Looking forward, while some short-term give-up of recent gains seems to be on the cards, opinions on the longer term appear to be divided. With the Asian iTraxx indices trading at or sub-300 levels, which is the tight end of our forecast range, and given our expectation for impending fundamental deterioration and real impairments over the next two quarters, we recommend investors exercise a degree of caution. While there could be some MTM pain in resetting shorts, from a long-term perspective, uncertainties
around the scope and scale of fundamental deterioration appear underpriced in Asian credit spreads. A fair amount of news flow this week is likely to provide some insights. In addition to Asian corporates and banks earnings reports, the market will be focused on US banks’ earnings results, indicators on the US housing market and durable goods orders, the UK Treasury’s statement on future economic and fiscal borrowing outlooks. News flow on stress tests of US banks is also likely to drive sentiment on the global/Asian credit markets in the near term.
The recent rally in risky asset classes begs the question of whether it is the beginning of a secular bull run or a bear market rally. As shown in Figure 3, the peak-to-trough declines in equities seen in 2001-2002 were of broadly the same magnitude (which was a milder growth contraction). However, the recent uptick in equity valuations is slightly larger than the bear market rallies witnessed during the earlier downturn. Our primary concern is that credit, especially in Asia, has followed the equity markets despite indications of impending credit fundamental deterioration. We believe that imminent earnings releases could put pressure on credit metrics and ratings/default rates. In our view, as significant uncertainties around the scope and scale of credit deterioration remain, and Asian credit indices are now hovering around the tighter end of our comfort range, current levels present a good long-term opportunity to reduce risk, even though short-term MTM pain may have to be incurred. The near-term sentiment drivers are likely to be earnings and economic data, which we discuss below.
The bank earnings season began last week on a positive note, starting with Wells Fargo forecasting an unexpected $3bn in quarterly profits. The markets reacted with a strong rally in US banking stocks, rising to their highest level in three months. The positive mood was reinforced by Goldman Sachs reporting strong 1Q results on Monday, beating expectations by reporting a net income of $1.81bn, revenue of $9.4bn and EPS of $3.39. Goldman also announced a $5bn public offering of common stock and said that the proceeds of the sale, pending stress testing results, will be used to repay $10bn
of TARP funds. UBS hit a more negative note by warning about a possible 1Q loss of $1.75bn at its annual shareholders meeting on Wednesday. However, the generally upbeat tone continued with JP Morgan the next day releasing expectation-beating results, with profits of $2.1bn, and a statement that it would not need additional capital to repay the TARP funds. Citigroup rounded off the week by also reporting better-than expected earnings.
Various positive policy actions and other measures taken by the government have helped to reduce the cost of borrowing for banks. Furthermore, the FASB rule changes, which have resulted in the relaxation of the mark-to-market rule, have eased the pressure on banks, at least in the short term, and have played a hand in the positive earnings that we have seen so far. While the assets on banks balance sheets are relatively safe from mark-to-market-related losses, the same is not true from a regulatory capital perspective. If assets suffer from further impairment, then downgrades could occur, forcing banks to post more regulatory capital, which could hit their Tier 1 capital ratios. While things are certainly looking up in the short term, we remain wary about the long-term scenario, especially as negative earnings from UBS, for example, are being largely ignored. More earnings are due out this week from the financials. Among the main US banks due to report are Bank of America on the 20th, US Bancorp and Capital One on the 21st and Morgan Stanley and Wells Fargo on the 22nd. In Asia, the banks’ earnings season kicks off with Axis Bank, ICICI Bank and Hana Bank reporting their results this week. As we highlighted in Asia-Pac Bank Insights, 14 April 2009, the Indian banks are expected to post decent FY09 results, following on from the positive trend seen in the nine-month results. Nonetheless, going forward, we expect earnings to come under pressure as margins decline and asset quality deteriorates. In Korea, we expect a mixed set of results. Asset quality is likely to show further signs of weakening, but the impact on earnings will depend primarily on how proactive the banks chose to be in 1Q. With the economic backdrop still weak, we are more concerned about 2Q and 3Q results. On the positive side, however, liquidity indicators are likely to improve, reflecting the easing of domestic and international funding pressures.
Recent economic data have not been as negative as during the previous months. For example, US retail sales fell 1.1% in March following an upwardly revised 0.3% increase in February. The March US Producer Price Index declined sharply, with the downside surprise mainly in the energy category. Meanwhile, US businesses continued to aggressively reduce inventories. The US Consumer Price Index declined in March as
expected, down 0.1%, in line with our forecast. Industrial production ended 1Q on a weak note, falling 1.5%, while manufacturing output fell 1.7%, reflecting a broad-based decline in activity. Finally, the Philadelphia Fed manufacturing index improved to -24.4 in April from its cycle low of -35.0 in March, above expectations. Expectations for the next six months also fared better, jumping to 36.2 in April from 14.5 in March. This is the highest reading since October 2007, and suggests that confidence is starting to return. Housing starts fell 11% m/m in March. US initial claims for unemployment insurance fell in week ending 11 April. The claims data are giving tentative signals that the pace of job losses is easing, although the labour market remains extremely weak and new jobs are still hard to come by.
While the incoming data in the US remains mixed, on balance, our US economists view the data as suggesting a better outlook. They have therefore raised their GDP forecast for 2Q09 (-2.0% from -3.0%) and 3Q09 (1.0% from 0.0%) in response to the combination of firmer 1Q09 consumption and faster pace of inventory liquidation. The 2009 real GDP forecast has accordingly been revised to -2.6% from -2.9%. From our perspective, we retain some concerns that the recent improvement in sentiment/ spending will prove transitory in the face of a weak labour market.
China also released its 1Q GDP last Thursday. Real GDP grew by 6.1% y/y in 1Q, down from 6.8% in 4Q. Nonetheless, the 1Q GDP was slightly stronger than the q/q saar of 5.4% that we expected. Industrial production also grew by 8.3% y/y in March, up markedly from 3.8% in January and February. The improvement in production seemed to be led by government-related investments as part of the stimulus package. On the back of this, together with other stronger-than-expected data releases and signs of a front-loading in the stimulus, our economists have raised their forecast of growth for 2009 as a whole to 7.2% from the previous 6.7%.