Carry An Umbrella | Value Research Simona Paravani, global CIO, Wealth, HSBC, believes that 2011 could see a few stormy showers…
Interview

Carry An Umbrella

Simona Paravani, global CIO, Wealth, HSBC, believes that 2011 could see a few stormy showers…

Simona Paravani, global chief investment officer, Wealth, HSBC Global Asset Management, believes that investors should invest not only across asset classes, but look to diversify across geographies as well. Excerpts from an interview with Sanjay Kumar Singh.

Which are some of the countries that you are really optimistic about this year?
If we start with developed markets equities, one country that we like tactically, and I stress tactically, because it means it could be a position that may not carry for the entire year, is Japan. That’s very much a tactical position driven partially by valuations, and partially by flows that have turned more positive. If one of those two factors were to change, we would most likely reverse position. So I wouldn’t call Japan a theme for 2011; it is more of a short-term idea.

Which are some of the emerging markets that you are positive about?
Within emerging markets, there are a number of interesting markets. For example, Brazil could be an interesting position from a medium- term perspective. While from a valuation point of view, Brazil and Latin America in general may not be as much of a bargain as they were, for example, in 2009, when they were trading at a very significant discount to Asia, even today valuations are still okay. And more importantly for investors worried about inflation, the Brazilian market, with its strong focus on commodities, could be of interest. Plus, it belongs to that part of the world that is growing at quite attractive rates.
Another interesting market is Russia, and again it’s a mix of factors there. From a valuation point of view, Russia stands out in terms of being attractively valued. It is trading at a price to earnings that is below seven. This is a very significant discount to other emerging markets and also compared to its own history. And given where the oil price is, and as we all know, energy is a very big component of the Russian market, that seems to be quite an interesting tactical opportunity to play.

What about the US?
The US is likely to see stronger growth, particularly in the first half of this year.

Would that be the result of QE2 (second quantitative easing programme)?
Not only that but also some of the other policy measures that have been put forward, such as taxation policy. Also let’s not forget that a lot of the policy measures enacted since the crisis act with a lag. So there is a series of factors at play. And as I said, there is also considerable cash on the balance sheet of corporate America that can be used for a variety of purposes, including investments. The recovery in the US underpins and supports our broadly positive view on equities, not just in the US but globally.
If we want to focus on where the strong convictions and ideas for 2011 are, I would put them more at the asset class level than individual equity markets. Because of the good macroeconomic picture, low interest rates and the high level of corporate cash, I think it is going to be a good year for risky assets, and in that I would include equities and high-yield debt. The real heart of the matter is pretty much an asset allocation decision as opposed to necessarily picking, say, between the US and the UK . It is more about being in risky assets such as equities and in high-yield debt.

Do you see the sovereign debt problem in Europe flaring up again this year?
When we look at level of spreads for any of the so called PIIGS countries, the level is well above any level that one can perceive as being normal or in line with history. To quote some statistics, if we look at Greek debt, Greek debt in terms of spread to German bonds in December 2007 was something in the region of 30 basis point, and now it fluctuates between 8 and 9 percentage points. That gives an idea that we are still not back to normal.
The issue with the Euro zone crisis is that the measures that have been put into place — and let’s not forget they were quite significant, amounting to about one trillion dollars — is that they are fine in terms of dealing with the problem when it is confined to relatively smaller players in terms of their contribution to GDP and the size of their debt, but it is unlikely to suffice if the crisis were to extend to bigger players. So again if you take Greece as an example, Greece accounts for less than 5 per cent of total Euro zone outstanding debt, and a small portion of GDP as well. But if the problem were to extend itself to some of the bigger players like Italy or Spain then we are in an entirely different space. Italy and Spain combined probably account for something in the region of 30 per cent of GDP and more than that in terms of their weight in the debt of the Euro zone. Italy alone accounts for about 24 per cent of Euro zone debt. So the bottomline is that for a final resolution of the Euro zone debt crisis, we need credible mechanisms for dealing with sovereign debt defaults in the monetary union.
Are we likely to see that? The answer is probably yes. But most of these processes are political in nature and are likely to take time. They will not happen overnight. So we’re likely to continue seeing volatility in the Euro zone, and more broadly in the developed world sovereign debt market, until the question is firmly and credibly addressed.

A lot of investments are now flowing into the northern Asian markets, like Taiwan and Korea. How do you view those markets?
The main attraction of markets like Korea and Taiwan is that they are export oriented and are likely to benefit as we believe, and other commentators do as well, that the US economy is likely to see a higher level of activity this year, particularly in the first half.
Korea is also a market that looks interesting from a valuation perspective.

Do you see oil prices moving higher?
The question is really how much higher could oil price go before it really becomes a problem. What is clear is that the higher it goes, the more likely it is to have an impact on inflation. And then we would be back to the key risk of monetary policy having to be restrictive to address the inflation issue.
It is very difficult to predict the point at which this is going to have a big impact on inflation. If we look at the developed world, United States and Euro zone, the inflation numbers, particularly core inflation, are not a cause for concern. Oil price would have to move much higher before inflation becomes a concern there, which would then lead to a change in interest-rate policy.
Another important point in linking commodity prices to inflation and central bank policies is whether these changes are expected to be just temporary. If these are largely temporary factors, then they would not have much of an impact on inflation expectations, so people would not change their wage demand or pricing policy. They are more likely to be worried by steady appreciation that is likely to last. In such a case they would most likely adjust their wage demands and prices, which, in turn could potentially exacerbate the inflation problem.

Aren’t the current levels already high?
We have been at higher levels earlier. We have to also take into account where the US dollar is and what is happening to the US dollar because most major commodities are priced in terms of the US dollar. While the oil price in USD was up by about 40 per cent in 2011 relative to the year earlier, the appreciation was a lot less when measured in emerging market currencies like the Brazilian Real.
Our forecast of global growth being in excess of 3 per cent is consistent with oil being in the elevated range that we have seen recently.

Would you like to add something?
I would like to leave you with an image that captures what 2011 would be like. It is a bit of a weather forecast. I think the overall weather forecast is for sunny days ahead but you still have the threat of a few stormy showers out there. The key advice to investors is to carry their own umbrella, which in practical terms means that diversification is a very important ingredient of investment. And by that we mean diversifying across asset classes and also geographical diversification to the extent possible.

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