Markets at the Tipping Point - Time for Portfolio Rebalancing?

Craig Williams, FT Knowledge Faculty

Read any quality financial newspaper, naturally our preference would be the Financial Times, and you’ll find yourself wading through descriptions of news events, tables of statistics, comments, and not just a little crystal-ball gazing. The problem for the professional or semi-professional investor is whether the doom-sayers, who have been predicting a pull back in the world’s economies are right, or the bulls who see growth and opportunity sprouting in many directions are more correct.

A glance at the stock market indices (rear of the second section - Companies and Markets, ‘World Markets at a Glance’) and you’ll find that most bottomed out in mid-March last year with Japan the same one month later. The previous page shows the major bond markets with the foremost showing historically steep yield curves and implying increasing public debt issuance. The US to fund its budget deficit and war on terror; Japan to finance currency intervention and banking system restructuring; and the Euro-zone to offset structural deficits.

The predominant currency trend at the moment is dollar’s weakness. In the Asia-Pacific region, this effect is focussing argument about an appreciation of the Chinese Yuan.

Hence, for investors in Asia, judging the future is a little more complicated. Geographically, North Asia has two power-houses: Japan, attempting for the fourth time to kick- start its economy and finally, beginning to address the dead-hand of non-performing loans (NPLs) in the banking system and at the same time trying to avoid its currency appreciating excessively and choking off export growth.

Next door, China, in an almost volcanic rumble, is pushing outwards ever more strongly and yet producing a sucking sound as it draws in capital, assets and commodities becoming the dominant driver of investor sentiment. On the opposite side of the Pacific, the western states of the US economy are straining to meet these twin demands and deficits. Outsourcing has suddenly become an issue, although perhaps it’s politics rather than the economics driving the dialogue. Nevertheless, the tariff reductions that come from China WTO membership are having a positive effect.

Sandwiched at the top of the region between these flows is South Korea. It has posted a 30% increase in exports in the past three months, although credit card losses problems are beginning to cause problems for the banks as the economy expands.

For South Asia, these trends are proving to be the opportunity to leave the shadows of the 1997 crisis and the more recent SARS one behind. The Australian and NZ currencies have surged past many commentator’s expectations to almost reach their 1996 highs. Singapore is adjusting to the opportunities and challenges. Malaysia is revitalising itself and the nascent capitalist economies in the centre of the region are finding themselves caught in the tide and are swimming hard to keep up. Thailand and Vietnam are growing strongly and Indonesia is beginning to recover as well.

Even more excitingly, another big beast is also in the water. India is flexing its economic muscles and is the third-force to be driving into the Asia-Pacific region.

The dilemma for our would-be portfolio manager is how to adjust from bond market rallies, equity market collapses and currency swings while taking advantage of these new trends.

Are there any other hints from our FT or other Pearson group publications? The Banker magazine in its New Year issue, surveyed the major banks and financial institutions around the world. Barcap (Barclays Capital) sees three major areas for explosive growth potential in the next year or so: structured credit-products and derivatives; commodities, specifically those for utilities, mining and metals firms driven by increasing Chinese demand, and the pure equity play. Various ‘bulge-bracket’ banks also discussed the increasing appetite for OTC derivatives in the US and the Asia-Pacific. All agreed that newer, liquid and more transparent products are pushing ever-more extensively into all regions.

A quick glance at other comments in our papers though gives us some pause for thought. Inflation, currently dormant in the major economies is one big issue that cannot be avoided. Commodity prices are rising, inevitably leading to more general inflation. A danger in our Asia-Pacific scenario is if the Chinese economy is seen to be over-heating and the authorities are forced to slow it down. What tools might be used, currency adjustments as currently being touted, or other forms of direct intervention remain to be seen. If they are too harsh and the markets take fright, then commodity prices could fall sharply. The impact on manufacturing goods could lead us with the irony of markets quickly retracing leaving our investor attempting to re-position again.

Portfolio rebalancing and asset allocation skills are what we need. Naturally, FT knowledge has a course to satisfy these demands.