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HSBC Global Asset Management retains cautious view on equities

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While equity valuations have fallen to attractive levels for long-term investors, the weak outlook for 2009 and the potential for more bad news, reinforces a cautious view, according to

While equity valuations have fallen to attractive levels for long-term investors, the weak outlook for 2009 and the potential for more bad news, reinforces a cautious view, according to HSBC Global Asset Management.

The firm’s March market update, compiled by Simona Paravani, global investment strategist, says it expects equities to remain volatile until uncertainties clear, and hence it maintains its bias for cash over equities.

For bonds, it favours investment-grade and high-yield corporate debt over US and European government bonds. The corporate debt sector has priced in an excessive level of default risk, which has made valuations attractive. While the earnings environment remains weak, the sector is likely to benefit from government action and low interest rates.

The US market fell 10.3 per cent in February as economic and employment conditions deteriorated further, while the bank rescue plan was criticised for lacking detail. With the broad-based decline in 2009 earnings forecasts, from -2 per cent to -11 per cent, the forward price-to-earnings ratio for the S&P 500 remained at just over 12 times.

As economic growth concerns extend to 2010, and recent news flow and corporate results remain negative, the risks to earnings remain to the downside. Combined with the inherent risks within the economy, HSBC maintains its moderate underweight of US equities versus cash.

The FTSE 100 and DJ Euro Stoxx 50 fell by 7.0 per cent and 11.4 per cent respectively during February, as economic data worsened and concerns over banks deepened.

Over the past several months, the 12-month forward price-to-earnings ratio has increased, suggesting that a greater level of pessimism is being priced in. Economic conditions continue to deteriorate, and investors are concerned that banks could be slow in receiving the assistance they need in order to stabilise. As a result, HSBC favours cash for the short term and expects European equities to perform in line with peers.

Japanese equities fell 4.7 per cent (Topix) in February as exports worsened and consensus GDP forecast of -3.8 per cent is significantly worse than other developed markets. As earnings projections have been revised down sharply, the forward price-to-earnings ratio has increased from 15 times to 20 times. Economic conditions continue to deteriorate, and earnings are further at risk as bankruptcies rise.

In the current environment of low growth, comparably high valuation and limited monetary flexibility by the Bank of Japan, HSBC says it sees limited tactical opportunities in Japan and retains a neutral position on Japan versus equities in other regions

Rising risk aversion caused emerging market equities to fall 2.8 per cent in February, outperforming most developed markets however.

Performance among emerging markets was diverse (e.g Argentina -11.2 per cent vs -0.7 per cent Brazil) due to country-specific issues and credit-rating downgrades.

Fundamentals deteriorated further, particularly in Eastern European countries with more concerns over economic growth and level of debts.

The price multiples of emerging markets are attractive but growth risks have increased with slowdown concerns, credit issues and stagnation of foreign investment. With the price multiple rising more in developed, the earnings yield gap between emerging markets and US has fallen slightly but remains similar to history.

Asia ex Japan equities fell 3.2 per cent in February as the region’s exports continued to decline and growth concerns remained elevated. From a valuation standpoint, markets are trading at relatively low levels versus history (12, 10 and 10 price-to-earnings ratio for Hong Kong, India and China respectively).

In addition, based on consensus GDP growth forecasts, Asia ex Japan would experience higher growth rates than other emerging markets and developed economies. However, weakening exports represent further uncertainty over the region’s future and whether the forecasted level of GDP growth for 2009 will be achievable. As such, HSBC maintains its underweight position relative to cash and expects Asia ex Japan equities to perform in line with peers.

Meanwhile, US Treasuries declined further with the 10-year bond yield increasing by 0.17 per cent, despite deteriorating economic conditions.

With interest rates at close to zero, the Fed may, as an alternative measure to simulate the economy, buy Treasuries as part of a quantitative easing policy. This would reduce yields on Treasuries. But despite the safe-haven status of government securities, the very low level of yields mean that Treasury valuations remain unattractive.

With economic data pointing towards a negative growth outlook, Eurozone bond yields fell across the maturity spectrum. HSBC believes that fear of sovereign defaults on account of problems in the banking sector in Euroland appear overdone.

‘Ongoing economic weakness is already reflected by the market’s expectation of further rate cuts from the ECB, with yields expected to continue to converge towards similar levels to US Treasuries,’ the report states. ‘With yields at such low levels, from a valuation perspective, Eurozone bonds remain unattractive.’

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