Converging on divergence in 2012 - The Asset

Significant room for upside despite dark macro-economic clouds<strong>Converging</strong> ondivergence in 2012What is in store for Asiancredit markets in 2012? Thetop individuals in sales, tradingand research were nominated byinvestors globally in this year’sAsian G3 bond survey. Froma record of more than 430nominees, the top ten in eachcategory share their outlookfor the year ahead– By Asset Benchmark ResearchECONOMISTSlater in the year.Johanna ChuaEnd of the bear marketI think we are in theend of the bear market– we will see somespread widening inthe near term, butthen I expect stabilizationand recoveryKaushik RudraCredit cycle turningI expect 2012 to bea challenging yearfor the Asian bondmarkets. Global riskassets are likely tocome under significantpressure inearly 2012, as the European sovereigndebt crisis intensifies. However,I expect the Asian bond markets toperform well in the second half of theyear following our expectation of theresolution of the crisis.I expect Asian credit markets tohave a negative 3% first quarter returnfor 2012; however, for the year as awhole, I expect the market to generatemoderately positive 5.7% returns. Thecredit cycle appears to be turning – withcredit fundamentals having peaked forboth banks as well as corporates.Viktor HjortBullish on global creditmarketsWe are bullish onglobal credit markets.The re-pricingof corporate creditwas significant lastyear. While we expectmany of the challenges to remain,we see scope for spread tightening onthe back of (i) recession-discountingvaluations; (ii) compelling micro fundamentalsbalancing the macro risks; andEconomists and credit strategistsRank Name and Bank1 Johanna Chua, Citi b2 Kaushik Rudra, Standard Chartered Bank3 Wang Tao, UBS4 Frederic Neumann, HSBC b5 Jonathan Anderson, UBS b6 Viktor Hjort, Morgan Stanley7 Tao Dong, Credit Suisse8 Krishna Hegde, Barclays Capital9 David Fernandez, J.P. Morgan10 Joey Cuyegkeng, ING bb Ranked in the top 10 for thepast three years or longer(iii) a sluggish but fixed-income-friendlygrowth environment. We see US financialsand high yield (HY) as amongthe most compelling credit trades globally,and within Asia we are most bullishon China HY.Krishna HegdeDeterioration in creditfundamentalsWe have a constructiveoutlook for creditmarkets in Asia for2012. Valuations inAsia provide significantroom for upside,even accounting for the deteriorationin credit fundamentals for the region.Regional dynamics remain supportive– in terms of strong investor interestand flows into Asia, coupled withbenign sovereign profiles. Investorsare being amply compensated for thevarious risks spanning European sovereignsand banks, a softness in globalgrowth as well as a slowdown in China.That said, volatility may remain elevatedat least in the first part of the year.ANALYSTSEdwin ChanSpreads to tightenWe are constructiveon the Asian dollarbond market for2012, as we expectcredit spreads totighten and Asia tooutperform the USas market beta falls.Still solid fundamentals, attractive valu-38 February 2012No unauthorized reproduction by any means.All rights reserved. Asset Publishing and Research Limited

How China manœuvres itself through the year willaffect how Asian credit markets perform in 2012ations and some stabilization in the marketshould argue for sector rotation intoAsian dollar bonds, which means highernet inflows. However, we will need togo through the initial period of volatility,though so far the market turns out tobe firmer than expected – which we willtake advantage of by finding better entrypoints for bonds we like.Harsh AgarwalConstructive on marketsin the near termAsian HY corporatebonds have made astrong start to theyear. Technicals remainstrong as of now,but the lack in HYsupply – unlike high-grade (HG) – hasmade most real money investors underweightin HY and hedge fund investorssitting on a lot of cash. This could changeif we see a major negative headline fromEurope, potentially from Greece. However,the consequent dip is likely to beshort and shallow and investors coulduse it as a buying opportunity. Our largernear-term concern is fresh supply in theHY space, as we think there is a lot ofpent-up demand from issuers with USdollar bond markets closed for aroundseven months. Apart from this, headlinescould come from a China and Indiasoft landing, disappointment with USgrowth, etc. So, while we are constructiveon markets in the immediate future,we suggest investors should gradually useit as a way to cut longs and wait for theirchances to get long again.Imtiaz ShefuddinMost of the attention onEurozone eventsLike 2011, 2012 willbe another challengingyear, more so asexternal events willhave a major influenceover the performanceof Asian credit markets. We expectmost of the attention to be on howevents in the Eurozone pan out. HowAnalystsRank Name and Bank1 Edwin Chan, UBS b2 Harsh Agarwal, Credit Suisse3 Imtiaz Shefuddin, Royal Bank of Scotland b4 Pradeep Mohinani, Nomura5 Vivien Gui, Morgan Stanley6 Dilip Shahani, HSBC7 Ray Heung, BNP Paribas b8 Annisa Lee, Nomura9 William Mak, Nomura10 Keith Chan, HSBCChina manœuvres itself through the yearand whether or not this comes with areasonably robust growth rate (hard orsoft landing) will be another major factorin how Asian credit markets perform in2012. Our current forecast is for Chinato record an 8.5% GDP growth rate in2012, although we remain conscious ofthe broader implications of several ‘whatifs’ and/or a larger than expected slowdown.Current credit spreads providefor significant spread contraction opportunitiesin the event of some favourableoutcomes. However, just as 2011has shown on a couple of occasions, theimportance of a disciplined approach towardsstock picking with a focus on bondstructures and covenants remains – if ithasn’t grown.Pradeep Mohinani,Annisa Lee,William MakPoorest liquidityconditions since 2008Since mid-2011, Asiancredit spreads havewidened by 80bp to100bp for HG andHY sovereigns and by 350bp for HY corporatebonds to current levels of 300bp,285bp and 940bp, respectively, and historicaldata suggests that a recession isclose to being priced in. On the otherhand, we need to consider that liquidityconditions are the poorest since 2008,with dealer inventory running at nearten-year lows.Also, we are certainlya long way frompricing in systemicrisks. Of course, wecould further complicatematters byfactoring in the riskof a China hard landing.But for starters,if Lehman’s collapseis any guide, HG corporatespreads wereas wide as 670bp,HY sovereigns 950bpand HY corporates2,700bp in the fourthquarter of 2008.Our recommendedtrading strategy heading into 2012 isaimed at protecting capital in HG, whilefocussing on generating sufficient returnsfrom the wider HY trading creditsthat are unlikely to be default candidates.Vivien GuiBetter return thanlast year2012 will be a bumpyride. However, itshould end up withbetter returns than2011 with the EUhaving a clearer wayout and China turning to looser policies.Dilip ShahaniShift to a defensive ornegative positionWe have shifted backto a defensive ornegative position towardsthe Asian credituniverse, from ourneutral position lastAugust. Putting this viewpoint into thecontext of credit performance, we see theHSBC Asian Dollar Bond Index (ADBI)and Asian HY Bond Corporate Index(AHBI-Corp) spreads revisiting the wideprints of around 440bp and 1,150bp,respectively, before the end of the firstquarter of 2012. We are calm about theUS Treasury yield direction and volatil-No unauthorized reproduction by any means.All rights reserved. Asset Publishing and Research LimitedFebruary 2012 39

Regulatory considerations and the race to meet Basel IIIrequirements will constrain banks’ balance sheetsity, with the Fed committed to holdingits policy rate steady until mid-2013.Equally important, the Fed continues tosignal a bias to further monetary easing,especially as the US still faces headwinds.In the corporate and sovereign space, weadopt a defensive stance in view of theweak outlook for the first quarter of 2012and recommend high-quality names.Besides the fundamental risks comingfrom Europe, we believe investorsneed to grasp the significance of thefront-loading of HG corporate and HYsovereign Asian new issuance in early2012. We are looking for gross total issuancein the range of US$65 to US$72billion in 2012, which is 96% to 106% ofthe 2011 level.Ray HeungTough year for investorsWe expect this year to be tough for investorsas a combination of macro andtechnical factors continue to linger. Onthe macro side, the European crisis isstill going to be themain focus. Again,Asian economies arelikely to performbetter but the Asiancredit universe willcontinue to ebb andflow with the globalfinancial market.Market makers in Asia are dominatedby non-Asian banks and with fundingcosts increasing, dealers’ inventory levelsand capacity to bid will be put to thetest. We expect a more volatile marketin 2012 overall.TRADERSDean WangSlower growth and lower ratesThe main theme of slower growth andlower rates remains. Risks from banks’deleveraging will persist. Similar to2011, this means continued volatilityand will require a constant reviewof trading strategies.Europe aside,regulatory considerationsand the raceto meet Basel III requirementswill constrainbanks’ balancesheets. This dragslevels of intermediaryactivities lower, thereby hurtingmarket liquidity. I see these factorsdampening risk appetite over time.However, cash needs a home eventually,and I think credit will remain thepreferred asset class.Archie SyResults hinge onmarket timingWith benchmark ratesnow being kept lowerfor longer and longer(again), it is easyto get sucked intothe carry game andSpread forecasts for Asian G3 bonds from the end of 2011 to the end of 2012 and expected total return for the yearHigh yield (bp)> +200+200+100 Viktor Hjort (+110)Evelyn Wong0 Sandeep AggarwalJohanna Chua (from -100 to 0)Ray Heung-100 Nicolas LeeJay ParshottamKaushik RudraArchie SyBarry TanTiong Su Ming-200 Edwin ChanKrishna HegdePracheesh MishraImtiaz Shefuddin< -200 Angela ChanVivien GuiDean WangInvestment grade (bp)> +50+50 Ray Heung+25 Vivien Gui0-25 Sandeep AggarwalJohanna ChuaViktor Hjort (-35)Pracheesh MishraKaushik RudraArchie SyBarry TanTiong Su MingEvelyn Wong-50 Angela ChanKrishna HegdeNicolas LeeDean Wang< -50 Edwin ChanJay ParshottamImtiaz ShefuddinTotal return (%)> 12.510-12.57.5-10 Angela ChanEdwin ChanPracheesh MishraImtiaz ShefuddinDean Wang5-7.5 Sandeep AggarwalVivien GuiKrishna HegdeNicolas Lee (< 6)Kaushik RudraBarry TanEvelyn Wong2.5-5 Johanna ChuaRay HeungArchie SyTiong Su Ming0-2.5 Jay Parshottam< 040 February 2012No unauthorized reproduction by any means.All rights reserved. Asset Publishing and Research Limited

It is going to be challenging for the Asian credit marketsto have a sustained medium to long term rally in 2012be a buyer on anything that resemblesa decent spread. This is like déjà vu –remember late 2010 to early 2011? –although you didn’t have an EU sovereigndebt crisis at that time. As an assetclass, credit markets in general will takea liking from investors with benchmarkrates staying low. But with the Europeanproblems not going away soon,coupled with a questionable recovery inthe US and reservations on Asia’s resiliency,it will be a trading market, withenough volatility to keep us on our toes.Returns will greatly hinge on markettiming and stock picking, which won’tbe easy, in light of the risks mentioned.Jay ParshottamContinued volatility2011 highlighted thefact that the Asianmarkets depend largelyon G3 economiesand returns in bondand equity markets underperformedthat ofthe US significantly, even though mostof the global concerns began from Europeand the US. I think 2012 is a yearof low rates and continued volatilityof Asian credit markets. In addition tothe uncertainty in G3, the Asian bondmarkets have several concerns of theirown: factors such as the outlook for theChinese economy; the state of its propertymarket; the onshore lending by itsbanks; and corporate governance. Aftersuch a weak performance in India in2011, many investors will be cautious togo back in until there is a clear directionon the domestic economy and stabilityin the currency. Lastly, the outlook forKorea with the new leadership in NorthKorea is also to be determined.In view of these factors, it is goingto be challenging for the Asian creditmarkets to have a sustained mediumto long term rally during 2012. Giventhe low level of borrowing rates in theUS dollar market, the external marketis going to remain attractive for issuersto raise money versus the domesticmarket, so supply will continue to hitTradersRank Name and Bank1 Dean Wang, Morgan Stanley b2 Kevin Aepli, UBS3 Archie Sy, Royal Bank of Scotland4 Jay Parshottam, Citi5 Nicolas Lee, Standard Chartered Bank b6 Richard Cohen, Credit Suisse7 Pracheesh Mishra, Citi8 Frederic Mahoue, BoAML9 Anthony Ngai, J.P. Morgan10 Sandeep Aggarwal, Nomurathe market, especially in the investmentgrade sector. I have a negative outlookfor Asian credit in 2012 relative to otherregions like Latin America.Nicolas LeeDynamic trading androtationsI am cautiously constructiveabout theAsian credit marketthis year for severalreasons. First, withthe market expectingabout US$60 billion in new issues,the supply-demand dynamic remainsfavourable with a low value of US$38billion worth of bonds redeeming. Especiallysince we expect inflows into theAsian credit market to remain positive,albeit not as robust as the last threeyears. Second, market participants aregenerally bearish and defensively positioned,which adds to the positive underlyingtechnicals. Third, a lot of therisk has been well flagged, which meansthe potential for a sudden surge involatility has diminished. Having saidthat, there are still a good number ofoverhangs. Doing well this year wouldrequire dynamic trading and rotations– and you would need to stay nimble.Pracheesh MishraPositive total returnsOur base case for 2012 envisages positivetotal returns for Asian credit witha trajectory involving a weak first halffollowed by a rallyinto the year-end asmultiple tail risksfrom Europe andChina get alleviated.Volatility will remainelevated as high cashlevels, light dealerbalance sheets andfickle/trading-oriented investor sentimentcontinues to magnify macro marketmoves.Additionally, total return based investorswill continue to find the Asiancredit market attractive, especially inHY, due to the twin attractions of double-digityields and low realized defaultrates. It is important to note that alternativescenarios for 2012 (all with negativecredit ramifications) have a muchhigher probability as compared to otheryears and those will result in potentiallymuch lower and possibly negative totalreturns.Sandeep Aggarwal2012 returns fromcouponsA lot of major risksmay crop up in 2012.Apart from the recessionand tail risksin Europe, there arerisks of a soft patch inthe US and major slowdown in China.There will be geopolitical issues in theMiddle East and North Korea that willcome into play.As such, I expect credit marketsto remain volatile. It is important tobear in mind that current wide creditspreads do incorporate these risks to afair degree. For example, high-yieldingChinese property bonds at yields of12% to 25% do price in major slowdownin China’s property sector. So,while we are starting this year withmuch wider spreads, the market has tograpple with a lot of macro risks. Onbalance, the wide credit spreads arelikely to persist alongside high volatility;with most of the returns for 2012coming from coupons.No unauthorized reproduction by any means.All rights reserved. Asset Publishing and Research LimitedFebruary 2012 41

By the second half of 2012, it will be easier to take directional risk in credit aswe would have more clarity on China’s growth outlook and the Eurozone crisisSALESPEOPLEEvelyn WongMarket likely tooutperform Europe andthe USI have adopted acautious outlook towardsthe Asian G3bond market in 2012.Having said that, themarket is still likely to outperform theEuropean or US G3 bond markets onthe expectation of deleveraging by Europeanbanks, more risk-conscious investorsand mounting new Asian corporateor bank issuers.Tiong Su MingMacro events driveperformance2012 will be the yearin which numerousmacro events drivethe performance ofAsian credit markets,rather than fundamentals.These events include the Eurozonecrisis, a soft or hard landingin China, the China property bubbleburst, US growth and elections, and theMiddle East tension and oil prices. Thisis why, despite knowing that certainspreads are wide to fundamentals andactual default risk, it is still hard to feeloptimistic on credit spreads going intothe first half of 2012.The two main developments thatclients are focussed on are the Eurozoneand China. In both, things are likely toget worse before getting better, so creditspreads have the potential to go muchwider following macro risk headlines.The Middle East tension can be a wildcard too, as investors overlook that risk.By the second half of 2012, however, itwill be easier to take directional risk incredit as we would have more clarity onChina’s growth outlook (assuming a softlanding as a base case) and the Eurozonecrisis would start to ease (assuming nobreakup of the Eurozone).In terms of the new issue pipeline,SalespeopleRank Name and Bank1 Evelyn Wong, Standard Chartered Bank2 Tiong Su Ming, Citi3 Barry Tan, Standard Chartered Bank b4 Stephen Mak, Barclays Capital b5 Angela Chan, UBS6 Jamie Fernando, Royal Bank of Scotland7 Chong Hui Chin, BoAML8 Una Lee, HSBC9 Leonora Lok, Citi10 Danny Lee, Royal Bank of Scotland= Anthony Neo, Citiwe expect much more supply from HG(especially in banks refinancing andGreater China corporates) as comparedto HY. With the deleveraging of Europeanbanks, corporates will have to turnmore to capital markets rather than thesyndicated loans market for funds.Barry TanGreater support forriskier assetsMacro headlines willcontinue to dominatethe bond marketsin 2012 and driveprices. It will be atale of two halves.In the first half of 2012, the unresolvedEuropean sovereign debt crisis, the developedmarkets growth story and thepotential of a Chinese hard landing willtake centre stage. This will likely lead toa flight to quality. Safe haven assets likeUS Treasuries and HG sovereigns andcorporates will therefore continue to bewell bid.That said, some of the bad news hasalready been priced in and any downsidewill be supported by fund flows awayfrom equities and into the bond markets,which will in turn prevent a massive selloff. Assuming quantitative easing in theUS and Europe later in the year, theglobal macro picture should improveand therefore enable greater support forriskier assets, particularly emerging marketand HY credits.Angela ChanFundamentals strongfor AsiaThe expectation ofthe EU entering intorecession this yeardoes not help marketsentiment. Yet,growth in other partsof the world is stable and flourishingin selected emerging market countries.The fundamentals are strong for Asia inview of slower but solid growth. Valuation,however, is still rich and technicalsremain supportive. Strong support inthe Asian primaries in the beginning ofthe year has shed some light in terms offund flows and sentiment. But consideringthat pent-up supply has been on thesidelines since last autumn, there is achance of some initial indigestion.Chong Hui ChinRipe conditions for creditspreads to narrowIt is hard to feel optimisticabout risky assetsin 2012, when investorsare confrontedwith the same issuesof sluggish economies,deleveraging balance sheets and fragileconfidence. Yet global markets shrug offS&P’s downgrade of nine Eurozone countries,S&P 500 posts the best start in 25years and US dollar credit issuances arecoming in strong. Are we surprised? Perhapsnot. Bond yields today are alreadypricing in a recession and investors aremore cashed up than before. Coupled withlight inventories on dealers’ books, conditionsare ripe for credit spreads to narrow.Still, investors will remain cognizantof volatility stemming from the Eurozonesovereign crisis. Most are painfully awarethat a relatively limited set of options isavailable to global policy makers and thatslowing growth raises the risk of policymissteps. Assuming discussions about theGreek debt crisis come to a head in thenext few months, and macro data improve,we could see a return in risk appetite, helpingspreads to tighten.42 February 2012No unauthorized reproduction by any means.All rights reserved. Asset Publishing and Research Limited