“Rediscovering Japan”: Outlook and Opportunities

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Historically, Japan has been a difficult market for many overseas investors to fully comprehend, with several misconceptions about the Japanese corporate sectors.  This offers compelling opportunities for active managers such as Nomura Asset Management to add value through their proprietary research, market insights and company engagement.

Nomura Asset Management will host the “Rediscovering Japan” virtual conference on January the 26th , where you will learn more about the current opportunities from our experts, and hear market insights from the guest speaker Seiji Kihara, Member of the House of Representatives.

Yuichi Murao, CFA, Senior Managing Director and Chief Investment Officer, Equities, will open the event with the Bank of Japan’s monetary policy outlook and the impact on exchange rates.

Andrew McCagg, Senior Client Portfolio Manager, will present the “Japanese Equity Market Outlook for 2023”.

Seiji Kihara, member of the House of Representatives and deputy Chief Cabinet Secretary, will speak on “Towards Realizing a New Form of Capitalism”. Kihara also serves as special advisor to the Prime Minister for National Security Affairs.

Please register here: click here

Pictet Asset Management: After the Storm

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Photo courtesyLuca Paolini, Pictet Asset Management's Chief Strategist

New year, same risks? The global economy continues to face challenges – not least weak growth and tightening monetary conditions – and for this reason we have chosen to retain a defensive stance; we remain underweight equities and overweight bonds.

That said, there are encouraging developments in emerging markets.

China’s unexpectedly rapid exit from its zero-Covid policy is likely to result in a strong acceleration in growth towards the end of this year. This, coupled with a weakening US dollar and emerging market assets’ attractive valuations, should help boost the appeal of emerging market stocks and bonds over the medium term. We have consequently upgraded China and the rest of emerging markets to overweight.

Our business cycle indicators show that the deterioration in global economic conditions is gathering pace. A recession will be unavoidable this year, but it should be both shallow and short before the economy begins to recover in the middle of 2023.

Global inflation is likely to decline this year to 5.2 per cent from 7.7 per cent in 2023, helped by weaker commodity prices and falling wage demands and rental prices.

In the US, the high level of excess household savings should support consumption and help the economy avoid a sharp contraction; we expect the US to register real growth of 0.4 per cent this year.

We also think the risk of a deep recession in the euro zone has somewhat receded. Despite weak economic activity and tighter lending standards, industrial production remains resilient.

Falling energy prices, meanwhile, should lead to a significant decline in price pressures across the region, with core inflation more than halving to 1.6 per cent from a 2022 peak.

Japan’s economy, meanwhile, is likely to outperform the rest of the world next year, supported by improving leading indicators, booming tourism and resilient capital spending.

That said, weak retail sales and consumer morale and a rapid deterioration in the current account balance – which is now negative for the first time since 2014 – point to a weak recovery in the coming months.

China’s recent economic data has been weak across the board, but the recent reopening of its economy suggests plenty of scope for recovery, especially for retail sales, which are currently some 22 per cent below their long-term trend on a real basis.

Beijing is likely to adopt a more pro-growth economic agenda, which should help lift growth in the world’s second largest economy to 5 per cent in 2023 from last year’s 3 per cent, according to our calculations.

Our liquidity indicators support the case for retaining a cautious stance on risky assets over the near term. But conditions will likely improve after the first quarter of 2023, especially in emerging economies.

We expect the global economy to experience a net liquidity drain equivalent to 6 per cent of GDP in 2023 as central banks including the US Federal Reserve and European Central Bank continue to tighten the monetary reins. Investors should however expect a shift in monetary tightening trends.

The Fed is, we believe, entering the final phases of its tightening campaign with the benchmark cost of borrowing set to peak at 4.75-5 per cent in the first quarter of this year. The ECB’s balance sheet contraction, meanwhile, is likely to be more aggressive than the Fed’s, amounting to a reduction of some EUR1.5 trillion, or 11 per cent of GDP, which should add to downward pressure on the dollar.

After a hawkish statement in December, investors now expect euro zone interest rates to rise to 3.25 per cent by September 2023.

The Bank of Japan’s surprise change to its bond yield control policy – it will now allow the 10-year bond yield to move 50 basis points either side of its zero rate target – should pave the way for the central bank’s eventual exit from its zero interest rate policy.

Bucking the global trend, China is leading a moderate easing cycle with the People’s Bank of China delivering targeted support measures.

The credit impulse – a leading economic indicator – is positive while China’s real money supply (M2) is expanding at 12 per cent year on year, the highest in six years. In contrast, developed economies continue to experience tighter conditions.

Our valuation model shows bonds and equities are both trading at fair value.

Valuations for global bonds are neutral for the first time since February, with yields 50 basis points lower than their peak in mid-October.

Global equities, meanwhile, trade at a 12-month price earnings ratio of 15 times, in line with our expectations, but our models point to mid-single digit re-rating of multiples over the next year provided that US inflation-adjusted 10-year bond yields fall to 1 per cent.

Corporate earnings momentum remains weak across the world and we forecast 2023 global EPS growth to be flat, which is below consensus forecasts of around 3 per cent growth, with significant downside risks in earnings in case of weaker than expected economic growth.

Our technical and sentiment indicators remain neutral for equities with seasonal factors no longer supporting the asset class.

Data shows equity funds experienced outflows of USD17 billion in the past four weeks. Emerging market hard currency and corporate bonds posted consecutive weekly inflows for the first time since August.

 

Opinion written by Luca Paolini, Pictet Asset Management’s Chief Strategist

Discover Pictet Asset Management’s macro and asset allocation views

Emerging Market Corporate Bonds Begin to Sparkle

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Photo courtesySabrina Jacobs, Pictet Asset Management's Senior Client Portfolio Manager

Professional investors joke that the UK is turning into an emerging market (EM). This is a disservice to actual EM economies. In fact, in some respects less developed countries are proving a relative haven of stability – not least in the corporate bond market.

Broadly speaking, EM corporate borrowers are less vulnerable to capital flight than in the past due to greater local investor ownership of their bonds, have relatively low leverage and are by and large based in countries with robust macro-economic fundamentals. And at a time of general bond market volatility, yields on short duration EM corporate credit look particularly attractive (see Fig. 1).

Of course there is plenty of variation between regions and sectors, so investors need to be diligent in analysing corporate nitty gritty as well as having good understanding of the macro-economic picture. But such efforts are likely to be well rewarded: in many cases, EM corporate bonds are cheap compared with their fundamentals, such as, for instance, the yield spread they offer relative to leverage.

Fundamental attractions

EM companies have done exceptionally well so far in 2022, with revenues up 22 per cent and earnings up 27 per cent during the second quarter on the same period a year earlier. At the same time, their balance sheets are looking healthy, with net debt down 7 per cent year-on-year in the second quarter. This has helped reduce the net leverage ratio to some 1.2 times from 1.3 times in 2021 (excluding Russia and Ukraine for obvious reasons and real estate), according to JP Morgan research.

Many EM companies have built up their profit margins in the wake of the pandemic. This, in turn, leaves them better able to absorb among other things, higher costs from commodity price inflation. Take steel companies in India. The sector has been one of the hardest hit from rising input costs and more recently export taxes. Yet, due to their post-pandemic profit surge, domestic operators have been able to absorb a reduction of 6 percentage points in profit margins to a 12–month average of 21 per cent in Q1 versus a peak of 27 per cent last year.

For credit investors, this still represents a good margin of safety. Furthermore, while these rising input costs might prompt a tick up in leverage, large Indian steel makers have also been on a deleveraging trend for the past few years. Similarly, most other commodity exporters have been doing well.

Meanwhile, many retail-focused companies and those with premium products are in a strong position to maintain pricing power and thus keep up with inflation. In China, large and highly rated tech companies have maintained strong margins as their ultimate customers are to a good extent retail, as well as to the fact that inflation has been running at a considerably lower rate in China than elsewhere. Signals from central government that its regulatory clampdown has come to an end has also helped. At the same time,  US restrictions on Chinese tech is having limited impact, restricted to chipmakers.

At the other end of the spectrum there are industries in which rapidly rising costs cannot immediately be passed on to customers and where there is no natural hedge against foreign exchange volatility, such as telecoms. We generally like the sector for its defensive characteristics and predictability of cash flow. But where companies have issued longer tenured contracts for instance for broadband, this means no opportunity to raise pricing for existing customers in the near-term.

What’s more, the more generic the product, the harder it is for companies to pass on costs. And some sectors have been heavily exposed to the energy shock – those utility companies not fortunate enough to be extracting oil or natural gas are feeling the pinch. This is especially the case for utility companies selling to retail customers, not least where governments have been keen to stem inflationary pressures by limiting how much costs are passed through to households.

Prudent financial policies and balance sheet deleveraging in the past five to 10 years have helped most EM corporations across Europe, Africa and the Middle East to prepare themselves for current financial market disruptions.

The wider good health of the EM corporate universe is reflected in its default rates. Strip out Russia, the Ukraine and Chinese real estate and the default rate is a mere 1.2 per cent year-to-date.

Sticking closer to home

EM corporations are also benefiting from increasingly mature domestic financial markets. Being less reliant on foreign sources of capital means that investment programmes are less prone to the whims of global finance and therefore can be more stable than in the past – domestic sources of finance also tend to be stickier. As these countries have grown richer, their banking sectors have become better able to service increasingly sophisticated domestic savers. Furthermore, domestic banking sector balance sheets have been built up in the wake of the Covid pandemic and thus enabled banks to extend credit actively again.

As such, companies in Indonesia, the Philippines and India in particular have increasingly been buying back their outstanding dollar denominated debt and refinanced through cheaper bank loans priced in local currency. That shift is being accelerated by the US dollar’s appreciation and rising US interest rates – increasing the cost of dollar funding – and the cost of these liabilities has helped push companies toward domestic lenders. So, for instance, Indian banks, supported by strong and improving credit quality, have been happy to extend credit and as a result their loan books have grown at a rate of some 12-15 per cent through the first half of 2022 (see Fig. 2).

And with many EM central banks either well ahead of developed market peers in tightening monetary policy or not needing to act as forcefully in combating inflation, funding rates there are likely to grow less significantly than they are for dollar borrowers – though determining the balance of effects here needs good macro analysis on the part of investors.

A good place to start

Seasoned investors know that entry points matter. As with other asset classes, EM debt has been battered during the past year. Overall, there was USD62 billion in cumulative outflows by September, though there were signs that this was stabilising, with around a quarter of that likely to have been in credit products.

Spreads over US Treasury bonds are generous – at 400 basis points against a ten-year average of 315 basis points. And given that Treasury bond yields are themselves at highs not seen in a decade, actual EM corporate yields are at levels not seen in years – 8.3 per cent, last seen in August 2009.1

With lower demand and market volatility, gross supply of EM corporate debt has slumped to USD196 billion so far in 2022 (as per end Sept), against around USD450 billion during the same period in 2021 (see Fig. 3). However, EM companies are relatively well insulated against current fixed income market gyrations. Many firms took advantage of historically low rates during recent years to extend the maturity of their debt, so there’s little in terms of a near-term financing wall, especially in high yield EM, where only USD85 billion comes due in 2023, USD95 billion in 2024 and USD100 billion in the following year.

Times of market stress create opportunities for investors who can pick out the diamonds from the shattered glass. There are plenty of these in the EM corporate universe, where investors are increasingly well compensated for taking on risk with yields that haven’t been seen in many years generated by high quality, well-run companies.

 

 

Opinion written by Sabrina Jacobs, Pictet Asset Management’s Senior Client Portfolio Manager

 

Discover more about Pictet Asset Management’s Emerging Markets capabilities 

 

Note

[1] All for JP Morgan CEMBI Broad Diversified as per 14th October 2022; average rating of BBB-.

Pictet Asset Management: The Investment Landscape in 2023

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Luca Paolini, Pictet Asset Management's Chief Strategist, and Arun Sai, Pictet Asset Management's Senior Multi Asset Strategist

2023 will be a year when the investment environment slowly gets back to normality. Inflation will come down – even if not quite as fast as the market seems to expect. Economies will struggle for growth, but manage to stave off a deep downturn.

Equities are set to tread water, but fundamentals will suit high quality bonds. Meanwhile, emerging market assets, particularly local currency debt, are set to shine amid a weakening dollar and a revival in the Chinese economy.

The global slowdown – a number of indicators suggest various leading economies might already be in recession – has been the most anticipated one in living memory. Central banks have responded to this year’s surge in inflation by putting on the brakes, and that’s filtering through to their economies. As a result, global annualised quarterly real GDP growth is set to run at below potential through to at least the final three months of 2023 (see Fig. 1).

But at the same time, the slowdown is likely to be less painful than past recessions. Corporate and household balance sheets are healthy, both still have excess savings built up during the Covid crisis, particularly in the US. This has allowed them to absorb some of the impact of inflation, while at the same time banks have continued to lend. Nominal growth, which is key to economies’ resilience, has been running at some 10 per cent, largely on the back of very high inflation. So, unlike during the global financial crisis of 2008, this time there is no sign of a looming debt crisis in any of these economic segments.

An inflationary hurdle

Inflation will remain a hurdle, but it won’t be the market’s primary driver during the coming year (see Fig. 2). While there are signs it has already peaked in most major economies, we think investors are too optimistic about how fast inflation is likely to fall. The jobs market especially in the US remains strong, supporting wages. And components such as rents, which are a sizeable proportion of the consumption basket, are slow moving, taking longer to normalise.

We also believe central banks will be cautious about entering into a new easing cycle – certainly, they won’t make the switch anywhere near as quickly as the market expects. In part that’s because central bankers are particularly sensitive to the risks of cutting rates before inflation has been fully suppressed. To do so would risk another, even less controllable surge in inflation, which would shatter their credibility and force even more drastic efforts to get back to price stability. We don’t think they will start to ease policy until 2024.

Direction of travel is key

What matters most for markets, however, is that official rates will have stopped rising. The end of monetary tightening will be greeted with relief, giving a lift to high quality debt – both sovereign bonds and investment grade credit. Shorter maturity debt is likely to benefit first, with bonds further along the yield curve showing more modest gains amid expectations of an economic revival. Investors should be more cautious about higher yielding debt, with the economic downturn is set to push up default rates.

And once rates peak, equities should start to benefit from improving valuation multiples offsetting weaker earnings – though that’s more a story for the second half of the year.

With the US further along its tightening cycle than other major central banks, a peak in US rates is likely to put downward pressure on the dollar. The greenback is already considerably overvalued and its long-term fundamentals are poor – a currency’s long-term value is determined by fiscal discipline and productivity growth and the US scores badly on both counts.

A weakening dollar will be beneficial to emerging market assets, particularly emerging market local currency debt, which we see as a bright spot on the investment landscape, not just during the coming year but for some time to come. Further support for emerging market bonds and stocks is set to come from China’s economic revival. We think that the government will have to respond to recent protest against its draconian zero-Covid policy by relaxing restrictions. At the same time, it has been offering some support to the country’s vital but beleaguered real estate sector. Together, we think these effects will underpin growth of some 5 per cent over the coming year. Healthier Chinese growth will also benefit other emerging Asian economies.

In a nutshell, 2023 will be a year of caution for investors. But after a miserable 2022, when virtually all asset classes suffered drawdowns (with the notable exception of energy), there will also be reasons for cautious optimism.

 

 

Opinion written by Luca Paolini, Pictet Asset Management’s Chief Strategist, and Arun Sai, Pictet Asset Management’s Senior Multi Asset Strategist

 

Discover Pictet Asset Management’s full Annual Outlook for 2023

Get Anti-money Laundering Training With FIBA’s CPAML and AMLCA Certifications: What Are They and How Can They Help You?

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The Florida International Bankers Association (FIBA) is a non-profit professional association founded in 1979. The main focus of FIBA members is international finance, international correspondent banking and wealth management or private banking services for non-residents.

FIBA has long been recognised by regulators for its knowledge and expertise in Anti Money Laundering (AML) compliance and its excellent courses. FIBA has been providing anti-money laundering training for more than two decades, including its Annual Conference and FIBA AMLCA and CPAML certifications in partnership with Florida International University (FIU). FIBA will soon be organising two new courses for which you can register with a $200 discount code provided by Funds Society (FS200).

CPAML Certification (25/26th October)

The CPAML is an advanced level certification designed to expand the knowledge of professionals, officers, directors, or managers of any organization, with respect to the prevention of money laundering and financing of terrorism (AML / CFT).

The program is developed with a risk-based approach to identify potential risks, design an effective control system, investigate suspicious cases, and how to use these processes to best evaluate the effectiveness of internal controls.

The online course is an interactive option design for participants interested in completing the certification at their own pace. Through open discussions and activities, participants will have the opportunity to actively engage with the instructor and classmates to discuss the assigned materials.

October 25-26: Students will attend the CPAML course via Zoom videoconference

October 28: Students will work on their assignments and submit their workbooks before 5:00 PM EST

November 24: Final exam deadline – must be completed via Canvas before 11:59 PM EST

Participants who pass the final exam with an 81% or higher will earn the CPAML certificate. This certificate is valid for 2 years with 20 AML Continuing Education credits.

The registration fees are $1595 USD for non-members; $1395 USD for FIBA members; and $1195  USD for Government. Funds Society readers can access an exclusive discount with the code FS200.

AMLCA Certification (From 17th November)

The internationally recognized AMLCA Certification (Anti-Money Laundering Certified Associate) is designed for intermediate-level compliance officers in both financial and non-financial sectors. The in-depth curriculum is based on best practices and international standards regarding the origin, practices, and development of regulations in money laundering, terrorism financing, and the proliferation of weapons of mass destruction.

The next edition will start in 17th November. The online course is an interactive option design for participants interested in completing the certification at their own pace. Through open forums and discussions, participants will have the opportunity to actively engaged with the instructor and classmates to discuss the assigned materials. Participants will have 90 days to complete the reading materials, PowerPoint narratives, 23 practice quizzes and the final certification exam.

The final certification exam consist of 100 multiple choice questions that must be completed within 1 hour and 45 minutes. Participants must pass the exam with a 75% or higher mark to receive the prestigious FIBA AMLCA Certification.

The registration fees are $1395 USD for non-members; $1195 USD for FIBA members; and $995  USD for Government. Funds Society readers can access an exclusive discount with the code FS200.

UK Budget Proposal: Beans on Toast or Sunday Roast?

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Given all the noise in the UK and now in other quarters including the halls of the IMF, here is a summary of what Chancellor of the Exchequer Kwasi Kwarteng has announced that has upset the market along with commentary.

  • Quicker cut to the basic income tax rate. It was scheduled to go down 1% (from 20% to 19%) in 2024. The new plan moves this date up to April 2023.
  • The bigger headline was the change to the 45% tax rate for people earning over £150K/year, since rescinded as a “distraction” putting the max rate down to the 40% tax rate for people earning over £50K/year. Combined, these would have been the biggest tax cuts in 50 years. Unsurprisingly, these rate cuts were not popular with the public.
  • National Insurance tax was set to rise 1.25% in November. That is now being done away with. The goal of the planned increase was to fund health and social care. The plan is now to fund that through general taxation – a funding program that is questionable given the accompanying tax cuts. As with many of the measures, the insurance tax cut is heavily skewed to benefit higher earners while taking away social benefits.
  • Stamp duty: Doubled the property value exemption from £125K up to £250K with the exemption for new home buyers increasing from £300K up to £425K. This will be heavily skewed to benefiting well-off home buyers in areas such as London.
  • The cap on bonuses for bankers has been taken away. While this is intended to make the UK more attractive for talent in finance, it seems almost provocative to put in at this point. Banks hadn’t even been pushing for it.
  • The Corporate Tax Rate was scheduled to rise from 19% to 25%. It will now remain at 19%.

 

There are several issues of concern with the new budget proposal.

First off, given the massive pressure on households from inflation, tax cuts for high earners are unlikely to be popular.

The government is pushing hard against welfare benefits. There has been a lot of pressure to raise benefits to keep up with inflation. Instead, the government is developing a plan to cut benefits for those who are not taking more steps to find work or better-paying jobs.

The energy assistance that the new government was giving under Truss incentivized the continued use of energy and did nothing to fix the underlying problem of fossil-energy dependence. While seemingly short-sighted, it may have sprung from a desire to win favor with voters while passing off the cost to someone else in the future.

If that measure was intended to win popularity with voters, this new round of plans around taxes seems almost intended to do the exact opposite. Some commentators have suggested the Truss government is channeling Thatchernomics. Boris Johnson’s government was technically ‘conservative’, but it was a very populist version that did not really overlap much with ‘traditional conservative’ stances at all. While the initial energy policy was at least in line with the voter base, Kwarteng’s new plan seems much more in line with Reagan/Thatcher trickle-down economic policies and tone-deaf for populist voters.

Liz Truss didn’t come in with a strong mandate for change. She replaced a highly unpopular Johnson from an increasingly unpopular Tory party. If there were a mandate for change, it was about a return to responsible governance which these measures are not. Further, the budget plan offers austerity measures mostly for the poor and is, in fact, likely to be massively inflationary.

The budget proposal increases the odds of a Labor government next time around. That already looked likely, but if nothing changes from here, positioning for a Labor government would be a smart move. The next election is not scheduled until January 2025 and a lot could change by then, but it can be brought forward under unusual circumstances.  While this would be technically the PM’s call, this budget could lead to extreme pressure from her own party and a near-term election might not be totally out of the realm of possibility.

Pass the Gravy

Obviously, the outcome of these budget measures is intended to be positive, even though the markets don’t subscribe. The investable angle would be if these measures turn out to be smarter than they look à la Thatcher and the government was able to use the tax cuts to grow the economy faster than debt is increasing.

One area of interest is the change to stamp duty for the housing market. The change is intended to encourage home purchases as lower taxes make them more affordable. However, in the near term, the expected increases in rates to offset these measures and protect the pound are presumably going to more than cancel out that benefit. Homebuilders are understandably down on the news and expectations, but perhaps there’s a case for the long-term investment thesis there. If homebuilder share prices drop enough, there could be an argument that over the long-term, rates will recover while the stamp duty could remain in place making home ownership more affordable.