Fed Unwinding of QE Has Limited Hong Kong Impact, JPMorgan Says

A gradual increase in U.S. interest rates will have limited impact on Hong Kong equities because benefits from a stronger economy will outweigh the negatives, according to JPMorgan Asset Management Ltd.

The Federal Reserve may slow its asset purchases in the second half of this year if the U.S. labor market continues to improve, and may start raising interest rates from mid- to late 2014, said Tai Hui, Hong Kong-based chief market strategist for Asia at JPMorgan Asset Management, which oversees about $1.5 trillion globally. A liquidity withdrawal caused by U.S. interest-rate hikes will have little impact on the city’s equity market because most of the fund flows associated with quantitative easing have been into fixed income, he said.

“As long as it’s not a shock to the upside in interest rates, Hong Kong should be able to withstand it,” Hui said in an interview on May 29. “We still like equities despite acknowledging the event of the Fed cutting back on quantitative easing and raising interest rates.”

The Hang Seng Index surged 21 percent from September through January as the Federal Reserve undertook a third round of quantitative easing. Cash inflows forced the Hong Kong Monetary Authority to intervene in foreign-exchange markets for the first time in three years in order to protect the Hong Kong dollar’s peg to the U.S. currency.

Federal Reserve members are debating when to reduce stimulus that includes holding benchmark interest rates in a range of zero to 0.25 percent and $85 billion a month of bond purchases. Chairman Ben S. Bernanke said last week that the central bank could begin winding that back if the economy shows sustained improvement.

Worst Market

Even with increasing evidence of a recovery in the world’s largest economy, Hong Kong’s benchmark Hang Seng Index is down 1.7 percent this year, the worst among developed markets.

Slowing growth in China and government efforts to damp property prices in Hong Kong and the mainland have weighed on equities. Brokerages and the International Monetary Fund lowered their forecasts for world’s second-biggest economy last month. Government data on June 1 showed the nation’s manufacturing expanded last month, while a private survey yesterday from HSBC Holdings Plc and Markit Economics signaled a contraction.

“When Chinese growth is not matching expectations, it will be a struggle for Hong Kong to perform well,” Hui said. “Over the long run, we still think China is cheap. There’s a lot of potential, but you need earnings to really set the house on fire and that’s just not happening.”

Buying Opportunities

Still, there’s buying opportunities in Chinese companies listed in Hong Kong and in the mainland, Hui said, without naming any companies.

Financial companies have room for organic growth, he said. Valuations are attractive after shares priced in potential credit quality concerns.

A gauge of banks, developers and insurers in the MSCI China Index is down 3.7 percent this year and is trading at 6.9 times estimated earnings. That compares with a global financials measure, which trades for 12 times estimated earnings after gaining 8.7 percent this year.

Consumer companies may have steady growth and investors are willing to pay a premium, Hui said. Exporters and materials companies should be avoided because of the slow European economy and a sluggish recovery in the U.S., he said.

Asian equities will offer returns through the second-half of this year and into 2014, according to Hui. The upside for equities relative to bonds is much more attractive because capital gains for fixed income will be limited, he said.

“We have been advocating to clients they should really start to tip-toe back into equities,” Hui said, noting that the company may increase its equity allocation further. “When earnings start to cooperate, we will advocate an even more aggressive stance on equities.”

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