Yuan bonds get thumbs-up at Standard Chartered

This could be the year for developed-market equities to deliver wealth and Chinese yuan-denominated bonds to remain hot investor favorites, according to Steve Brice, chief investment strategist at Standard Chartered Bank.

Brice has served in senior positions for more than 15 years, including as head of global markets for the bank in South Africa, head of research in the Middle East and South Asia, and chief economist for Southeast Asia.

He started his career at I.D.E.A Ltd, a financial consultancy in London, where he was regional head of foreign exchange for Europe before joining Standard Chartered. He holds a master's degree from the University of Liverpool.

Sitting in Standard Chartered China's headquarters in Shanghai's Lujiazui area last month, Brice explained to Shanghai Daily why investors must remain agile this year and why Chinese financial stocks are performing so weakly.

Q: What's your global investment outlook for 2014?

A: This year, if you have three investment decisions right, you'll do pretty well. Those three things are: overweight global equities versus global bonds; overweight development market equities versus emerging market equities and overweight high-yield bonds versus investment-grade bonds.

We expect global equities to be the strongest performing asset class. We have a high preference for high-yield bonds. We still favor developed market equities over emerging market equities.

However, we are less comfortable projecting that all the way through 2014. As the market develops, we might change our views. So being "agile" throughout the year is important.

Q: What do you mean by "agile?"

A: "A-G-I-L-E" is our view from a macroeconomic perspective.

"A" is for advanced economy as the key to the global economy. We believe emerging markets are likely to slow. Therefore, it's really important that the United States and Europe, in particular, see their economies accelerate this year. The good news is we expect them to.

"G" is growth of earnings as the key to equity returns. In the US and Europe, consensus says we are going to see an acceleration in growth.

"I" is for income in high demand. It's an important view for us but has been reduced in the past three years. Income is still important for investors, but it's getting harder to generate good income with positive returns.

"L" is for liquidity remaining ample. The US Federal Reserve's tapering is not tightening. The Fed is reducing the amount of money it's adding to the economy. So it's a slower pace of easing. We expect further stimulus in Japan, probably around June. The European Central Bank is also under pressure for more stimulus as well.

"E" is for emerging markets embarking on reform. Clearly, China is a very important part of that. We are also seeing other emerging markets in the trend of transferring to a more sustainable growth model.

Q: Would you like to elaborate on China's case?

A: There's no hard landing in China, and we are going to see growth above 7 percent this year.

However, we don't expect a strong recovery. The policy environment will be focused on clamping down on loan growth to rebalance the shadow banking system back to the formal banking sector, which should keep a cap on growth as well. Overall, we don't expect faster growth in China through 2014.

Q: What investment opportunities do you see in China?

A: For a risk-return profile, we recommend onshore yuan bonds, which are expected to give 6 to 8 percent returns to investors.

We liked offshore yuan bonds last year. This year we would like to highlight the opportunities presented by the onshore yuan bond market. The yield gap between offshore and onshore yuan bond markets has widened significantly. We believe that it offers a decent yield for both domestic and international investors. International investors will also benefit from yuan appreciation.

Q: In terms of your preference for equities in different markets, do you think that developed market equities are expensive and emerging market equities are cheap?

A: We don't believe either that developed market equities are expensive versus history or that emerging market equities look cheap. They look cheap because the Chinese banks are very cheap. Secondly, South Korea equities are very cheap. If we take out those two factors, the emerging market does not look very cheap.

The key concern we have for China is the financial sector. Normally, the banks perform well when the non-performing loan (NPL) ratio is coming down. And the NPL ratio is not going to go down very much.

The question is when and how much the ratio is going to rebound. That's the key concern of investors in the Chinese stock market because Chinese banks are index heavyweights. Until we see some clarity on this, the Chinese market is going to underperform developed markets.

Q: Chinese banks have an average bad loan ratio of around 1 percent. Given the correlation between bank share prices and NPL ratios, is there a chance the stocks could rally with improved asset qualities?

A: Chinese banks have lower NPL ratios than their Asian peers, yes. And there's no further scope for them to fall. We don't have a formal forecast on how far the NPL ratio will go. As we see it, there's greater focus on credit constraint by the government to control excessive reliance on credit for growth. It's more likely that more and more companies will be in stress. Therefore, the key for the stock market is when the NPL ratio will peak.

Of course, historical relationship could break down. But from our perspective, we don't really see the driver for sustained strong performance.

Q: What's your take on the gold price?

A: Gold is overvalued and is likely to fall as we see the outlook for US dollar is appreciation generally. The gold price is weak despite its previous strengthening. The fundamental factors are getting more supportive for the US dollar, such as an improving current account and budget deficit.

Q: What do you think is the reason behind the recent depreciation of the Chinese yuan and how do you see its trend in the long term?

A: The top two currencies we recommend to our clients are the Chinese yuan and the US dollar, and the yuan is the No. 1 currency.

I think the authorities were concerned about positions built to short dollars, which increased reserves. So they wanted to reduce some uncertainties. I think it's a deliberate policy to do that. The fact that we are having this conversation means the authorities have succeeded.

We've seen similar weakness historically, where the authorities allowed the currency to weaken. It's slightly different this time because it's through the onshore market instead of the offshore market.

I think the authorities are sending a signal that it won't be just appreciation day in and day out. So there will be some volatility around.