Hou Wey Fook, DBS
The prevalence of negative real rates around the world is here to stay as inflationary pressure rages on while policymakers continue to maintain an overall stance of monetary accommodation, according to DBS.
In the US, even if the Federal Reserve proceeds with three rate hikes in 2022 (assuming 6% inflation), that would only bring real interest rate to -5%, Hou Wey Fook, chief investment officer at DBS, said in the bank’s its 2022 first quarter investment outlook.
“Negative real rates are stimulative for economies as they encourage credit growth and help governments finance outstanding debt burdens. More importantly, negative real rates are also commonly associated with strong performance in the equity markets,” Hou said.
Much has been said about equity valuations being elevated, in particular, on a forward price to earnings ratio basis. But, from a portfolio perspective, looking at equity valuations on a standalone basis makes little sense as this methodology does not take into account the valuation of other asset classes, he added.
In an environment flushed with central banks’ largesse, money needs to find a home (in either bonds or equities) and the more appropriate valuation tool here is the ERP. Based on DBS’s dividend discount model, the ERP for US equities currently stands at 4.4%. While it is lower than the 5.0% ERP seen at the start of 2021, it remains above the long-term average of 3.9%; this augurs well for the outlook of the asset class.
“Heading into 2022, we maintain our positive stance on US and Europe, and stays underweight in Asia ex-Japan and Japan equities,” Hou said.
The earnings outlook for technology-related companies remains robust and the high concentration of tech exposure in US looks well for the trajectory of S&P500. Resilient earnings growth is likely to support momentum in US equities despite the Fed’s policy tightening, and big tech will continue to lead the way with health care and financials also favoured he explained.
Europe versus Asia
The positive case on Europe is two-fold, Hou said. First, the European Central Bank is one of the more dovish central banks in developed markets (DM) and the persistence of monetary accommodation will be supportive of domestic equities. Second, the absence of sharp wage pressures in the region reduces margin pressure for European companies.
Meanwhile, as the Federal Reserve cuts back on its asset purchases, the underperformance of Asia ex-Japan relative to DM is expected to persist in coming quarters. “We will review our underweight call on Asia ex-Japan should greater policy clarity in China – in particular the internet space – emerge,” according to Hou.
DBS has been underweighting Asia ex-Japan since the fourth quarter of 2021, but Hou urged investors not to write off China a few months ago.
There have been 30%-to-40% plunges in the Chinese stock market every few years during other periods of heightened Sino-US trade tensions and domestic fiscal and monetary tightening, but very quickly afterwards, the market recovered and bounced back to new highs, he said.
Although several asset managers also favour US and European equities over Chinese equities, others such as Blackrock hold the opposite opinion. They believe it is time to invest in China.
The regulatory clampdown on several business sectors last year resulted in market volatility in the near term, but the measures are necessary to transit the country’s economic structure to the next stage, according to Blackrock, which also predicts more pro-growth and pro-market policies to kick in from the People’s Bank of China this year.