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Investment
Quarterly
Q2 2014
Outlook for 2014
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Overview
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Despite a few surprises, 2014 is unfolding much as envisaged
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Emerging market sell-off: the importance of managing risks to optimise returns
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China’s credit boom and deleveraging
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Ask the expert: asset allocation
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Fixed income update: outlook for developed market credit
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Navigating markets
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Global data watch
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Contents
Overview4
Despite a few surprises, 2014 is unfolding much
as envisaged
6
Emerging market sell-off: the importance of
managing risks to optimise returns
10
China’s credit boom and deleveraging
14
Ask the expert: asset allocation
22
Fixed income update: outlook for developed
market credit
26
Navigating markets 28
Global data watch
30
Contributors38
IQ is part of a suite of investment communications produced by the Macro
and Investment Strategy Unit of HSBC Global Asset Management. The
views expressed herein are as of the end of March 2014 and subject to
change as the macroeconomic environment evolves.
HSBC Q2 2014 3
Overview
Despite a few surprises, 2014 is unfolding much
as envisaged
When we set out our outlook for 2014 we were, broadly
speaking, positive on risk assets which still look attractive on
a relative basis to perceived “safe haven” assets, especially
given the expected pickup in global growth during 2014. Our
long-term investment views have not changed significantly
in light of the events of Q1. We argued that the pickup in
global growth this year would be led by the developed world
and, while it would be more varied in Emerging Markets
(EM), growth would stabilise in many regions.
We still favour risk assets, such as Developed Markets
(DM) and EM equities, corporate credit and EM hard and
local currency debt, against “safe haven” government
bonds, while recognising the need to be selective –
especially for EM assets. We expect EM markets to
continue to be volatile, but see potentially attractive prices
for long-term investors.
Emerging market asset sell-off: the importance of
managing risks to optimise returns
EM assets sold-off over the past 12 months. This was
initially due to a systemic shock when the US Federal
Reserve (Fed) signalled its intention to wind down its bond
buying programme and, thereafter, on the back of countryspecific issues, like the sharp currency depreciation in
Argentina or the annexation of Crimea by Russia. External
imbalances were the root cause of the sell-offs, as most EM
current accounts gradually fell into deficit over the past few
years, increasingly financed by short term, volatile foreign
capital. The sell-offs can be seen as a reassessment of
risks after a period of relative complacency, a negative side
effect of extremely loose monetary policies. However, not
all emerging markets are alike, and identifying those with the
greatest strengths, like a strong industrial base or positive
demographic trends, for example, will be key to benefiting
from the still remarkable growth potential of EM countries.
China’s credit boom and deleveraging
There has been growing concern about China’s shadow
banking system and corporate default risks. The investment
boom since 2009 has given rise to over-capacity in
several sectors, excess supply in the property market in
some cities, and a surge in corporate leverage and local
government debt. Low deposit rates and the absence of an
appropriate risk-pricing mechanism in the financial industry,
coupled with lending practices that favoured state-owned
enterprises over private companies, have worsened the
debt problems. The credit boom and high leverage will
inevitably lead to financial losses and corporate defaults, as
interest rates rise and economic growth slows. However,
managing financial risks will be a major challenge for
4
Chinese policymakers in a delicate balancing act between
growth and reform, which will also result in increased
financial markets volatility. We think the government should
be able to contain the contagion risk from selective defaults
to a manageable level, and prevent a credit crunch or a
significant economic slowdown.
Ask the expert: asset allocation
Asset allocation is the key driver of investment returns over
the medium term, but many investors have not realised
their return objectives over the past decade. We argue
that the main causes of this have been poorly calibrated
asset return expectations and a tendency to let asset
allocations be static and go stale over time. We adopt a
dynamic approach to asset allocation, renewing the asset
mix as important information changes. Asset returns can
be quite volatile over time, but we argue that returns are
more predictable over the medium term using valuation
indicators. Using this framework, our asset allocation
process tilts portfolio weights toward “cheap” assets,
even when they may be unpopular with other investors,
and seeks to avoid the bubbles that can occur when the
valuation arithmetic is stretched to its maximum.
Fixed income update: outlook for developed market
credit
We review the good performance of global high yield over
the past six months and consider whether the asset class
can continue to provide attractive returns for investors.
Growth of the global economy should support corporate
sales growth and maintain healthy cash flow generation.
Recent corporate results in the US and Europe confirm
these trends. In addition, the credit ratings of US and
European high yield companies have also been stable.
While the yield spreads on high yield corporates have fallen
over the past six months, we believe there is some limited
room for further yield compression over the next year or
two, especially for lower rated credits.
In summary, we believe the environment remains positive
for lower rated credit with good fundamentals and attractive
valuations. We expect lower rated credit to outperform
higher rated corporates and government bonds.
Navigating markets
In the first quarter of the year, equity markets led by EMs
sold-off but other risk assets, such as EM debt and global
high yield bonds, posted positive returns. In contrast to last
year when bonds performed poorly, we have seen both
core government bonds as well as riskier fixed income
assets, such as EM debt and peripheral sovereign eurozone
bonds, perform well in Q1. Peripheral European bonds
have generally benefited from the European Central Bank’s
(ECB’s) low interest rates and improved outlooks for their
creditworthiness.
particularly vital in gauging the outlook for US monetary
policy.
In the first quarter, economic data was weak in the US, but
improved towards the end of the quarter. We would argue
that the weakness in US data was the result of severe
weather, rather than a sign of underlying weakness. In the
eurozone, macro data has been modestly stronger with
industrial production data in key economies picking up
and unemployment in both core and peripheral eurozone
economies falling.
Secondly, on-going EM volatility is also likely to dominate
markets in the near term, as investors reprice risk and
weigh the impact of quantitative easing tapering on various
EM asset markets. Elections in some key emerging
economies, along with geopolitical tensions between
Russia, Ukraine and the West are likely to induce further
volatility into financial markets. However, from a long-term
perspective we continue to believe valuations will be a key
driver of expected returns, and these still look attractive for
riskier assets relative to perceived “safe havens”.
For the rest of the year, we believe risk asset performance
is likely to be driven by two key factors. Firstly, global macro
data will continue to be important with US data being
HSBC Q2 2014 5
Despite a few surprises, 2014 is
unfolding much as envisaged
Julien Seetharamdoo, Chief Investment Strategist
At the end of last year, we set out our outlook for 2014
which was broadly positive on risk assets, as they still
looked attractive on a relative basis to perceived “safe
haven” assets, especially given the expected pickup in
global growth during 2014.
We argued that the pickup in global growth this year would
be led by the developed world. In particular, by the US
and eurozone as “tail risks” in these countries gradually
diminished further and the fiscal drag, ie further increases in
taxes and cuts in government spending, in these countries
faded compared to 2013. As a result of increasing signs
of a self-sustaining recovery, we expected the US Federal
Reserve (Fed) to continue tapering its quantitative easing
(QE) asset purchase programme.
Indeed, the Fed has continued tapering asset purchases
this year, despite some soft data in the first few months
of the year, that was probably a reflection of very severe
winter weather and problems with the seasonal adjustment
process, rather than something more fundamental. Overall,
we still expect growth in the US in 2014 to be stronger than
in 2013, and possibly to be even stronger than the consensus
forecasts, which currently expects 2.8% growth in 2014.
Figure 1: Eurozone government bond spreads continue to
narrow as “tail risks” diminish further
%
18
16
14
12
10
8
6
4
2
0
The eurozone economy also gradually continues to recover,
though with inflation remaining low, and in fact falling
further, mainly due to the large amount of excess capacity
in the economy. As we highlighted previously, the European
Central Bank (ECB) may eventually have to respond by
relaxing monetary policy, eg by cutting interest rates
again or by taking the bold step of announcing an asset
purchases programme of its own. Such a policy response
would arguably be positive for risk assets. Indeed, investors
continue to price out so called “tail risks” in the eurozone,
with the spread between periphery and core eurozone
government bond yields falling further in recent months.
In the emerging world, we expected growth to stabilise in
many regions, but to remain weaker than in recent years. We
also highlighted the importance of elections and the need for
further reform in order to boost potential growth in emerging
markets in the medium to long term.
In addition, we highlighted that Chinese growth could be
bumpy as policymakers attempted to reduce the economy’s
reliance on credit as a source of growth. We thought that
policymakers would ultimately be successful in stabilising
growth at a lower rate and ensuring orderly deleveraging
given the benign inflation backdrop and the scope that exists
to ease monetary and fiscal policy should it prove necessary.
More or less, these themes have played out so far this year.
Emerging Markets (EM) have generally been more volatile
than Developed Markets (DM) with Russia annexing Crimea,
concerns about Chinese growth and local specific issues
affecting EM markets.
01
02
Spain
03
04
05
06
Portugal
07
08
Italy
09
10
France
11
12
13
Ireland
However, at the same time, economic data, eg the
Purchasing Manager Index (PMI) has generally been
encouraging in DM, and has at least stabilised in many EMs
(except China where data have continued to weaken since
the turn of the year).
Source: HSBC Global Asset Management, as of March 2014.
Figure 2: Eurozone growth picking up but inflation falling due
to substantial spare capacity
% yoy
6
In time, higher policy rates should help these economies
rebalance and reduce their sizeable current account deficits
(for more on this see the article “Emerging market sell-off:
the importance of managing risks to optimise returns” by
Hervé Lievore).
4
2
0
-2
-4
-6
-8
95
97
99
01
03
Eurozone inflation
05
07
09
Eurozone GDP
Source: HSBC Global Asset Management, as of March 2014.
6
Encouragingly, policymakers in a number of EM countries
have responded flexibly to asset price volatility and falling
currencies by raising interest rates.
11
13
Upcoming elections in many EM countries could add to
volatility and uncertainty through the course of this year, but
also hold out the possibility that governments with fresh
mandates will re-engage with the reform process.
Figure 3: Purchasing Managers’ Index (PMI) surveys of business activity generally above 50 and often improving (except in China)
Headline PMI
New Orders
Employment
Nov 13
Dec 13
Jan 14
Feb 14
Nov 12
Dec 12
Jan 13
Feb 13
Nov 12
Dec 12
Jan 13
Feb 13
53.6
53.0
53.0
53.3
54.8
54.4
54.4
54.6
50.8
51.3
51.0
51.3
US
57.3
56.5
51.3
53.2
63.4
64.4
51.2
54.5
55.4
55.8
52.3
52.3
UK
58.4
57.2
56.7
56.9
64.6
60.4
61.7
60.7
54.5
54.3
54.1
55.4
Global
Germany
52.7
54.3
56.5
54.8
54.5
56.6
59.7
57.1
48.0
50.8
51.7
50.0
France
48.4
47.0
49.3
49.7
46.8
45.6
48.7
49.2
48.6
46.8
49.4
48.5
Eurozone
51.6
52.7
54.0
53.2
52.3
54.1
55.7
54.5
48.8
49.9
51.0
50.6
Japan
55.1
55.2
56.6
55.5
58.4
57.2
59.2
56.2
50.9
52.8
52.7
53.7
Australia
47.7
47.6
46.7
48.6
48.8
47.8
48.8
50.0
50.1
47.0
48.3
47.4
Brazil
49.7
50.5
50.8
50.4
49.3
50.7
52.4
50.9
49.2
49.7
49.5
50.2
China (HSBC)
50.8
50.5
49.5
48.5
51.7
51.6
50.1
48.6
48.9
48.7
47.3
47.2
India
51.3
50.7
51.4
52.5
51.9
51.3
52.4
54.9
50.5
50.8
51.0
50.2
South Africa
52.4
49.9
49.9
51.7
51.6
51.8
50.2
53.4
50.8
45.8
50.7
48.2
South Korea
50.4
50.8
50.9
48.8
50.1
50.7
51.3
49.9
51.5
50.8
51.2
50.6
Russia
49.4
48.8
48.8
48.5
50.6
49.8
49.6
48.6
Taiwan
53.4
55.2
55.5
54.7
55.2
58.2
58.1
57.8
Turkey
55.0
53.5
52.7
53.4
57.1
54.7
53.9
55.1
Mexico (HSBC)
51.9
52.6
54.0
52.0
53.4
54.3
56.6
> 50 + rising
> 50 + falling or
> 50 + unchanged
< 50 + rising or
< 50 + unchanged
45.8
47.3
52.3
51.6
51.5
50.9
53.7
53.2
53.1
53.3
50.8
50.5
50.2
< 50 + falling
Data unavailable
at time of release
Numbers greater than 50 imply growth is accelerating, those below 50 imply growth is slowing.
Source: Markit data for PMIs, as of March 2014. US data refers to the Institute of Supply Management’s (ISM) manufacturing index.
Investment views
The bottom line is that our long-term investment views
have not changed significantly in light of the events of Q1.
We still broadly favour riskier assets, such as DM and EM
equities, corporate credit and EM hard and local currency
debt, against perceived “safe haven” government bonds
while recognising the need to be selective, especially
for EM assets. We expect EM markets to continue to be
volatile, but see attractive prices for medium- to long-term
investors. For more on this see the article by Joe Little:
“Ask the expert: asset allocation”.
Risks to our scenario and views
In terms of risks to this scenario, China’s credit bubble
and various ongoing geopolitical tensions are probably
the two main ones. As in 2012 and 2013 the first quarter
of the year so far has seen soft Chinese economic data,
with lower industrial production growth and weaker
Chinese business confidence. Broadly speaking we think
Chinese policymakers will be able to manage a relatively
orderly deleveraging/soft landing for the economy (see
the article by Renee Chen: “China’s credit boom and
deleveraging”), but there are considerable risks, as well
as the chance of a policy mistake. The rest of the year
will probably see more negative headlines, such as more
defaults of trust companies. At the 12th annual National
People’s Congress, Chinese Premier Li Keqiang outlined
the government’s official plans and targets for 2014. Most
importantly, the growth target for 2014 was maintained at
7.5%, the same as 2013’s. Some form of stimulus, fiscal
or monetary, might be needed given the weak start to
reach the growth target and an economic package along
these lines has recently been announced.
The combination of low inflation and ample foreign
exchange reserves suggest the government has the ability
to restimulate the economy if growth slows too sharply.
However, rebalancing the economy and making it less
dependent on credit growth will be a bumpy process and
HSBC Q2 2014 7

2014 has seen the first corporate and trust defaults in a
number of years on the Chinese mainland.
Geopolitical tensions, such as the situation in the
Ukraine, are also a risk, especially if it deteriorates further.
Tensions seem to have diminished somewhat at the time
of writing (the end of March), but the situation needs
careful monitoring. The US and EU have agreed to impose
sanctions in the form of travel bans and asset freezes on
key Russian officials. These are modest but the message
is that they will be increased, should the situation
deteriorate. The situation remains fluid, but it is in no-one’s
interests for it to deteriorate further. If it did deteriorate
then the outcome would be damaging for both Russia
and the West with the former at risk of losing foreign
8
investment and trade, while Europe is primarily exposed
through its dependence on Russian energy supplies. In
the event of trade sanctions that extend to trade in energy,
Europe could face a significant shortage in the supply of oil
and natural gas.
Political calendar
Date
Country
Event
April-July 2014
South Africa
General elections
22 May 2014
European Union
European Parliamentary elections
14 May 2014
India
Parliamentary elections
06 April 2014
Hungary
Parliamentary elections
09 July 2014
Indonesia
Presidential election
10 August 2014
Turkey
Presidential election
05 October 2014
Brazil
General elections
26 October 2014
Uruguay
General elections
04 November 2014
United States
Mid-term Senate and House of Representatives elections
Source: HSBC Global Asset Management, as of March 2014.
HSBC Q2 2014 9
Emerging market sell-off: the importance
of managing risks to optimise returns
Hervé Lievore, Senior Macro and Investment Strategist
Investors feared a liquidity squeeze would impact
emerging markets (EM)
EM asset performance disappointed in 2013 and the
first quarter of 2014 have seen a continuation of
underperformance by EM equities. Last year, EM equities
lost 2.3% in USD in total return terms, while DM equities
gained 27.4% in total returns. Consequently, advanced
market stocks outperformed by about 30 percentage points,
a level unseen since the EM crisis of 1997-98. EM bonds
also posted negative returns in 2013 (-4.6%, in USD, total
return) while US High Yield gained 8%. However, volatility
was most visible in the foreign exchange (FX) market,
with many EM currencies depreciating by between 5%
and 20% against the USD over the year.1 After a relative
rebound late in the second half of 2013, EM assets generally
continued to underperform early in 2014, with the notable
exception of bonds. During this period, the US Federal
Reserve (Fed) effectively started to reduce its liquidity
injections but Treasuries rallied as the flow of US economic
data disappointed.
The EM asset sell-off of 2013 was triggered by investors’
growing concern about the majority of EM countries’ reliance
on foreign capital. Since 2008, EM countries have seen a
significant deterioration in their combined current account
balance. As a group, and excluding the specific case of
China, their combined current account has been in deficit
since 2010, after 11 years of surpluses. By construction, this
deficit needs to be financed, which can be done essentially
through three channels: foreign direct investments (FDI),
international lending and portfolio investments.
Between 2010 and 2012, the combined EM current account
deficit was entirely covered by FDI net inflows, considering
a sample of 18 EM countries that also excludes China.
The situation deteriorated at the very end of 2012 and, on
1 The indices used are: for equities, the MSCI Emerging Market and the MSCI
World (total returns in USD) and, for bonds, the Barclays EM USD aggregate
and the Barclays US Corporate High Yield.
Figure 1: EM aggregate current account deficit and portfolio
investments
average, FDI flows were insufficient to cover current account
deficits in 2013. At the same time, international lending was
constrained by the derisking of European balance sheets.
Bank for International Settlements (BIS) data shows that
banks’ aggregate foreign claims outstanding have been
plateauing at about USD25 trillion since 2009, with no
net increase. EM markets had no alternative but to rely
on portfolio investment inflows that can be unstable and
sensitive to market sentiment in order to fund their growing
current account deficits.
This reliance on portfolio investments became an even
more worrisome issue after Fed Chairman Ben Bernanke
signalled in May 2013 the willingness of the US central bank
to gradually unwind its large-scale bond buying programme.
Even though the Fed will not withdraw liquidity from the
market quantitative easing (QE) tapering means it will just
stop adding fresh money and will maintain Fed fund rates at
levels close to zero for a considerable time after QE ends.
In other words, monetary policy will remain extremely
accommodative, markets feared a de facto tightening of
financing conditions through higher Treasury yields. This
shift in US monetary policy stance had both a material and a
wide impact on risk assets, especially EM.
The core problem for EM was external imbalances
EM dependency on unstable external capital flows is a
problem that exists because, in most countries, current
account balances have gradually fallen into deficit. There are
two key reasons why this deterioration happened. The first
one is related to weak global demand. Western countries
in general, and the eurozone in particular, had to address
substantial external deficits after the credit bubble burst. By
construction, a current account imbalance reveals an excess
level of investment relative to domestic savings. To say it
in a different way, it is a sign of excess domestic demand,
particularly consumption. Restructuring and austerity
measures implemented in advanced economies after the
Figure 2: Foreign claims of banks reporting to the BIS
USD bn, 5-month moving average
80
USD tn
32
60
29
40
26
20
23
0
0
-20
-40
17
2006
2007
2008
2009
2010
2011
2012
2013
Current account plus FDI
Portfolio investments
Source: Datasteam, as of March 2014.
10
14
2005
2007
2009
Source: Datasteam, as of March 2014.
2011
2013
financial crisis took their toll on demand for exports from EM
markets. At the same time, EM domestic demand remained
Figure 3: EM current account balance and real effective
exchange rate (REER)
REER
84
% GDP
4
89
94
99
2
0
104
1994
1998
2002
2006
2010
2014
Median EM REER (lhs)
EM ex-China current account balance (rhs) % of GDP
-2
more resilient and, as a result, trade deficits tended to become
the norm in the EM group, a reversal of previous trends.
The second reason for higher EM current account deficits is
a loss of price competitiveness over the past decade. This
appears when currency appreciation outpaces productivity
gains in a given economy, for example, after massive capital
inflows. Trade-weighted exchange rates, net of inflation,
or real effective exchange rates (REER) are convenient
proxies for external price competitiveness. Between 2004
and 2012, EM REER tended to rise as nominal exchange
rates appreciated against the USD and as the average rate
of inflation in EM nations tended to converge towards US
inflation. As EM currencies appreciated over time, EM
export competitiveness gradually eroded. Combined with
softer exports to advanced economies, this decline in price
competitiveness played a key role in weakening EM exports.
Source:Bloomberg, as of March 2014.
HSBC Q2 2014 11

Policy response
However, many EM countries, under intense market
pressure, have taken bold steps over the past few months to
stabilise market sentiment and anchor inflation expectations.
For instance, the Central Bank of Turkey raised its overnight
lending rate from 7.75% to 12%,the Russian Central Bank
also decided to hike its benchmark rate by 150bp at the
beginning of March, from 5.5% to 7.0% and the Central Bank
of Brazil continued to tighten its policy, pushing the SELIC
rate to 10.75%, 500bp higher than headline inflation and up
from 7.25% in January 2013.
Rebalancing their economies should be a priority for EM
policy makers and this goal should be achievable, through
reduced domestic demand and/or weaker exchange rates.
In India, for example, the Reserve Bank of India (RBI) raised
its policy rates by 75bp between September and January,
contributing to depress domestic demand, while the rupee
depreciated by about 13%. While painful in the short term,
these measures allowed the country to reduce its current
account deficit significantly from USD21 billion in Q2 2013
to USD5 billion in Q3 and USD4 billion in Q4 (non-seasonally
adjusted). Restrictions on gold imports were also imposed
as part of this process. India is a good example of the way
in which adequate policies can address external imbalances
and explains why investors should not disregard EM assets
altogether, but rather be selective.
EM asset prices now reflect a more realistic economic
scenario and embed a higher risk premium
To a large extent, the low yield environment that has
prevailed over the past five years was the consequence of
the historically loose monetary policy adopted by the Fed
after the financial crisis. Initially, the Fed pushed money
market rates close to zero and, subsequently, extended
the flattening to the long end of the yield curve through
large-scale bond buying programmes. In doing so, the Fed’s
primary goal was to ensure abundant and cheap financial
resources to support the US economy. But it came at the
Figure 4: Gap between US and EM equity implied volatility
Percentage points (pp)
17
12
7
2
Jan-12
Jul-12
Jan-13
Source: Bloomberg, as of March 2014
12
Jul-13
Jan-14
expense of risk premiums not only in the US but also in EM
and the sell-off of 2013 also reflected a broad-based repricing
of risk, especially macro risk.
Implied volatility in US and EM stocks provide an illustration
of this mispricing of risk before the Fed signalled in May 2013
the possibility of QE tapering. The typical gap between US
and EM stock market volatility stands at around 9 to 13pp.
In Q4 2012, the gap narrowed sharply to a 5 to 6pp range,
as EM volatility fell and US volatility remained relatively
stable. The gap remained at this low level in Q1 2013 before
widening back to the previous 9 to 13pp range in Q2, when
the market became aware of the upcoming QE tapering.
This form of normalisation in the perception of risk occurred
in other asset classes, especially in the FX market. Over
time, weaker currencies should help EM countries to reduce
their current account deficits. As a side effect, they should
also contribute to reduced future volatility by reflecting
more accurately the current strengths and weaknesses of
these economies.
The optimisation of EM returns implies a rigorous
assessment of risks and selectivity
Although it is convenient to lump all the emerging markets
together, in truth this can be misleading, given that they
are a very diverse set of countries. The EM space is not
homogenous, neither in terms of financial performance or
economic fundamentals. For instance, some EM currencies
proved to be resilient in 2013 gaining while others depreciated
sharply. Credit spreads in Asia widened significantly less than
in Latin America and, while some local equity markets are
close to their all-time highs, others are back at the same levels
last seen in the trough of March 2009.
When assessing the outlook for emerging markets,
identifying external and internal imbalances is important.
We saw in 2013 that countries running current account
deficits showed greater volatility, a logical consequence
of the fact that they are net capital importers. Conversely,
countries like South Korea and Taiwan, which have a net
financing capacity, were significantly more resilient. Inflation
and fiscal deficit dynamics are also key variables, among
others, to monitor macro risks for a given country. As a
general rule, long-term sustainable economic development
rests on productivity gains or, in other words, the capacity
of a country or company to increase its output with the
same resources. Provided that wage growth stays below
productivity growth, inflation pressures will likely remain
muted; the appreciation of the currency will not reduce
exporters’ price competitiveness; and fiscal deficits, if any,
will not fuel excessive public debt. Obviously, it is almost
impossible to anticipate the long-term trend of productivity
exactly but certain characteristics create a favourable
Emerging market sell-off: the importance
of managing risks to optimise returns
environment. For example, a strong manufacturing base;
a high level of trade openness; labour force mobility and
education as well as an efficient legal framework to protect
intellectual property rights and innovation. On the other
hand, an excessive dependence on commodities could limit
the long-term prospects of an economy as history has taught
us that, over time, commodity prices tend to fall relative to
manufactured goods. The diversification of the economy is
thus another important parameter to monitor.
Figure 5: Equity performance in EM and advanced economies
yoy %
100
50
0
-50
-100
When liquidity starts to dry up, markets tend to ignore the
differences between EMs. The sell-off of 2013 impacted EM
across the board because it was triggered by a “systemic”
shock (the decision of the Fed to slow down its liquidity
injections and the fear of a liquidity squeeze). Due to this
systemic event, and on the back of previously mispriced
risks, markets did not really discriminate in the first wave
of sell-offs of Q2 2013. The “second wave” of sell-offs, in
January 2014, was different in nature, based on idiosyncratic
factors like the decision of Argentina to stop slowing down
the depreciation of its currency as the country saw a rapid
decline in its FX reserves. This time around markets were
more selective and countries with robust fundamentals fared
better. This suggests investors in EM are gradually becoming
more discriminating and is an encouraging sign.
Conclusion and investment implications
The EM asset sell-offs of 2013 and early 2014 were a
useful, though painful, reminder that the intrinsic risks
associated with EM countries need to be compensated
through appropriate risk premia and that a rigorous and
systematic monitoring of these risks would lead longterm investors to adopt a selective approach. The fact that
central banks in countries under market pressures took
bold measures to stabilise their currencies, at the expense
of economic activity, is encouraging in the sense that it
shows a heightened level of accountability. By the same
token, several countries took unpopular measures to rein
in their burgeoning fiscal deficits, like Indonesia. Overall,
EM equity and bond attractiveness remains high, but future
returns will depend on the appropriate pricing of risks and
the prospect for long-term economic development. It is likely
that markets will experience volatility in the near term, as
investors reprice risk and weigh the impact of QE tapering on
various asset markets. We would view this potential rerating
as an investment opportunity as many EM assets are being
oversold given their positive long-term fundamentals.
2006 2007 2008 2009
MSCI EM Total Return (TR)
2010 2011 2012 2013
MSCI World Total Return (TR)
Source: Datasteam, as of March 2014.
Figure 6: EM and US High Yield Total Return (TR)
yoy %
100
50
0
-50
2006 2007 2008
US High Yield TR
2009
2010 2011 2012 2013
EM USD Aggregate TR
Source: Datasteam, as of March 2014.
Figure 7: Average EM currencies exchange rate against the USD
%
113
108
31 December 2012 = 100
Depreciation
103
100
98
Jan-13
Apr-13
Jul-13
Oct-13
Jan-14
Source: Bloomberg, as of March 2014.
Figure 8: EM bonds (EMBIG) credit spread
Basis points
450
425
400
375
350
325
300
275
250
225
Jan-12
Jul-12
Jan-13
Jul-13
Jan-14
Source: Datasteam, as of March 2014.
HSBC Q2 2014 13
China’s credit boom and deleveraging
Renee Chen, Macro and Investment Strategist
There is growing concern about China’s shadow banking
system and corporate default risks. The investment boom
since 2009 has given rise to over-capacity in several sectors,
excess supply in the property market in some cities, and a
surge in corporate leverage and local government debt. Low
savings rates on offer in the traditional banking system which
have led to savers seeking higher rates elsewhere, as well
as the absence of an appropriate risk-pricing mechanism
in the financial industry, coupled with lending practices
that favoured state-owned enterprises (SOEs) over private
companies have worsened the debt problems. The credit
boom and high leverage will inevitably lead to financial losses
and corporate defaults, as interest rates rise and economic
growth slows. Managing financial risks will be a major
challenge for Chinese policymakers. Overall, the government
should be able to contain the contagion risk from selective
cases of default to a manageable level in our view, but
policy adjustment to support growth at a lower level will be
needed, with incremental steps in structural reforms.
Overinvestment and overleverage
The leverage in China’s economy, particularly the corporate
sector, has risen sharply since 2009 as the government
implemented stimulus policies in response to the global
financial crisis in 2008. Easy financial conditions fuelled
an investment boom – from infrastructure and property
investment to capital expansion in the mining and upstream
manufacturing industries. Ultimately, the investment boom
gave rise to over-capacity in several sectors, particularly
metals and mining, building materials, solar equipment and
shipbuilding. This resulted in excess supply in the property
market in some tier-3 and tier-4 cities as investment and
construction have far outpaced sales. There has also been
investment misallocation in infrastructure.
Among which, credit to non-financial corporations exceeded
more than 150% of GDP in 2013. Despite such rapid
expansion of credit, GDP growth has slowed. This indicates
that debt-fuelled capital spending has become much less
efficient at generating growth and/or a lot of credit growth
has gone to refinance existing loans (we think both), which
flags serious potential problems. The root cause of the
excessive leverage build-up was the investment-driven and
state-led growth model which resulted in low investment
efficiency, diminishing returns to capital/credit, and a
deceleration in overall productivity gains.
Leverage is concentrated in a few sectors dominated by
large enterprises, especially SOEs. These highly leveraged
sectors tend to suffer from overcapacity and deflationary
pressures, further exerting pressure on their debt
repayment.
In addition local government debt has increased significantly.
It totalled CNY17.9 trillion (31.5% of 2013 GDP) as of endJune 2013, including CNY10.9 trillion directly borne by local
governments and CNY7 trillion of contingent liabilities. That
represents a 64% increase between end 2010 and June
2013. Among the debt, debt by local government financing
vehicles (LGFVs) rose to CNY6.97 trillion (12.3% of 2013
GDP) as of end-June 2013 from CNY4.97 trillion (12.4%
of GDP) by end-2010. Local government borrowings were
mainly to finance long-term infrastructure and social projects
which have been unable to generate sufficient cash flows to
service their debt.
Non-financial credit (borrowing by the government,
households and non-financial corporations) surged from
about 150% of GDP in 2008 to over 230% of GDP in 2013.
Market distortions and financial vulnerabilities
The low savings rates on offer in the traditional banking
system and the absence of appropriate risk-pricing
mechanisms in the financial industry and the bond market,
coupled with an uneven playing field that favoured SOEs
over private companies have worsened the debt problems.
The absence of defaults and the perception of an implicit
Figure 1: Growth in GDP versus bank loans and outstanding
total social financing (TSF)
Figure 2: Return on invested capital (Shanghai Composite nonfinancials index)
% yoy
35
30
25
% yoy
35
%
12
20
11
10
20
15
15
10
8
5
7
10
5
0
1Q03
1Q05
1Q07
TSF stock (lhs)
Real GDP (rhs)
1Q09
1Q11
1Q13
Bank loans (lhs)
Nominal GDP (rhs)
Source: CEIC and HSBC Global Asset Management, as of March 2014.
14
0
9
6
5
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2014
Index-weighted average
Simple average
Source: Bloomberg, HSBC Global Asset Management, as of March 2014.
HSBC Q2 2014 15
China’s credit boom and deleveraging
guarantee by product issuers, eg banks and trust companies,
and support from the government has been a major
distortion in China’s financial system and corporate bond
market. Interest rate controls have led to low and even
negative real returns on deposits. The strong demand for
trust products and wealth management products (WMPs)
has been driven by high-net-worth individuals and depositors
looking for alternative investment opportunities to low
interest rate deposits, and by a perception that product
issuers and distributors provide an implicit guarantee. There
were several reported cases of the investment failure of
trust products or WMPs, but eventually investors were all
repaid under various arrangements. The outstanding amount
of bank-issued WMPs surged to CNY10.8 trillion (10.1%
of bank deposits) as of end-2013, from just CNY1.7 trillion
(2.7% of bank deposits) at end-2009. The trust sector’s
assets under management (AUM) grew rapidly from CNY2
trillion (6% of GDP) at end-2009 to CNY10.9 trillion (19% of
GDP) as of end-2013.
Artificially low lending rates resulted in excess demand for
bank loans and increased the use of quantitative targets
to control credit growth. Banks favoured lending to large
corporations, mainly SOEs and LGFVs, perceived to
present less risk with implicit guarantees from central or
local governments, even in sectors with widespread overcapacity. Consequently, such biased lending behaviour
has given rise to moral hazard and crowded out small and
medium-sized enterprises (SMEs) from relatively lowercost bank loan financing to high-interest-rate trust loans
or other shadow banking channels. Trust funds have been
utilised as a channel of alternative financing to offer credit
to money-hungry firms and risky borrowers that do not
have access to bank loans. This source of credit has allowed
banks to arrange off-balance sheet refinancing for maturing
Figure 3: Liability-to-asset ratio: by selected industries
loans that risky borrowers cannot repay from their cash flow
and to keep their businesses and projects afloat to avoid
default on bank loans. Outstanding trust loans increased
sharply to CNY4.9 trillion as of end-2013 from CNY1.7 trillion
at end-2011. Shadow banking lending is less transparent
and less subject to supervision, regulation and capital
requirement, raising concerns about the systemic risk.
Another risk area is credit hidden in the interbank market.
Interbank business was initially limited to lending between
banks to address short-term liquidity issues. However, since
2010, the interbank business has undergone a fundamental
change, expanding a variety of off-balance-sheet assets
and creating many types of interbank products. Banks have
increased their use of the interbank market to manage their
regulatory ratios and maximise returns. The interbank market
has facilitated bank co-operation with the shadow banking
sector, for example, WMPs investing in interbank assets or
claims on trust assets being traded in interbank markets.
The previous bailouts in the onshore corporate bond market
by the government and/or state-owned banks, by providing
last-minute loans to companies in trouble, created moral
hazards and encouraged investors to seek the highest
yields without considering the underlying credit risks. The
corporate bond market has grown significantly in recent
years, although issuance is still predominantly by SOEs
(including LGFVs). While bank loans remained the biggest
component of local government debt, local governments
have increasingly relied on bonds and other forms of
financing including trust loans. Bank loans accounted for
56.6% of total local government debt as of end-June 2013,
down from 79% at end-2010. Local governments enjoyed
low financial costs often not compatible with the underlying
risks when issuing bonds, due to a perceived implicit
guarantee or bailout prospects.
Figure 4: Shadow banking credit and corporate bonds
outstanding
CNY trn
20
Water supply
Non-ferrous metals
Ferrous metal smelting
15
Chemical fibre
Petroleum and coking
10
Ferrous metals
5
Coal
Overall
0
20
40
2013
60
2008
Source: CEIC and HSBC Global Asset Management, as of March 2014.
80%
0
2008
2009
WMPs (AUM)
2010
2011
Trust (AUM)
2012
2013
Corporate bonds
Note: corporate bond statistics include enterprise bonds, corporate bonds,
MTN, STFB and ABS; the numbers have been adjusted for the double counting
issue due to duel market listing.
Source: BofAML, CEIC, CBRC, WIND and HSBC Global Asset Management, as
of March 2014.
16
Deleveraging and default risks
The credit boom and high leverage will inevitably lead to
financial losses and corporate restructuring and defaults,
as interest rates rise and economic growth slows. Interest
rates will move higher, due to interest rate liberalisation to
gradually end financial repression and policy efforts to rein
in credit growth. The People’s Bank of China (PBoC) faces
challenges with a fast evolving financial landscape due to the
rapid unfolding of interest rate liberalisation driven by market
forces via the shadow banking sector and financial innovation.
The explosive growth in WMPs has been one major force
driving interbank rates up and raising banks’ funding costs,
as it reduces the supply of low-cost deposits for banks which
increasingly rely on funding from the interbank market. Banks
also face intense competition for deposits from money
market funds (MMFs) offered by internet platforms. The
AUM of MMFs has surged since July 2013, to CNY1.4 trillion
as of end-February from CNY304 billion at end-June driven
by web-based MMFs. The AUM of MMFs is still very small
compared with that of bank WMPs, but the rapid growth of
MMFs has surely been a force speeding up China’s marketdriven interest rate liberalisation. The potential risk of deposit
outflows has prompted banks to increase their dependence
on WMPs and/or roll out similar products. Banks may also
raise loan pricing as funding costs rise.
Deleveraging in a rising interest rate environment could
exacerbate vulnerability among heavily leveraged sectors
and investment projects that have cash flow problems and
rely heavily on shadow banking financing.
Corporate bond default risks
In March, a small and heavily-indebted solar equipment
maker failed to pay interest on a bond, marking the first
onshore corporate bond default in recent history. The
event was seen as a landmark which could signal greater
government willingness to let lenders be subject to market
discipline. Previous cases in which Chinese companies came
close to defaulting were averted at the last minute, usually
with government intervention.
In general, corporate bonds should be less risky than trust
credit because the market is more transparent and subject
to tighter regulation, but significant risks still exist. SOE
bond issuers tend to have lower default risk than non-SOEs,
partly because of their relatively easy access to other funding
channels. LGFV bonds also have relatively less risk due to
lower funding costs, longer duration and stronger incentives
for local governments to support them. Analysts from Bank
of America Merrill Lynch (BofAML) identified 20 risky bonds
with the highest potential default risks from some 6,800
bonds traded both on the interbank and exchange market,
worth about CNY20 billion. Bonds issued by non-SOEs in
“high-risk” sectors, eg industries that suffer over-capacity
and property that had their ratings cut over the past three
years and/or issued by companies that made losses over the
past two years are particularly vulnerable.
Shadow banking credit risks
Given their focus on relatively higher interest-paying
segments, trusts are exposed to higher levels of credit
risks compared with other major financing channels for
companies such as bank loans and debt markets. Collective
trusts, which are sold to multiple investors and accounted
for about a quarter of the trust sector’s AUM in 2013, tend to
be riskier than single trusts (sold to a single investor). There
is a busy schedule of trust products maturing and LGFVs
that need refinancing this year. According to statistics from
Use-Trust Studio in February collective trusts worth about
CNY900 billion will mature this year. There are likely to be
more potential shadow banking product defaults over time.
20% and 16% of total local government debt (as of end-June
2013) will mature in 2014 and 2015, respectively (18% in
2013), which will put near-term pressure on debt rollover.
Among various trust types, energy and mining trusts
invested in private projects will likely have the largest risk
of defaults this year due to a busy maturity schedule, low
profitability and less government support, but these trusts
account for just a small share of the total.
Trust companies have played an important role in
infrastructure. While we see a risk of defaults by LGFVs at
village and town or even county levels, we think most LGFVs
will still enjoy implicit guarantees from local governments
which may prevent defaults this year. Infrastructure and
LGFV trusts could face severe financing problems if land
purchases by developers fall, as land sales are a major source
of local government revenue and land is often utilised by
local governments as collateral for borrowing.
Property market a major risk
The property market has been reasonably buoyant in recent
years, but tighter credit conditions, rising funding costs and
slower economic growth will challenge property sales this
year. Supply and demand dynamics remain favourable for
property markets in the four tier-1 cities (Beijing, Shanghai,
Guangzhou and Shenzhen) and many tier-2 cities (mostly
provincial capitals). However, there are problems in some
lower-tier cities, where the housing market has cooled
considerably with sales declining and prices stagnant or
falling. There is also a rising divergence among property
markets in different cities. Some property developers
will face pressures as transaction volumes slow and cash
HSBC Q2 2014 17

flow conditions tighten. This problem is expected to be
more severe for small developers with limited funding
channels and weak execution in lower-tier cities where the
property sector is overinvested. They may face difficulties
in refinancing and will likely have to cut prices further. Real
estate trusts with lending to small, unlisted developers with
single-city operations in tier-3 and tier-4 cities could be in
trouble, but default risks by larger and national developers
should be low. We believe the government has an incentive
to maintain the stability of the property market given the
sector’s importance to the economy and its link to the whole
fiscal and financial system through land sales and value (as
collateral especially for LGFVs). The government will employ
differentiated property policies in different cities reflecting
local conditions and will adopt a new “two-way” approach
that mainly focuses on increasing the supply of affordable
housing and curbing demand for commodity housing for
investment purposes.
Although many of the potential default cases could still get
bailed out in some way, given that the underlying problems
are corporate insolvency risks, it is just a matter of time
before many products will ultimately default, in our view.
Bailouts will only delay or even amplify the problem in the
longer term. China’s shadow banking is closely connected
with the regular banking system. Banks are the largest holder
of corporate bonds and may suffer meaningful losses if many
corporate bonds default. WMPs have channelled funds to
trusts and corporate bonds. An increase in default rates
in the trust sector or corporate bond market would pose a
high risk to WMPs. A loss of confidence by investors and
depositors in trust products or WMPs could risk triggering a
negative chain reaction.
Policy implications
With credit risks likely to rise significantly and some defaults
unavoidable this year, it will test the central government’s
willingness and ability to allow selective defaults to address
Figure 5: Newly increased collective trust funds: investment
by industries
CNY trn
1.5
1.0
0.5
0
2010
2011
Real estate
Infrastructure
Financial institutions
2012
2013
Industrial and commercial enterprises
Securities market
Others
Source: CEIC and HSBC Global Asset Management, as of March 2014.
18
the moral hazard problem, impose market discipline and
improve risk control, while preventing any individual defaults
becoming a systemic financial problem, which could result
in heavy economic and social costs. We believe China’s
deleveraging will be a gradual multi-year process, not a quick
fix, so as to alleviate the impact on growth and system-wide
liquidity. The government does not intend to cause a systemwide credit crackdown, but instead aims to correct the
problems of financial excesses and credit dislocation.
Chinese policymakers have the ability to respond to systemic
financial risks using fiscal, regulatory and monetary policy.
China has a high savings rate and its financial sector is
funded primarily by domestic savings. The government holds
major stakes in many banks and the central government
balance sheet remains sound with significant financial
resources, eg owning the country’s natural resources
and holding large foreign exchange (FX) reserves, etc.
The government has a set of policy options to avert a
crisis, including debt nationalisation, securitisation, asset
management companies (AMCs), and government-led
restructuring. The PBoC has various tools to avert a credit
crunch, including the standing lending facility and cuts to
the reserve requirement ratio. In addition, it could even
loosen the quantitative controls on bank credit expansion.
The government will also expand the financial safety net,
eg a deposit insurance scheme and exit mechanism for
failed financial institutions and improve regulatory and legal
process governing company bankruptcy and restructuring.
China’s potential GDP growth has slowed, due to a
combination of structural factors such as a gradual
slowdown in productivity growth in the industrial sector,
an unfavourable demographic trend, as well as loss of cost
competitiveness and a significant reduction in the export
contribution to growth. To enable an orderly deleveraging
without a credit crunch or economic hard handing, credit
growth needs to be constrained and any reduction in the
HSBC Q2 2014 19
China’s credit boom and deleveraging
rate of credit growth must be accompanied by extensive
measures to ensure that the productivity of each dollar
of credit issued is far higher than in the past. Therefore,
financial reforms to substantially raise the efficiency of credit
allocation and the returns to capital, accompanied with other
structural reforms to unlock the economy’s productivity
potential, are crucial. This requires more market-based
pricing of credit and the diversification of credit channels, via
the establishment of a multi-layer capital market. Deposit
rate liberalisation and SOE reform will be key to improving
productivity of capital allocation. Fiscal reforms will focus
on redistributing fiscal revenues and expenditures between
central and local governments, which will help improve local
governments’ fiscal sustainability, and strengthen control
over government debt and associated risks.
Overall, we think the government should be able to contain
the contagion risk from selective cases of default to a
manageable level. Under such a scenario, which is our
base case, the government should be able to manage
around 7% growth in 2014 and 2015, but policy adjustment
to support growth will be needed, with incremental
steps in structural reforms, especially on demand- and
productivity-enhancing reforms.
Investment implications
More negative headlines on default risks, expected slower
economic growth, tighter financial conditions, and more
volatile money market rates and CNY exchange rates could
unsettle financial markets from time to time and cause
higher volatility. The low valuation of the Chinese stock
market has probably discounted many macro risk factors,
but a sustained market rebound looks unlikely until there is
some conviction that financial risks have been brought under
control. The performance of Chinese stock markets will likely
be driven by policy and depend on the balance between
reform and growth in the short-to-medium term. Effective
reform implementation could boost investor sentiment
and raise valuations of Chinese stocks, but reform-driven
rerating potential is likely to take time to be realised. Stock
selection based on corporate fundamentals is the key to
outperformance.
For fixed income, risk aversion in the event of defaults and
perceived elevated onshore credit risks would mean a higher
risk premium for credits (both onshore and offshore). There
will also be greater differentiation between stronger and
weaker credits. It is likely that total return potential will mainly
come from carry and credit selection this year. However,
greater market discipline with better pricing of credit risks
and reduced incentives for financial institutions to continue to
20
channel credit to unproductive and risky entities will lead to a
more efficient allocation of capital, which should benefit both
onshore and offshore creditors in the long term.
Defaults or heightened credit risks could lead to periods of
CNY depreciation and weaker CNY expectation/outlook in
the near term, but we expect the PBoC to act to prevent any
sharp currency moves while encouraging greater two-way
volatility of the CNY exchange rate. The PBoC still has good
control over the FX market and the CNY exchange rate and it
is in the Chinese policy makers’ interest to prevent excessive
CNY volatility given the potential negative repercussions on
other local financial markets, domestic liquidity conditions,
and credit risks. China’s current account surplus, large FX
reserves, net FDI inflows and its net creditor position to the
rest of the world provide longer-term fundamental support
for the currency.
HSBC Q2 2014 21
Ask the expert: asset allocation
Joe Little, Senior Investment Strategist
What do we mean by asset allocation?
Asset allocation is all about balancing risk and return
by constructing a portfolio of different asset classes
(government bonds, corporate bonds, equities, etc)
according to investor return objectives, risk tolerances,
time horizons and other constraints. We believe that asset
allocation is the core driver of investment performance in
the medium term1, a view that is supported by academic
research, and that we should take a dynamic approach.
This means that we are not focusing on every twist and
turn in markets. We take a multi-year perspective, seeking
to capture phases of normal or exceptionally strong asset
returns, and avoid phases of weak or negative asset returns.
What do you think are the common mistakes asset
allocators make?
Over the past decade, many investors have not realised their
return objectives. We think there are two common mistakes:
(i) expectations of asset returns are typically poorly calibrated
which leads to disappointment and (ii) asset allocations are
often left static and become stale.
During the 1990s bull market, UK pension funds substantially
increased weightings to equities. Strong markets fostered
a high degree of confidence in future returns which were
buttressed by hindsight bias and myopia, ie overemphasising
the recent past. By the end of the 1990s, the average UK
pension fund had more than 75% of its assets in equities.
What came next, a decade of flat equity performance
punctuated by two large bear markets, was a major
disappointment. The clear conclusion is that historic returns
are not a good guide to the future. Rather, the implication
is that what you buy and when you buy is more important.
Secondly and related, many investors employ a “set and
forget” strategy to asset allocation. But asset returns are
Rolling 20 year inflationadjusted return
Figure 1: US equities rolling returns (inflation adjusted)
%
16
14
12
10
8
6
4
2
0
-2
1920
1932
1945
1957
1970
1982
1995
2007
Source:Global Financial Data, as of March 2014.
1 Ibbotson and Kaplan (2000), “Does asset allocation policy explain 40%, 90%
or 100% of performance”, Financial Analysts Journal.
22
volatile, even over long holding periods (see Figure 1) and
so a “set and forget” strategy can lead to regret.
How should we respond to these mistakes?
In our view, the short answer is that a valuation-based
approach to asset allocation should be adopted, rather than
merely applying a standard economic forecasting approach.
The distribution of future asset returns is not random;
empirical evidence has shown that valuation factors can be
good predictors of returns, at least in the long term. We think
it makes sense, therefore, to construct asset allocation using
forecast returns based on current valuations, updating our
views regularly to reflect important new information.
We also believe in a policy of systematic rebalancing.
Following the crowd is an emotionally-comfortable approach
and buying into what has recently been working seems
sensible. However, segregating assets into buckets of
“winners” and “losers” is a behavioural trap. It means that
we under-emphasise portfolio considerations, particularly
the benefits of uncorrelated returns. Moreover, while adding
to an asset class which has recently fallen in value might
feel frightening, it is often the best time to buy. Regular
rebalancing of multi-asset portfolios means that they should
closely reflect our current views.
Can we forecast asset class returns?
The influential “efficient markets” approach of modern
financial theory proposed that available information was fully
incorporated in prices. Dividend yields, for example, were
assumed to reflect the market’s view of future dividend
growth. This might be a reasonable rule of thumb for the very
short run, but as we extend the time horizon to the long term,
we find that asset prices are “excessively volatile” relative to
what fundamentals would imply. This implies that to some
extent, returns can be predictable across asset classes.
In equities this means that high dividend yields today predict
high equity market returns in the future. In government
bonds, the slope of the yield curve forecasts future bond
returns, not the direction of interest rates. In credit, higher
spreads are not just about increased corporate default risks,
instead they forecast higher investment returns. Long run
return predictability is pervasive across asset classes.2
How do you construct your return signals?
We model asset class returns over the next ten years.
Returns for each asset class reflect a risk-free rate and
additional “risk premia” compensating investors for
uncertainty (see Figure 2). Over the long run, risk premia
should revert to asset-specific norms.
2 See Cochrane (2011), “Discount Rates”, Journal of Finance.
HSBC Q2 2014 23

So, we start with a projection of where policy and cash rates
will be in ten years’ time and, using a combination of thirdparty data and in-house interest rate modelling, we construct
a trajectory for short-term interest rates for various markets.
These predicted short rates will vary across economies
depending on estimated real interest rates and inflation.
We then build-up our asset class return signals by modelling
asset-specific “risk premia”, or excess returns, over this
cash scenario. For government bonds we assess the
“term premium” today in relation to long-run averages. For
credits, we incorporate the so-called “credit risk premium”,
the additional yield reward the market is offering for taking
credit risk in excess of likely default or downgrade losses.
Finally for equities, we incorporate a measure of the “equity
risk premium”, which we measure using a version of the
dividend discount model.
Today, cash still hardly offers a positive return in inflationadjusted terms across developed markets. Prospective
returns on government bonds, particularly in Germany and
Japan, remain very low. Return signals for bond markets
with with steeper yield curves, like the UK and US, are
stronger. Emerging market government debt currently looks
attractively priced in aggregate.
During boom periods, cash rates rise but “risk premia”
compress as investors become less risk-averse. These
moving parts create a dynamism in our expected return
signals. What follows is a consistent and systematic process
which models asset returns by emphasising: (i) starting
valuations, (ii) projected economic fundamentals, and (iii)
mean-reversion in “risk premia” (excess returns).
How does this feed into a multi-asset portfolio?
When we construct portfolios, we quantitatively and robustly
“optimise” the trade-off between asset risk and return to
maximise expected return for a given level of risk or volatility.
There is also an important element of experience and
common sense; asset allocations are fine-tuned to reflect
“tail risks” and scenario-analysis. Finally, portfolios are
systematically rebalanced back to their strategic mixes to
ensure client experiences are aligned with our asset class
return signals.
What about currencies? Are they not hard to forecast?
When we take exposure in a foreign asset we have to
decide whether to leave our currency exposure unhedged or
hedged. Our work is focused on thinking about this as a longrun decision rather than trying to gauge foreign exchange
(FX)market direction in the short term. We model asset
returns in local currency terms and then translate these into
hedged and unhedged returns for, say, a sterling or dollarbased investor.
We construct hedged returns using country interest rate
differentials implied by our modelling work. Unhedged
returns are calculated using a modified version of the socalled “Purchasing Power Parity” theory which proposes
that a basket of goods should, in equilibrium, trade at the
same price across countries. This is a reasonable longrun model for forecasting currencies. We take unhedged
exposures in assets where we believe that the currency will
appreciate over the medium term.
We have moderated our enthusiasm for global equities
which are now broadly in line with equilibrium. US equities,
for example, offer a prospective return over cash somewhat
below long run averages of around 4% per annum. EM
equities have become more attractive but they have not yet
reached compelling valuations in the aggregate. However,
there do appear to be some selective country-specific
opportunities in EM for the long term.
What do you consider to be the benefits of this
approach?
The potential advantage is the “dynamism” around the
asset allocation mix which comes from our return signal
work. Our core belief is that asset allocation is the central
driver of investor returns over the medium term. We also
take a valuation-based approach, different to the traditional
forecast-based style. This means that there is a repeatability
and transparency to the process. There is also flexibility in
the assets we allocate to, and the vehicles we use to fulfil,
those exposures.
Figure 2: Stylised pecking order of equilibrium asset real returns
%
5
4
What are you saying today?
We update our return signals each quarter. The recent
picture has been one of extremely low returns to perceived
“safe haven” assets such as cash and government bonds,
which therefore appeared to be quite dangerous. In contrast,
more volatile assets such as credit and equities have been
attractively priced relative to our sense of equilibrium.
3
2
Term premium
1
0
Cash
Inflation-linked
bonds
Govt
bonds
Credit
Credit risk premium
Equity risk premium
Duration premium
Inflation risk premium
Real short rate
Source: HSBC Global Asset Management, as of March 2014.
24
Global
equities
HSBC Q2 2014 25
Fixed income update: outlook for
developed market credit
Marcus Pakenham, Director, Product Specialist
Six months ago we were expecting improving global
growth and continued good corporate performance. We
expected that government yields would rise modestly and
that lower rated corporate bonds would provide attractive
yields and low sensitivity to higher government yields.
Over the past six months, global economic growth
has been slightly higher than expected last summer.
Expectations for 2014 have not changed much overall,
although US growth forecasts have moved higher while
LatAm growth forecasts have moved lower.
Figure 1 shows Consensus Economics’ GDP growth
forecasts for 2014 and 2015. The picture is positive with
good overall global growth driven broadly by developed
and emerging countries. In particular, eurozone prospects
continue to improve and global growth is expected to
accelerate slightly from 3.1% in 2014 to 3.3% in 2015 as
the pace of growth accelerates in the eurozone and is
maintained at a decent pace in Asia Pacific and the US.
Over the past six months, 10-year US Treasury yields
have traded in a range of 2.5% to 3.0% with US economic
factors and emerging market problems the main influences.
Corporate yield spreads have moved considerably lower
since last summer as risk appetite has remained strong and
the corporate sector has performed well. The lower rated
parts of the credit market have outperformed the more
highly rated areas.
We believe that, over the next couple of years, lower rated
credit will likely continue to provide positive returns for
investors. Growth of the global economy should support
corporate sales growth and maintain healthy cash flow
generation. While we expect government yields to rise, we
also believe that lower rated spreads in particular can fall
further.
Looking at the global economy, while the overall growth
rates are good, there have been concerns about banking
systems and the ability of banks to extend loans to support
company activities. However, there have been some
reasonably positive developments. Figure 2 shows the
balance of banks in the US and eurozone that are tightening
or loosening lending conditions. If the lines are falling,
credit conditions are getting tighter, as we can see in 2008.
Recent surveys show that the balance of lending conditions
in the US is back to pre-crisis levels, while banks in the
eurozone are close to pre-crisis levels.
Banks have made great strides in improving the quality
of their balance sheets and increasing their capital levels
so that they are in line with new regulatory requirements.
This puts banks in a better position to extend loans to both
individual and corporate customers and should also make
banking systems more resilient in times of crisis.
The corporate sector continues to perform well in most
countries with the last set of US company results, from Q4
2013, showing good revenues and cash flows and broadly
stable balance sheets. Cost cutting has continued and
we expect revenues to pick up in 2014. In Europe, sales
have been slightly disappointing, but cost cutting has kept
profits stable.
When buying corporate bonds it is important to seek stable
or improving credit quality. Figure 3 shows one metric that
helps illustrate the health of the higher risk high yield sector.
This data is from US high yield companies and shows how
the ratio of cash flow to debt cost is close to an all time high.
In other words, companies can still comfortably afford to
service their debt.
This stability of high yield fundamentals is also shown in
figure 4. Migrations show how the rating agencies are
Figure 1: Forecasts for 2013 and 2014 GDP growth
Figure 2: Lending conditions in the US and eurozone
%
5
%
-40
-20
0
20
40
60
80
100
4
3
2
1
0
World
US
Eurozone
2014 Real GDP % growth
UK
Asia
Latam
Pacific
2015 Real GDP % growth
Source: Consensus Economics, as of March 2014.
26
lending
standards
tightening
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
US Net % of Domestic Respondents Tightening Standards –
C&I Loans for Large/Medium Companies
ECB Survey Change Lending to Business Last 3 month net
percentage Bank's (change in bank's credit standards)
Sources: Bloomberg, as of 31 December 2013.
upgrading or downgrading individual bonds. You can see
the sudden increase in downgrades during the credit
crunch in Q4 2008. The more recent data shows stability
in US and EUR migrations, but still a net balance of
downgrades in EM. We are cautious about EM high yield
and prefer investment grade and higher quality high yield
companies. We expect migration rates to remain low and
default rates to also stay well below historic levels.
Figure 3: US fixed charge ratio: EBITDA/interest expense
(rolling 12 months)
Figure 4: Rating migration rates for US, EUR and EM HY, % of
issuers
In summary, we believe the opportunity for positive returns
still remain for lower rated developed market credit with
good company fundamentals and attractive yields.
% yoy
8
5
4
4
0
3
-4
-8
2
-12
1
-16
0
1998
2000
2002
2004
2006
2008
2010
2012
HY Coverage ratio
Sources: Bloomberg, as of 31 December 2013. EBITDA – earnings before
interest, tax, depreciation and amortisation.
-20
1998
2000
2002
2004
2006
2008
2010
EU HY
EM HY
Trailing 3 month Rating Migration Rate – US HY
2012
2014
Source: Bloomberg, as of 31 December 2013.
HSBC Q2 2014 27
Navigating markets
Paras Patel, Associate, Macro and Investment Strategy
Figure 1: Q1 Performance
Equities
Asian IG
US Corp
Global HY
Global EM
Gold
Commodities
Global Agg
WTI Crude oil
Shanghai Comp
MSCI EM
India Sensex
Nikkei 225
FTSE 100
Euro Stoxx
S&P 500
8
6
4
2
0
-2
-4
-6
-8
-10
MSCI ACWI
%
Bonds
Note: MSCI and fixed income indices are USD based, all other indices are based
on local currencies.
Source: Bloomberg, as of 31 March 2014.
Equity markets started off the quarter on a weak note with
most major equity markets falling in January on the back
of a combination of some poor US macro data (specifically
December’s payroll numbers) and on increasing EM volatility.
However, in February, markets shook off concerns about
EM tensions as central banks tightened policy. Turkey’s
central bank raised rates aggressively on 28 January. Brazil
(26 February), South Africa (29 January), India (28 January)
and Russia (3 March) also raised rates. Markets once again
came under pressure in early March, on geopolitical tensions
between Ukraine and Russia, but recovered later in the month
as tensions eased. Overall, the MSCI EM (USD) was down
0.4%in Q1, while the US S&P 500 and the Euro Stoxx 50
were up modestly. The Japanese Nikkei 225 was the worst
performing major developed world equity index losing 9%
on investor concerns about the resilience of the yen against
the USD (which benefited from safe haven flows), the impact
on corporate earnings from exports and the outlook for
consumption given the sales tax rate hike on 1 April.
In contrast to last year when bonds performed poorly, we
have seen both core government bonds as well as riskier
peripheral sovereign eurozone bonds, corporate credit and
EM debt perform well so far in Q1. European bonds have
generally benefited from the European Central Bank’s
(ECB’s) low interest rates and improved outlooks for their
creditworthiness. Furthermore, Ireland became the first
eurozone country to exit an EU/IMF bailout successfully
selling EUR1 billion of 10-year paper at a yield of below 3%,
in its first regular bond auction since their suspension three
and a half years ago. Credit fundamentals for the peripheral
eurozone economies have also improved; Moody’s
upgraded Spain’s credit rating to Baa2 with a positive outlook
and Ireland’s sovereign rating was upgraded to Baa3, with its
outlook changed to positive.
28
In terms of the macro environment in the first quarter,
economic data was weak in the US at the beginning of the
year but improved over the quarter. The second estimate of
Q4 GDP was revised down to 2.4% qoq from the preliminary
estimate of 3.2%, US payroll data surprised to the downside
in January but were stronger in February and March, retail
sales and housing market data have also been weak while
the Institute of Supply Management’s (ISM’s) manufacturing
index has generally been resilient during the first quarter.
However, we would argue that the weakness in US data was
the result of severe weather, rather than a sign of underlying
weakness. In the eurozone, macro data has been modestly
stronger with industrial production data in key economies
picking up and unemployment in both core and peripheral
eurozone economies falling. Fourth quarter GDP growth
also showed that for the first time since 2011, all four of the
major eurozone economies expanded (Germany: 0.4% qoq,
France: 0.3% qoq, Italy: 0.1% qoq and Spain: 0.3% qoq),
with overall growth for the region accelerating to 0.3% qoq
in Q4 from 0.1% qoq in Q3. However, deflationary concerns
continued to play on investors’ minds with the latest reading
in March showing inflation falling to just 0.5% yoy from an
already low 0.7% yoy in February, while the unemployment
rate held steady at around 12%.
On the policy front, new US Federal Reserve (Fed) Board
Chair, Janet Yellen, gave her first testimony before Congress
as Fed Chair at the end of January. She signalled that no
changes would be made to the schedule of quantitative
easing tapering and that interest rates are likely to remain
low for some time. This was positively received by investors.
However, during the Federal Open Market Committee
(FOMC) meeting in March, the Fed flagged a potentially
more aggressive policy tightening path than previously
anticipated by financial markets. Specifically, the Fed
released new forecasts showing officials predicting the
benchmark rate (now at almost zero) would rise to at least
1% by the end of 2015 and then to 2.25% by the end of 2016.
At the end of January, Congress approved a deal to raise the
government’s debt ceiling until March 2015 with no strings
attached. This boosted markets amid relief that October
2013’s government shutdown would not be repeated. While
in Europe, the ECB did not announce any major change in
monetary policy this quarter but hinted it could take action if
inflation stayed below target with the latest reading in March
showing a drop of 0.5%.
In EM, equity and currency markets came under strong
selling pressure from mid-January, due to specific local
factors such as civil unrest and political uncertainty in some
countries as well as concerns about a slowdown in China.
However, EM assets rebounded at the end of January
and in February, as EM central banks responded to market
volatility by taking some action. Turkey’s Central Bank raised
rates aggressively on 28 January. Brazil (26 February),
South Africa (29 January), India (28 January) and Russia (3
March) also raised rates. In addition, the recently announced
Chinese reform plan should help support long-term growth.
However, in March the evolving crisis in Ukraine hurt investor
sentiment with geopolitical tensions adding another layer
of uncertainty to already risk-averse sentiment towards EM
assets. Overall, EM equities were down 0.8% (MSCI EM
USD index) on the quarter.
For the rest of the year, we believe risk asset performance
is likely to be driven by two key factors. Firstly, global macro
data will continue to be important with US data being
particularly vital in gauging future Fed monetary policy.
In terms of analysts’ expectations, although much of the
developed world is expected to keep rates on hold, policy
rates in the emerging world are expected to be mixed with
some economies raising rates in the next 12 months (Brazil,
Turkey and Mexico) while others are expected to cut rates
(Russia and Thailand).
of quantitative easing tapering on various EM asset markets.
Elections in some key emerging economies, along with
geopolitical tensions between Russia, Ukraine and the West
are likely to induce further volatility into financial markets.
In terms of the long-term outlook for asset markets more
generally, we continue to favour corporate assets on a
relative return basis, ie equities and corporate bonds over
core government bonds. It is worth noting that the size of
the valuation gap between equities and perceived “safe
haven” government bonds is not as large as it was a year
or so ago, but it still favours riskier assets in our view. The
“risk premium” on global equities is a little below its long-run
historic average, at around 4% versus cash. Against global
government bonds, we think equities offer excess returns
of around 3.5%. The additional expected return for taking
equity risk has compressed as valuation ratios have moved
higher. As this process continues, it will present some
risks for equity investors. However, when we consider the
balance of risks to growth and inflation, we think corporate
profits remain well supported in developed markets.
On-going EM volatility is also likely to dominate markets in
the near term, as investors reprice risk and weigh the impact
HSBC Q2 2014 29
Global data watch
Paras Patel, Associate, Macro and Investment Strategy
Key highlights
uuGrowth: Economic growth in the developed world
generally accelerated in Q4 2013, with the US, the UK,
Japan and the eurozone posting higher year-on-year Q4
GDP numbers. In contrast, most of the BRIC economies
saw their GDP growth rates stabilise or fall marginally.
uuIndustrial production: Industrial production in the
developed world came in weaker with the US and the
eurozone posting lower levels of growth in Q4 versus
Q3, while the UK posted the same level of growth as in
Q3 2013. Industrial production growth for all the BRIC
economies fell in Q4 compared to Q3.
uuInflation: Inflation in the UK, Japan and the eurozone
slowed down in Q4, while US inflation picked up
modestly. The latest monthly inflation figures for the
eurozone dropped to 0.5% in March 2014, well below
the European Central Bank’s (ECB’s) inflation target of
close to, but below, 2%. Inflation trends in the BRIC
economies were more mixed with China and India
posting falls while Brazil and Russia posted higher
inflation figures for Q4.
Annual real GDP growth – developed markets (% yoy)
uuLabour market: The labour markets in the developed
world improved in Q4 with the US, the UK, Japan and
the eurozone all posting falls in unemployment.
Annual real GDP growth – BRIC markets (% yoy)
%
10
%
20
5
10
0
0
-5
-10
-10
Dec-07
Dec-08
Eurozone
Dec-09
Dec-10
Japan
Dec-11
UK
Dec-12
US
-20
Dec-07
Dec-08
Brazil
Dec-09
China
Dec-10
Dec-11
India
Dec-12
Russia
GDP growth picked up on a year-on-year basis in the
developed world in Q4 2013, with the US, the UK, the
eurozone and Japan all posting faster growth than in Q3.
In contrast, most of the BRIC economies saw their economic
growth rates stabilise or fall marginally in Q4. Year-on-year
growth rates in China, India and Brazil all fell marginally
compared with the previous quarter.
Headline inflation – developed markets (% yoy)
Headline inflation – BRIC markets (% yoy)
%
6
%
20
4
10
2
0
0
-2
-4
Dec-07
Dec-08
Eurozone
Dec-09
Dec-10
Japan
Dec-11
UK
Dec-12
US
Inflation in the UK, Japan and the eurozone slowed down in
Q4, while US inflation picked up modestly. Inflation dropped
to 0.5% in March 2014, well below the ECB’s inflation target
of close to, but below 2%.
Sources: MSCI, Thomson Reuters Datastream and Bloomberg, as of March 2014.
30
-10
Dec-07
Dec-08
Brazil
Dec-09
China
Dec-10
Dec-11
India (WPI)
Dec-12
Russia
Inflation trends in the BRIC economies are more mixed with
China and India posting falls while Brazil and Russia posted
higher inflation figures for Q4.
Industrial production – developed markets (% yoy)
Industrial production – BRIC markets (% yoy)
%
30
%
40
20
02
10
0
0
-20
-40
-10
Dec-07
Dec-08
Eurozone
Dec-09
Dec-10
Japan
Dec-11
UK
Dec-12
US
-20
Dec-07
Dec-08
Brazil
Dec-09
China
Dec-10
Dec-11
India
Dec-12
Russia
Industrial production in the developed world generally came
in weaker in Q4. The US and the eurozone posted lower
levels of growth in Q4 than in Q3, while the UK posted the
same level of growth and Japan’s Q4 industrial production
growth came in higher than in Q3.
Industrial production growth fell in the BRIC economies in Q4,
with China, India, Russia and Brazil all posting lower growth
rates than in Q3.
Retail sales – developed markets (% yoy)
Retail sales – emerging markets (EM) (% yoy)
%
30
%
12
9
20
6
3
10
0
0
-3
-6
-10
-9
-12
Dec-07
Dec-08
Eurozone
Dec-09
Dec-10
Japan
Dec-11
UK
Dec-12
US
-20
Dec-07
Dec-08
Brazil
Dec-09
China
Dec-10
Dec-11
Russia
Dec-12
Taiwan
Retail sales growth figures for most of the major developed
economies were disappointing in the last quarter. The US,
Japan and the eurozone all posted weaker retail sales growth
than in Q3. The UK was the only exception posting faster
retail sales growth than in Q3.
Consumer spending patterns in the EM countries were mixed
in Q4 with China and Russia posting rising retail sales growth,
while Brazil and Taiwan posted falling retail sales growth
figures.
Unemployment rates – developed markets (%)
Unemployment rates – emerging markets (EM) (%)
%
15
%
10
8
10
6
5
0
4
Dec-07
Dec-08
Eurozone
Dec-09
Dec-10
Japan
Dec-11
UK
Dec-12
US
Labour markets in the developed world improved in Q4 with
the US, the UK, Japan and the eurozone all posting falls in
unemployment.
2
Dec-07
Dec-08
Brazil
Dec-09
China
Dec-10
Dec-11
Russia
Dec-12
Labour markets in emerging markets were relatively mixed
with unemployment rates in China and Russia rising modestly
while in Brazil the unemployment rate fell.
Sources: MSCI, Thomson Reuters Datastream and Bloomberg, as of March 2014.
HSBC Q2 2014 31

Economic forecasts for 2014 and 2015
uuGrowth: The Consensus Economics’ global growth
forecast for 2014 has been revised upwards significantly
since we published our last IQ. The most notable upward
revisions over the past three months have come in the
US and the UK.
uuInflation: The Consensus Economics’ 2014 global
inflation forecast has also been revised upwards since
December 2013. The most notable changes are for
Japan. Japanese 2014 inflation forecasts have been
revised up from 1.6% to 2.6%.
Consensus Economics’ growth forecasts
December 2013 Consensus
March 2014 Consensus
2014F
2015F
2014F
2015F
United States
2.6
–
2.8
3.1
Canada
2.3
–
2.2
2.5
Japan
1.6
–
1.4
1.3
UK
2.5
–
2.7
2.5
Developed markets
Eurozone
1.0
–
1.1
1.4
France
0.8
–
0.8
1.2
Germany
1.8
–
1.8
2.0
Spain
0.6
–
0.9
1.5
Italy
0.5
–
0.5
1.0
2.3
–
1.8
2.1
China
7.5
–
7.4
–
India
5.4
–
5.4
–
Emerging markets
Brazil
Mexico
3.4
–
3.0
4.0
Russia
2.3
–
1.3
2.1
South Africa
2.8
–
2.6
3.3
South Korea
3.5
–
3.5
–
Turkey
3.7
–
2.2
3.8
World
2.4
–
3.0
3.3
Any forecast, projection or target is indicative only and not guaranteed in any way.
Source: Consensus Economics, as of March 2014.
32
Consensus Economics’ inflation forecasts
December 2013 Consensus
2014F
2015F
United States
2.6
Canada
2.3
March 2014 Consensus
2014F
2015F
–
1.7
2.0
–
1.5
1.9
Developed markets
Japan
1.6
–
2.6
1.7
UK
2.5
–
2.0
2.2
Eurozone
1.0
–
0.9
1.3
France
0.8
–
1.1
1.4
Germany
1.8
–
1.5
1.9
Spain
0.6
–
0.5
1.1
Italy
0.5
–
0.9
1.2
Brazil
6.0
–
6.0
5.6
China
3.1
–
2.9
–
Emerging markets
India
8.0
–
8.0
–
Mexico
3.9
–
4.1
3.5
Russia
5.2
–
5.8
5.1
South Africa
5.7
–
5.6
5.9
South Korea
2.1
–
2.1
–
Turkey
6.6
–
8.1
6.8
World
2.7
–
3.0
3.1
Any forecast, projection or target is indicative only and not guaranteed in any way.
Source: Consensus Economics, as of March 2014.
HSBC Q2 2014 33

Policy rates
uuMonetary policy: Consensus forecasts for interest rates
in the US, the Eurozone and Japan indicate that policy
rates are likely to be on hold, at least for the next 12
months. However, market implied policy rates suggest
further rate hikes in Brazil and now possibly in South
Africa and Mexico in the coming 12 months.
Market implied policy rates
Current (%)
3 months (%)
12 months (%)
FED
0-0.25
0-0.25
0-0.25
ECB
0.25
0.25
0.25
BOE
0.50
0.5
0.75
BOJ
0-0.1
0-0.1
0-0.1
Developed markets
Emerging markets
Brazil
10.75
11.0
11.5
India
8.00
8.00
8.00
Korea
2.50
2.50
2.75
Mexico
3.50
3.50
3.75
South Africa
5.50
5.75/6
6.50
Taiwan
2.00
1.75/2
2.00
Turkey
12.00
12.25
12/12.25
Sources : Merrill Lynch, JP Morgan, Barclays, Deutsche Bank, Danske, Westpac, HSBC, Nomura, Credit Agricole, Société Générale, UBS, Citigroup, Commonwealth
Bank and HSBC Global Asset Management, as of 31 March 2014.
Central bank interest rate setting meetings
Date
Country
Event
06 May 2014
Eurozone
ECB interest rate decision
20 May 2014
Japan
BoJ interest rate decision
05 June 2014
Eurozone
ECB interest rate decision
06 June 2014
UK
BoE MPC interest rate decision
13 June 2014
Japan
BoJ interest rate decision
18 June 2014
US
Interest rate decision
03 July 2014
Eurozone
ECB interest rate decision
10 July 2014
UK
BoE MPC interest rate decision
30 July 2014
US
Interest rate decision
07 August 2014
Eurozone
ECB interest rate decision
08 August 2014
UK
BoE MPC interest rate decision
08 August 2014
UK
BoE MPC interest rate decision
17 September 2014
US
Interest rate decision
Source: HSBC Global Asset Management and Bloomberg, as of March 2014.
34
Currency expectations (quoted versus USD)
Spot
3 months
ago
1.38
1.38
6 months 12 months
ago
ago
2 months
forward
6 months
forward
1.38
1.38
9 months 12 months
forward
forward
Developed world
Eurozone (EUR)
UK (GBP)
Japan (JPY)
Sweden (SEK)
1.35
1.29
1.38
1.38
1.67
1.66
1.62
1.52
1.66
1.66
1.66
1.66
103.4
105.3
98.0
93.2
103.3
103.3
103.2
103.1
6.45
6.45
6.36
6.52
6.46
6.47
6.48
6.49
Norway (NOK)
5.97
6.07
6.00
5.83
5.98
6.01
6.03
6.05
Switzerland (CHF)
0.88
0.89
0.91
0.95
0.88
0.88
0.88
0.88
Australia (AUD)
0.93
0.89
0.94
1.04
0.92
0.91
0.91
0.90
Canada (CAD)
1.11
1.06
1.03
1.02
1.11
1.11
1.11
1.12
New Zealand (NZD)
0.87
0.82
0.83
0.84
0.86
0.85
0.85
0.84
6.21
6.05
6.12
6.21
6.25
6.26
6.27
6.28
Asia
China (CNY)
7.76
7.75
7.75
7.76
7.76
7.75
7.75
7.75
India (INR)
Hong Kong (HKD)
59.88
61.92
62.63
–
60.55
62.01
63.19
64.22
Indonesia (IDR)
11313
12180
11401
9725
11387
11637
11853
12037
Malaysia (MYR)
3.26
3.28
3.24
3.09
3.28
3.30
3.31
3.33
Philippines (PHP)
44.76
44.39
43.33
40.81
44.80
44.94
45.03
45.14
Singapore (SGD)
1.26
1.26
1.25
1.24
1.26
1.26
1.26
1.26
South Korea (KRW)
1058
1056
1074
1115
1060
1067
1071
1074
Thailand (THB)
32.37
32.95
31.23
29.31
32.46
32.67
32.83
32.96
Czech Republic (CZK)
19.90
19.90
18.96
20.08
19.90
19.88
19.86
19.84
Hungary (HUF)
223.2
216.4
218.9
236.7
224.0
225.6
226.7
227.8
Poland (PLN)
3.03
3.02
3.12
3.25
3.04
3.06
3.08
3.10
Russia (RUB)
35.11
33.71
32.21
31.14
35.59
36.55
37.32
37.95
2.15
2.15
2.01
1.81
2.19
2.27
2.33
2.38
10.61
10.53
10.13
9.20
10.71
10.93
11.12
11.31
8.00
–
5.80
–
8.34
9.40
10.24
11.24
EEMEA
Turkey
South Africa (ZAR)
LatAm
Argentina (ARS)
Brazil (BRL)
Mexico (MXN)
2.27
–
2.22
2.02
2.31
2.39
2.44
2.50
13.07
13.05
13.16
12.36
13.13
13.25
13.35
13.45
Source: Forward currency rates sourced from Bloomberg, as of 31 March 2014.
HSBC Q2 2014 35

Global equity market performance (MSCI indices)
Total return (% in USD terms) – MSCI indices
-1M
-1Q
-1Y
YTD
Developed world
0.2
1.4
19.7
1.4
Emerging world
3.1
-0.4
-1.1
-0.4
North America
0.7
1.8
20.9
1.8
Europe
-1.0
2.2
25.2
2.2
0.1
2.8
34.1
2.8
Eurozone
Europe ex-UK
0.1
3.7
29.5
3.7
Asia Pacific ex-Japan
2.4
3.0
1.6
3.0
Australia
4.0
6.0
1.3
6.0
Austria
-2.8
-2.7
16.5
-2.7
Belgium
-0.2
2.4
21.1
2.4
Brazil
11.0
2.9
-12.7
2.9
Canada
1.5
1.8
7.2
1.8
Chile
3.0
-2.2
-26.5
-2.2
China
-1.7
-5.9
2.5
-5.9
15.7
5.1
-11.3
5.1
2.1
7.6
15.1
7.6
Denmark
-1.9
16.5
40.6
16.5
Egypt
-2.4
9.2
32.5
9.2
Finland
-2.1
0.3
44.0
0.3
France
-0.1
3.0
30.6
3.0
Germany
-1.7
-0.3
31.7
-0.3
Colombia
Czech Republic
Greece
1.1
18.1
58.1
18.1
-2.2
-3.4
3.7
-3.4
Hungary
1.5
-8.7
-7.9
-8.7
India
8.7
8.2
6.7
8.2
Indonesia
5.5
21.2
-17.8
21.2
Ireland
-7.0
14.2
43.4
14.2
Italy
6.4
14.6
54.1
14.6
Japan
-1.2
-5.5
7.8
-5.5
Hong Kong
Korea
0.2
-2.0
5.5
-2.0
Malaysia
1.4
-0.4
8.2
-0.4
Mexico
5.5
-5.0
-10.2
-5.0
Netherlands
1.1
1.1
30.1
1.1
New Zealand
6.8
16.7
18.0
16.7
Norway
1.5
2.2
12.3
2.2
Peru
1.9
4.4
-24.9
4.4
Philippines
0.2
10.3
-9.1
10.3
Poland
-2.0
3.4
21.1
3.4
Past performance is not an indication of future returns.
Source: MSCI, Thomson Reuters Datastream and HSBC Global Research, as of 31 March 2014.
36
Total return (% in USD terms) – MSCI indices
-1M
Portugal
-1Q
-1Y
YTD
1.7
9.7
23.6
9.7
Russia
-2.5
-14.4
-10.5
-14.4
Singapore
2.6
-0.9
-2.1
-0.9
South Africa
6.7
4.9
8.4
4.9
Spain
2.4
4.8
46.5
4.8
Sweden
0.0
3.0
18.2
3.0
Switzerland
0.2
5.1
20.1
5.1
Taiwan
2.8
1.1
11.2
1.1
Thailand
5.0
7.5
-16.4
7.5
Turkey
16.8
4.8
-28.8
4.8
UK
-3.2
-0.8
16.8
-0.8
US
0.7
1.8
22.0
1.8
Past performance is not an indication of future returns.
Source: MSCI, Thomson Reuters Datastream and HSBC Global Research, as of 31 March 2014.
GEMs equity valuations
End year PE (x)
End year EPSg (%)
PEG
2012e
2013e
2014e
2012e
2013e
2014e
2014e
China
8.4
7.5
7.5
8.9%
11.7%
-0.3%
-22.8
India
14.3
12.5
9.5
17.3%
14.5%
32.2%
0.4
Indonesia
14.7
13.0
11.4
9.5%
13.1%
13.5%
1.0
9.0
8.1
7.3
25.1%
11.7%
10.6%
0.8
Korea
Malaysia
15.8
14.4
13.6
5.2%
10.0%
6.1%
2.4
Philippines
18.9
16.5
15.6
7.9%
14.8%
5.8%
2.8
Taiwan
14.6
13.2
9.9
8.6%
10.7%
34.2%
0.4
Thailand
12.0
10.7
9.9
13.5%
11.4%
8.9%
1.2
Czech Republic
11.9
12.7
12.9
-10.1%
-6.2%
-1.4%
-8.9
9.2
7.8
7.0
-12.6%
17.9%
12.4%
0.6
Poland
13.4
12.0
11.1
-1.5%
11.8%
8.2%
1.5
Egypt
10.8
9.8
6.2
57.2%
10.4%
58.3%
0.2
Hungary
Russia
4.2
4.3
3.7
-1.4%
-1.7%
13.8%
0.3
14.5
13.2
11.9
13.7%
10.4%
10.3%
1.3
Turkey
9.5
7.9
7.0
-4.7%
20.4%
11.6%
0.7
Argentina
6.4
6.2
5.9
-4.7%
2.9%
5.3%
1.2
Brazil
9.0
8.1
7.3
14.2%
11.1%
11.4%
0.7
Chile
14.8
12.3
11.4
36.1%
20.3%
7.6%
1.6
Colombia
14.8
13.5
11.7
16.4%
9.7%
15.4%
0.9
Mexico
17.4
15.3
13.0
12.8%
13.9%
17.5%
0.9
Peru
12.2
10.5
8.5
75.5%
16.3%
23.3%
0.4
GEMs
10.3
9.3
7.9
11.0%
10.6%
17.4%
0.5
South Africa
PE = price earnings; EPSg = earnings per share growth; PEG = price/earnings to growth ratio. Data is for end year.
Source: IBES estimates, MSCI, Thomson Reuters Datastream and HSBC Global Research, as of 31 March 2014.
HSBC Q2 2014 37
Contributors
Julien
Seetharamdoo,
Chief Investment
Strategist
Hervé Lievore,
Senior Macro
and Investment
Strategist
Renee Chen,
Macro and
Investment
Strategist
38
Julien Seetharamdoo is Chief Investment
Strategist within HSBC Global Asset
Management’s Macro and Asset Strategy
team where he provides analysis and
research on the key issues facing the
global economy and asset markets. Prior
to joining HSBC, Julien has worked for
Coutts Investment Services, RBS and
Capital Economics. He holds a first class
degree in Economics from Cambridge
University and a PhD. in Economics from the
Management School, Lancaster University
focusing on the implications of the European
Monetary Union.
Hervé Lievore is Senior Macro and
Investment Strategist based in Hong Kong.
Before joining HSBC, he spent five years at
AXA Investment Managers in London and
Hong Kong as an economist and strategist,
covering Asia and commodities. He was also
involved in the firm’s tactical asset allocation
committees. He started his career 18 years
ago at Natixis in Paris, where he mostly
covered Asian markets.
Renee Chen joined HSBC Global Asset
Management as Macro and Investment
Strategist in April 2012. Prior to this role, she
held Economist roles at Macquarie Capital
Securities, Nomura and Citigroup and has
over 13 years’ experience in economic and
policy research. Renee holds a master’s
degree in International Affairs and Economic
Policy Management from Columbia
University, New York and an MBA in Finance
and Investment from George Washington
University, Washington DC.
Joe Little, Senior
Investment
Strategist
Marcus
Pakenham,
Director, Product
Specialist
Paras Patel,
Associate, Macro
and Investment
Strategy
Joe Little is a Senior Investment Strategist
specialising in Multi Asset Research. He
works on Asset Allocation and Portfolio
Strategy for HSBC’s Multi Asset funds.
Previously he was a Fund Manager on the
HGIF Global Macro Fund and a sell-side
Economist at JP Morgan Cazenove. He
holds an MSc in Economics from Warwick
University and is a CFA charterholder.
Marcus Pakenham is the Product Specialist
for the global and sterling fixed income
funds managed in London and New York
and has been working in the industry since
1985. Previously he has managed GEM and
Asian portfolios. Prior to joining the firm
in 1999, Marcus worked for Global Asset
Management. He holds an MA degree in
Politics, Philosophy and Economics from
Oxford University.
Paras Patel is an Associate Macro and
Investment Strategist within HSBC Global
Asset Management. Prior to joining HSBC
Asset Management, Paras worked in the
sell side with HSBC Global Research as an
Associate in the Global Emerging Markets
team. He holds a first class degree in
Engineering from the University of Warwick
and a master’s degree in Finance from
Warwick Business School.
This document has been written by HSBC Global Asset Management (UK) Limited. This document has been approved for distribution in UAE, Qatar, Bahrain,
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Group. The views expressed are those of HSBC Global Asset Management and do not constitute investment advice. No liability is accepted to recipients acting
independently on its contents. Past performance should not be seen as an indication of future returns. The value of investments and any income from them can
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accepts no liability for any failure to meet such forecast, projection or target. This material is distributed by HSBC Bank Middle East Limited. Regulated by the
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