demographic changes, purchasing power for smaller units or flats targeting first-time homebuyers (e.g. studio flats or one-bedroom apartments) would decline, and become less lucrative compared with medium or large units, such as two-bedroom or three-bedroom apartments.

Property Price Increase Moderates

Trade-up Properties Become Top Investment Choice

The Outlook focused on the private residential market, with the goal of determining the direction of the Hong Kong property market. In addition, it aimed to ascertain the type of private homes with the highest investment returns in the current market environment. The Outlook forecast that during the period from 2019 to 2022, the property market supply-demand imbalance would ease, with an equilibrium in sight. Nevertheless, since the overall demand exceeds supply, the property market will maintain a steady uptrend.

Although overall demand outpaces supply, demand growth will moderate due to changes in the supply-demand ratio. Demand for private properties can be further broken down into (i) rigid demand (such as homeownership due to marriage and starting a family), and (ii) elastic demand (such as a switch from non-private housing to private flats). From 2019 to 2022, supply of new private residential properties is estimated to surpass rigid demand. The surplus supply will be absorbed by the elastic demand, slowing down the upward growth. Since elastic demand is responsive to price changes, the property market is likely to experience volatility.

The Outlook observed that, by estimation based on the area of government land sale and the number of private residential properties in construction, supply of new private residential homes is expected to significantly decrease from 2023 onwards. Coupled with the objective of long-term land supply, the ratio of public to private housing will be tilted from 6:4 to 7:3, further decreasing the supply of private residential properties. It is expected to bring support to the long-term upward momentum of the property market.

Steven Wong, author of the Outlook and HFG Investment Analyst, said, “According to our analysis, first-time homebuyers of suitable age have buttressed the demand for flats targeting them for the last 14 years. Under the present conditions, the demand for first-purchase flats prevalent in the past will shift to demand for trade-up properties. The investment value of the trade-up properties is relatively higher in response to the demand for these type of properties. As the upward momentum of the property market slows, investors can turn their attention to medium to large trade-up properties, such as two-bedroom or three-bedroom apartments, and increase their wealth through replacing their flats for one with a higher value.”

Refinance Property Investment in Anticipation of Interest Rate Cuts Cycle

Apart from investing in a replacement property, another viable option is to take advantage of the current low interest rate environment and create wealth through remortgage and property refinancing. Investing in higher-return assets so as to capture the interest rate differential between those and the property refinancing can generate additional “passive income”. Investors can choose interest-generating products of relatively stable prices, such as bonds, bond funds, REITs and high-interest stocks. Among these assets, bonds and bond funds are the most popular, owing to their steady interest payments and comparatively lower price volatility than stocks. These are preferred choices as the interests generated can be used to offset the property refinancing interests.

Cyrus Chan, Investment Strategist at HFG Research Department said, “Higher global property prices in recent years and the low interest rate environment are expected to continue. As a result, proceeds from the remortgage increase and interest expenses decrease, boosting the effectiveness of the interest arbitrage maneuver. Property refinancing, like magic, can reveal usually unseen capital for the investor. Whether used for investment or replacement property, it can create opportunities for wealth creation.”

Cyrus pointed out that with the current reference mortgage rate of 2.625% in Hong Kong, the monthly contribution was only $16,869 with the $4.2 million mortgages amortised over 30 years. If the $4.2 million mortgage amount is used for investment and the average annual return on investment can reach 6%, the average monthly return on investment of $21,000 is sufficient to cover the mortgage installment. Moreover, the mortgage installment is partially returned to the principal, meaning the actual net return will be even larger. The estimated monthly passive income can reach more than 10,000 Hong Kong dollars.

Cyrus continued that there are a lot of investment tools on the market, but he believes that straight bonds and bond funds are more ideal for refinancing investment, because of more stable dividend and price stability characteristics. If the investment amount is more than HK$4 million, one of the options is to consider diversifying the portfolio into straight bond and bond funds. Conversely, if the amount is below 4 million, investing in 1-2 regionally diversified bond funds can be considered. Cyrus said that the average annual dividend payout ratio or total return can reach more than 6% for many straight bonds and bond funds in the market. And the income return can cover the mortgage contributions in a low interest rate environment, thus achieving passive income generation.

In addition, Cyrus did not forget to draw attention to the risks of this mortgage refinancing investment operation, including the mortgage loan interest rate increase, interest income risk, handling fee and liquidity risk; also risks related to the principal and mortgage, including market risk, non-guaranteed or default risk, changes in mortgage ratio risk and inflation risks.

For the market outlook, Cyrus expected that two major worldwide trends will continue, including the slowdown in global economic growth and the low interest rate environment. Under the trend of slowdown in global economic growth, Cyrus believes that the performance of Investment Grade bonds may outperform High-Yield bonds. It may be more desirable for investors to use investment-Grade bonds as a carrying asset. In addition, Cyrus expected that the global low interest rate environment will persist, which will support the refinancing investment environment. Moreover, if the interest rate is further lowered, the bond price will increase and the refinancing investment will produce double benefit in both income and capital.

The Research and Investment Team

Steven Wong is the Investment Analyst at Harris Fraser. He has rich experience in asset allocation, investment management and credit analysis, exceling in combining macroeconomic analysis and technical analysis to determine the optimal asset allocation strategy. Currently he is responsible for macroeconomic analysis, investment strategy development as well as discretionary portfolio management. He actively shares his investment ideas and commentaries in public and he has his own columns in different media including Sing Tao Daily, ET Net and Capital Weekly. Prior to joining Harris Fraser, he was a corporate banker and managed loan accounts of listed companies from the Greater China region. He has experience in M&A loans, project financing and cross-border financing. The loan size that he has dealt with was more than 10 billion Hong Kong dollars.

Cyrus Chan, CFA, currently works as Investment Strategist at Harris Fraser. He advises and manages portfolio for the group's clients. In addition, by doing thorough market research on global economy and investment markets, he also produces investment research reports. He actively shares his investment ideas and commentaries in public, publishing on newspapers, magazines and online sections including ET Net, OrangeNews, Sing Tao Investment Weekly and Headlines News. In addition to the columns, he is also active in multimedia channels, participating in the online videos collaborated by Mason Securities Limited and Harris Fraser Group. Prior to joining the Group, he worked in a number of international banking and financial institutions including HSBC, BOC Hong Kong and Taifook Securities (currently known as Haitong International Securities). He holds a bachelor degree in business administration. Cyrus is a Chartered Financial Analyst® (CFA) charterholder.

The MSCI Emerging Market Index dropped by 5.08% in August. We encourage investors to exercise more caution regarding the emerging markets towards the end of 2019, mainly due to risk factors mounting with limited visible positive developments. Two important factors for the emerging markets to perform, continued growth and a weaker dollar, might not hold true in the remaining portion of the year, but we will still need to keep an eye on any future developments. Our overall EM outlook for the year is neutral.

Building on Trump’s tweets at the beginning of August, the US-China trade conflict quickly escalated over the month, with both sides at greater odds with another. As we have yet to see the light at the end of the tunnel, the ongoing trade war is unlikely to come to an end before the end the year, the global economy is likely going to suffer with the increased trade tensions as global demand falls. This is reflected in various economic data, notably the global manufacturing PMI, with a significant number of large economies lying in the contraction zone. This is expected to disproportionally affect EM instead of DM since many of the countries in EM are export based economies, the drop off in global trade and world economy brings a lot of challenge to the relevant countries with the reduced demands and falling prices.

Another reason calling for more caution is the ‘hidden’ risk factors like political and regulatory risks that are inherent in EM. Take the recent Argentina incident as an example, both the Argentinean equity market and Peso dropped by huge margins of 35% and 25% respectively, after there were election surprises in the primary elections, where the incumbent Mauricio Macri was handedly defeated by the Peronist Alberto Fernandez. Investors were worried that if Fernandez got into power, the prior reforms implemented by Macri upon request of IMF could have been overturned, resulting in a potential country default. The panic reaction of the market towards the surprising result illustrated some of the hidden risks of investing in EM, where surprise factors could have lasting consequences, and the possible default of one EM country have the potential of spilling over to other EM economies with close ties. In Argentina, peer Latin American countries are potentially at risk of an economic downturn due to the situation in Argentina.

Another reason for caution is the relative strength of the US dollar. Historically, a weaker USD correlates with a stronger performance of EM investments, mainly through providing support via spillover effects when the market is ‘risk on’. Unfortunately for EM economies, the USD did not weaken at all over the past month. Instead, the DXY index rose 0.41%, despite Fed cutting rates in late July and interest rate futures implying further cuts in September and once more before the end of the year, USD stayed strong. While the weakening of the Euro and Pound provided support to the majority of the appreciation, as Europe is getting entangled in the Brexit matters, poor growth, and EU issues like Italy and Greece, global central banks including ones in EM economies are also following suit in rate cuts. Notable cuts include Reserve Bank of New Zealand which cut a hefty 0.50% and Reserve Bank of India which cut 0.35% to 5.4%, the lowest rate in 9 years. Global central banks following suit, freeing up liquidity in the financial system to stimulate their economy in the times of global uncertainty, is likely going to continue to be the norm as the trade war wages on, which relieves the downward pressure for the USD when the Fed cut rates in the future.

As mentioned in the past, we expect that EM growth in 2019 Q3 Q4 would be downward revised. For EM economic growth outlook, we are now less positive. Bear in mind that IMF did a downward revision of the global economic growth earlier which would likely drag the EM economy down due to its nature of export based economies. Despite the shaky fundamentals globally, we expect that the trade war beneficiaries like Vietnam and Taiwan should continue to benefit from the effects of the trade war as production lines move out of China. We revised our outlook of EM to neutral in the remaining portion of 2019, more caution is needed before investing in EM due to increased systematic risk.

Written by Harris Fraser Investment Research Team

Harris Fraser Investment Research Team embraces a top-down analytical approach to deliver a satisfying risk-adjusted return to meet the objectives of our clients. We start with macro-level research on an individual country, region, or sector before doing technical analysis like cross-market money-flow and trends to identify investment opportunities.