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What to buy as interest rates are set to rise

The Sunday Times Invest Seminar yesterday centred on strategies in the Year of the Taper. This week, we take a closer look at how investors should position their portfolios to prepare for a new era of higher interest rates.

Published on May 11, 2014 1:23 AM

By Chia Yan Min


Gold and property prices may fall

There cannot be too many of us around who do not know that interest rates are expected to rise, but it is a bit harder to work out what the next step should be.

No one outside United States Federal Reserve chair Janet Yellen quite knows when the hit will come but the first increase could land as early as next year.

That might be a blink of an eye in investing terms but it still gives savvy investors time to work out a strategy.

So as we prepare for a new era of pricier personal loans and mortgages, The Sunday Times looks at how investors can position their portfolios for leaner times ahead.

Stocks

All the investment strategists The Sunday Times spoke to agreed that investors should be going heavier on stocks than on bonds in what has been dubbed the Year of the Taper.

Taper is the much-used word to describe the US Fed's policy of winding back the huge stimulus programme that has kept rates at rock bottom for several years.

Certain sectors - including consumer goods and health care - are expected to be more resilient to interest rate changes while the cooling property market means related stocks are likely to do less well this year.

The brighter global economic outlook is also tipped to boost corporate earnings.

The Fed's bond-buying programme is expected to end in October at the earliest, with rates likely to stay low until mid-2015, says Mr Howie Lee, an investment analyst at Phillip Futures.

So with interest rates and bond yields still low, stocks are expected to offer better returns than fixed income assets for the rest of this year, adds Mr Lee.

However, investors should be "quick to take profit the moment it becomes clear that the Fed is looking to tighten money supply", given that equity markets have been on a five-year bull run since the global financial crisis.

Mr Benjamin Goh, retail market strategist at CIMB Research, says the Singapore stock market is likely to end the year higher, buoyed by strengthening US economic data and markets.

Stocks in sectors like telecoms, consumer staples and health care are usually more stable in the face of interest-rate movements, adds Phillip Futures' Mr Lee.

On the other hand, real estate investment trusts (Reits), utilities and consumer cyclicals are more sensitive to an increase in borrowing costs, he notes.

Singapore Reits are likely to be hit by higher rates after having outperformed amid the global hunt for high yield over the past five years, says Mr Kelvin Tay, regional chief investment officer for Southern Asia Pacific at UBS Wealth Management.

"Any investments into Singapore Reits will need to focus intensively on asset quality," he adds.

CIMB Research's Mr Goh says higher rates will be a boon to banks as their net interest margins will increase.

"This is already happening and is partly why the earnings of the local banks have exceeded expectations. This trend is probably going to continue as interest rates gradually rise," he notes.

Mr Tay advises investors looking beyond Singapore to be exposed to export-oriented Asian economies such as Taiwan and South Korea.

"The strong growth momentum in the US and economic recovery in the Eurozone will benefit Asian economies with a high degree of export-orientation," he says.

For the first time since the 2008 financial crisis, developed markets are expected to drive global economic growth this year, says Mr Steve Brice, chief investment strategist at Standard Chartered Bank.

Stronger growth in these markets should support corporate earnings in a period of low inflation, he adds.

While emerging market equities have been underperforming, an improving global economy should eventually lead to an upturn in earnings and reverse three years of steady pessimism, says Mr Brian Tan, head of fund sales at JP Morgan Asset Management (Singapore).

Bonds

Higher interest rates will have a mixed impact on various types of bonds.

With US economic growth gaining momentum, yields on Treasury bonds are likely to start going up due to stronger inflationary pressures, says Ms Fan Cheuk Wan, chief investment officer for Asia-Pacific at Credit Suisse Private Banking and Wealth Management.

"Returns on government bonds are expected to turn negative over the coming months as US growth accelerates," she adds.

While prices on the whole will start to fall as global interest rates rise, demand for corporate bonds should remain strong.

This is because investors will keep searching for yield amid a gradually improving global economy and while corporate balance sheets remain generally healthy, says Mr Matthew Colebrook, head of retail banking and wealth management at HSBC Singapore.

Conversely, government bonds, such as US Treasury bonds, "are pricing in an overly pessimistic macro scenario", he adds.

German bunds should also be viewed with some caution, given that they have benefited from being perceived as a "safe haven".

The asset class may still offer some opportunities for income-oriented investors but further underperformance, especially relative to equities, looks likely, says StanChart's Mr Brice.

Investors should focus on high-yield bonds from developed markets, while investment-grade bonds are expected to yield negative returns, he adds.

UBS' Mr Tay says rising US Treasury yields will put upward pressure on all global government bonds, including Singapore Government Securities.

"While the timing might be a little early, floating rate notes might be an interesting alternative for conservative investors," he suggests.

Commodities

Higher interest rates and a more positive global economic outlook will take the shine off gold this year.

The metal, which does not pay interest or a yield, is traditionally held as a hedge against inflation and volatility.

Low interest rates make gold attractive, as the opportunity cost of owning it is lower.

Gold has defied bearish forecasts to climb about 7 per cent so far this year to about US$1,290 an ounce on the back of sluggish economic data from the US and China, and the Ukraine crisis.

As the world's largest economies are expected to do better in the second half of the year, gold prices are likely to come down, strategists say.

Phillip Futures' Mr Lee adds that gold is expected to stay at about US$1,300 in the short term due to heightened tensions in Ukraine, but the metal's allure is likely to dim as a stronger US dollar makes it more expensive to buy.

Rising US Treasury bond yields are also prompting investors to shift their holdings out of gold, says UBS' Mr Tay.

"The only precious metal we favour is platinum, which is an industrial metal and hence a call option on global growth," he says.

Property

A deep gloom has settled over the Singapore housing market since the start of the year amid weak rental demand and tight loan curbs.

Cooling measures to rein in the once red-hot sector are having an impact, with both private home and HDB resale prices sliding in the first three months of the year.

A combination of higher interest rates, increased supply and slower foreign population growth are likely to depress prices further, says Mr Tay, adding that they are expected to dip a further 15 per cent over the next three years.

CIMB Research's Mr Goh agrees: "With a lot more new units coming onto the market over the next two years, we expect prices and rental yields to moderate further."

Rents and prices for industrial property, which showed signs of moderating in the first quarter, are expected to keep rising at a slower rate.

An average of 2.1 million sq m of industrial space is expected to become available every year for the next three years.

This is about 4 per cent to 5 per cent of the existing stock of industrial space, and significantly higher than the average annual demand in the last three years.

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