Fixed-Income Yields Flash "Buy" Signal for Equities

How can investors tell if it is the right time to buy equities by studying the bond yields?

Global market suffered a severe slump in January 2008. The Hang Seng Index dropped by 21.8% year-to-date as at 22January 2008. Singapore’s FSTE STI index fell by 17.3% during the same period. Despite all the volatility going on, we think that it is important for us to look at what has happened so far and if equity markets remain attractive versus fixed income markets. Would any indicators from the fixed income market signal overselling in the equity markets?

Inflow of Money into Bonds

Global markets underwent a severe correction due to the concern of a recession in the US. Money flowed from equities to fixed-income markets. Chart 1 shows the US Treasury Yield Curve. This curve is constructed by six different maturity yield points – 3 month, 6 month, 2 years, 5 years, 10 years and 30 years. As shown in the chart, the curve shifted downwards from 9 January 2008 to 23 January 2008; hence, the bond prices increased. However, the yield dropped less than the Fed rate cut of 75 basis points on 22 January 2008. Table 1 shows the change in bond yield and prices. As shown in table 1, the 10-year Treasury price went up by 305 basis points within this short period. What does the sudden drop in yield signal for investors?

Chart 1: US Yield Curve

Source: Bloomberg

Table 1: US Treasury Yield

Maturity	Yield		Price		% Change
	09-Jan-08	23-Jan-08	09-Jan-08	23-Jan-08
3M	3.23%	2.32%	99.20122	99.42114	0.22%
6M	3.25%	2.35%	98.4079	98.83722	0.44%
2Y	2.71%	2.01%	101	102.3438	1.33%
5Y	3.13%	2.58%	102.25	104.8125	2.51%
10Y	3.81%	3.44%	103.5313	106.6875	3.05%
30Y	4.34%	4.20%	110.875	113.4375	2.31%

Source: Bloomberg and Fundsupermart.com Compilations

Bonds Are Overbought!

We believe bond yields are hitting the lowest level, signaling that bonds are overbought. Chart 2 shows the yield difference between the 2-Year Treasury and the Fed rate. Since 1990, there were only a few periods where we saw a negative number for the spread between the US 2-year Treasury yield and the Federal Reserve target rate. On 22 January 2008, after the sudden rate cut of 75 basis points (bps), the negative difference in spread narrowed from -209 basis points to -149 basis points, which means that the Federal Reserve overnight target rate is now 149 basis points higher than that of the 2-year Treasury bond yield. This would seem technically illogical because an investor is getting a much better yield (of 149 basis points) from depositing monies in overnight treasury bills than the 2-year short-term US fixed-income bond. Thus, we think that this may signal overbuying in short-term bonds and overselling in equity markets. In fact, we are starting to see signs of the negative spread narrowing.

We think that the negative spread would narrow and eventually normalise to a spread of above zero basis points. From chart 2, you can easily spot that for most of the time, the spread was above zero. Thus, in time to come, there is a strong likelihood that the spread will converge. But how would this happen?

There are two ways that the spread will converge –it is either the Fed cuts rates by another 150 bps to 2%, or the demand for US treasury bonds decline and money flows out from bond investments. When the demand for bonds declines, bond prices would go down and inversely, bond yields will be higher.

We think the first scenario of a 150 bps rate cut to ‘normalize’ spreads is not likely to happen in the very short-term. Particularly since the FOMC has just cut rates by 75 bps on 22 January - the largest single rate cut since 1984. However, it could be a possibility in the next one to two years if the FOMC really wishes to spur spending by using this expansionary monetary policy.

Thus, we think that the latter scenario is more likely to happen. If investors start to become less risk averse, it would mean that demand for bonds would decline; yields would then rise. When that happens, spreads would gradually normalize. Given that negative spreads is not something we usually see, it is likely that once investors regain confidence in the equity markets, money would tend to flow out of fixed income and move into equities.

Chart 2: 2-year Treasury Yield Significantly Higher Than the Fed Rate

Source: Bloomberg and Fundsupermart.com Compilations

Buying Opportunities For Equities

What does the narrowing of negative spreads mean to our investors? Judging from the spread in the bond markets, we think that it signals overbuying of fixed income, which in turn means buying opportunities for equities.

From Table 2, the 2008 Estimated PE for most of the Asian markets is attractive after the severe market correction. In addition, earnings growth remains strong for 2008 and 2009. From a 3-year investment time horizon point of view, it is definitely a good time to buy into Asia ex-Japan equities. Investors could take a look at our article: ‘ Asian Equity Markets on Sale!’ to find out more about our view on which markets look particularly attractive now.

Table 2: Attractive Valuation and Strong Earnings Growth (as at 22 January 2008)

Market	Estimated PE for 2008	Estimated PE for 2009	Growth Yr 08 (%)	Growth Yr 09 (%)
MSCI Asia ex Japan	14	12.6	15.9	11.5
Singapore	12.5	10.9	11.3	15.0
Hong Kong	14.4	12.4	12.6	16.4
Taiwan	13.9	13	17.7	6.5
Korea	10.6	9.7	17.6	8.5
China (HSMLCI)*	16.4	14.4	20.2	14.1
Malaysia	15.1	13.7	13.5	10.9
Thailand	7.8	7.3	21.8	7.2

Source: Bloomberg and Fundsupermart.com Compilations

Conclusion

Market volatility is increasing as we see more economic indicators pointing to a recession in the US. Even if the recession is short-lived, it would impact market sentiment, particularly that in the US. However, we believe the Asia ex-Japan region will continue with its growth. Developing Asia is slated to grow 8.3% in 2008, according to estimates from the International Monetary Fund. Furthermore, it has attractive valuations and healthy earnings growth levels. The Asia ex-Japan region’s earnings is forecast to grow at strong rates of 15.9% in 2008 and 11.5% in 2009, propelled by continued domestic spending, investments and intra-Asian trade. Hence, we are optimistic over the performance of Asia ex-Japan equities in the coming two to three years.

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Eddy Wong (Analyst & Financial Adviser Representative) is part of the Research and Editorial team at Fundsupermart.com, a division of iFAST Financial Pte Ltd.

Briefing: The falling dollar

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New Diabetes Drugs Bad for Bones - Avandia -- and Probably Actos -- Speeds Up Bone Loss

The diabetes drug Avandia promotes osteoporosis not only by slowing bone growth but also by speeding up bone loss. Actos, the only other drug in the same class, likely does this as well.

The finding, from mouse experiments by Salk Institute researcher Ronald M. Evans, PhD, and colleagues, helps explain why clinical studies show increased bone fracture risk in people taking Avandia.

Bones stay healthy through an ongoing process called remodeling. The body is constantly breaking down and rebuilding bone. This system of resorption and deposition is tightly controlled with many checks and balances.

"The drug shifts this balance on both sides," Evans tells WebMD. "People taking this drug have somewhat decreased bone deposition -- that is a known action of the drug, resulting in mild bone loss. But what we discovered is it increases bone resorption in a fairly robust way."

Avandia belongs to the glitazone class of drugs, which enhances a chemical signal called PPAR-gamma. One effect of the drug is to increase the body's sensitivity to insulin. But another effect, Evans and colleagues now show, is to activate the bone-eating cells called osteoclasts.

"I would expect to see the same thing with Actos, although we did not actually do that experiment," Evans says. "But it is almost certainly a drug-class effect because the mediator of this effect is the target of both drugs."

Bone Risk From Avandia, Actos

"This is not meant to scare people," Evans asserts. "Only Avandia and Actos act in this unique way, and these drugs are an overall benefit for the patients who take them."

But bone expert J. Edward Puzas, PhD, professor of orthopaedics at the University of Rochester, N.Y., says the new finding confirms something bone researchers have been worrying about.

"This is a nicely done study of how these drugs stimulate the cells that eat away at bone. This leads to lower bone mass and higher bone fragility," Puzas tells WebMD.

Puzas is worried because bone changes occur very slowly, so researchers may only be beginning to appreciate the scope of the problem.

Philip T. Rodgers, PharmD, clinical associate professor of pharmacy at the University of North Carolina, hopes the new findings will make doctors pay more attention to the bone risks posed by Avandia and Actos.

"There is an underappreciation of the risks of osteoporosis with these drugs," Puzas says. "I don't think doctors are paying enough attention to testing the bone-mineral density of people on these drugs."

Mary Anne Rhyne, a spokeswoman for Avandia maker GlaxoSmithKline, says the company is already aware of the drug's bone risks. She notes that the company recently updated the drug's label to reflect new data on fracture risk.

"We have a comprehensive, ongoing clinical program to better understand the mechanism of fractures," Rhyne tells WebMD.

While they worry about the bone risks from Avandia and Actos, both Puzas and Rodgers note that the drugs' benefits outweigh the risks for many patients.

Both suggest that doctors should screen patients for osteoporosis before starting them on Avandia or Actos therapy. And both suggest that patients taking the drugs should discuss bone-protection strategies with their doctors.

Meanwhile, Evans says the new findings should help researchers come up with new diabetes drugs that improve insulin sensitivity without stimulating bone loss.

Evans and colleagues report their findings in this week's advance online issue of Nature Medicine.

SOURCES: Wan, Y. Nature Medicine, published online Dec. 2, 2007. Ronald M. Evans, PhD, professor, Salk Institute for Biological Studies, La Jolla, Calif. J. Edward Puzas, PhD, professor of orthopaedics, University of Rochester, N.Y. Philip T. Rodgers, PharmD, clinical associate professor, University of North Carolina School of Pharmacy; director of pharmacy education, Duke University Medical Center. Mary Anne Rhyne, spokeswoman, GlaxoSmithKline.

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By Daniel J. DeNoon
WebMD Medical News

Reviewed by Louise Chang, MD

China 2007: An intimidating but brittle colossus

The 2008 Olympics has been billed as the biggest coming out party in history, delivering a stage on which China can reclaim recognition as one of the world’s great and powerful nations. But in truth, the Olympics will simply provide a high-grade political gloss for a nation that has already well and truly returned to a position of pivotal global influence.

After nearly three decades of uninterrupted economic expansion, and five straight years of double-digit-plus increases in output, China has become a motor of growth for the global economy and is on the verge of becoming the largest trading nation in the world.

The reconstruction of its cities and the building of new ones to absorb millions of rural migrants each year has translated into a huge demand for resources, lifting global prices for commodities such as copper, nickel and iron ore.

China is also staking its claim to the management and ownership of global resources, striking deals in central Asia, Australia, and, most controversially, in Africa, where state companies have been backed by concessional loans from Chinese development banks.

Chinese technology, telecommunications and shipbuilding industries are striving to compete on the world stage. they are laying the ground for a stronger indigenous military capability, delivering not just the ability to mount a decisive attack on Taiwan, but also, eventually, to project power into south-east Asia and the Indian ocean with a blue-water navy.

Although consumption continues to grow more slowly than investment and exports, China has also become the most promising new market in decades for a host of multinationals – from carmakers to fast-food companies and industrial goods suppliers.

China’s transformation has been backed with a relentless and, for the most part, highly effective diplomacy, which embraces international institutions and global multinationals, even as its tries to leverage them for domestic interests.

Beijing’s position on the United Nations Security Council has ensured that it has become an indispensable, if not always enthusiastic, partner for Washington, carrying messages to North Korea, and to a lesser extent, Burma, and cautiously moving in tandem with the west on issues such as Iran. At the same time, China has been willing to defend robustly its interests in places such as Africa, remaining loyal to the regimes in Sudan and Zimbabwe, despite mounting criticism from many western governments and activists.

Business criticism of Beijing in the US and Europe has been relatively muted, largely because of the huge investments of multinationals in China and the growth they foresee in the market. But the downside of high speed economic growth has seen China set other, less enviable records. Even with an economy that is a quarter to one-fifth the size of the US, China is set to surpass the US this year as the world’s biggest emitter of greenhouse gases, largely because of a surge of investment in capital- and energy-intensive industries since 2000.

The cost of China’s headlong growth is evident across the country in the biting air pollution in the cities, and the factory waste that has damaged agricultural land and rivers. The fruits of China’s growth have also not been evenly shared. China is now more “unequal” than the US and Russia, according to a recent study by the Asian Development Bank. It is a galling achievement for a country that claims to be still “in the early stages of socialism”, and has been identified as a big political problem by Hu Jintao, the president.

Even some statistics cited as signs of strength, such as the country’s bulging foreign exchange reserves, which stood at $1,400bn at the end of August, are increasingly a sign of weakness, and a millstone around the government’s neck.

China’s decision to manage tightly its currency, the renminbi, means it has no choice as to its level of foreign reserves. The dollars coming into the country have to be bought by the central bank to keep the renminbi basically stable.

With the trade surplus running at about $25bn a month, the reserves have been swelling rapidly, and for the most part earning a relatively paltry return in low-yielding securities overseas. Over time, as the US dollar declines, China will inevitably suffer huge losses on reserve holdings.

China’s refusal to allow its currency to appreciate faster remains difficult to fathom. A stronger currency would help damp rising inflation and capital inflows, and provide reduced incentives for exporters – a stated aim of government policy.

But caution, a byword in financial reform, and the need for consensus among powerful ministries, continues to stay the hand of policymakers. So too, according to many critics of the government, does the weakness of Wen Jiabao, the premier, who seems incapable of putting his personal stamp on financial and economic policy.

China is attempting to encourage an outflow of capital, and has also established a sovereign investment agency to chase higher returns for a portion of its reserves, but neither measure will be able to stem the tide of incoming funds for the moment.

All in all, a China that can look intimidatingly powerful from the outside can equally seem dangerously brittle when examined up close.

Senior Chinese officials offer a similar mixture of confidence and trepidation in interviews. Liu Mingkang, chairman of the China Banking Regulatory Commission, has presided over a generational reform of the country’s big state banks, but says “their progress is very initial and sometimes very superficial”.

China’s development model, and the struggle of the government to change it, also puts Beijing on a potential collision course with the US and Europe. The European Union, to which exports have been growing at twice the rate of sales to the US this year, has taken over as China’s largest trading partner.

The current account surplus is set to reach 12 per cent this year, a level unheard of for a country of China’s size and weight in the global economy. Guo Shuqing, a former central bank vice-governor who now heads China Construction Bank, says the problem is not external imbalances, in the form of the current account surplus, but “the internal imbalances”.

“Although it is under-reported in several areas, consumption is too low, particularly in education, medical care and other areas, like financial services,” he says. “Government-financed public services are too small, especially compared with the growth rate.” If the US economy continues to slow, there are few other countries in the world that could make up for the demand that America generates in the world economy. Without China stepping up to the plate, any global downturn would be steeper and longer.

The Chinese supertanker, however, continues to change direction at a frustratingly slow pace, according to not just the benchmarks set by its trading partners, but also those mandated by the central government. Without an acceleration of policy change, a nasty collision may be just over the horizon.

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By Richard McGregor

Published: October 9 2007 08:48 | Last updated: October 9 2007 08:48

Market Scan:"

Market Scan:"

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