Hold Cash as ‘General Correction’ Looms, HSBC Says

March 11 (Bloomberg) — Global financial markets are yet to bottom and investors should hold cash, investment-grade debt or defensive stocks to ride out a coming “general correction,” according to HSBC Holdings Plc. A sputtering U.S. recovery, the winding back of stimulus in Asia and the likelihood that Europe will begin to “normalize” interest rates, even in the face of Greece’s continuing budget crisis, mean that markets haven’t fallen far enough, said Dilip Shahani, HSBC’s head of global research Asia-Pacific. Greece’s woes have shaken global markets, with the MSCI World Index of equities slipping 2.2 percent from its Jan. 14 peak, and a Bloomberg survey showing confidence in the world economy falling for a second month in March.

“Equity and credit markets, and foreign exchange and interest rates, have probably discounted about 60 percent of what’s happening,” he said in an interview in Hong Kong. “There’s a lot of event risk we know about, but there’s probably one or two things that are going to come and create the final surprise that will trigger the final push down on all the markets together.”

HSBC predicts the extra yield investors demand to hold investment-grade Asian dollar bonds rather than U.S. Treasuries will increase less than the premium commanded by the region’s high-yield notes, according to a March 5 research note. The spread on HSBC’s Asian Dollar Bond Index, which tracks investment-grade issues, will widen to 350 basis points by the end of June from 283 today, while that for the bank’s Asian High-Yield Corporate Bond Index will move to 750 basis points from 594, according to the report. Investors should be prepared to buy once the correction materializes because spreads will narrow again by the end of the year, the U.K.-based lender advised. A basis point is 0.01 percentage point.

‘A General Correction’

“The arguments against a general correction are getting harder and harder to ignore,” Shahani said. “Hold cash or high-quality bonds. Even if you have to be in equity, hold defensives or utilities. They will still go down but it won’t be by as much.” Mohamed A. El-Erian, whose company runs the world’s biggest mutual fund, also says deteriorating public finances may affect the global economy more than is currently realized. “The importance of the shock to public finances in advanced economies is not yet sufficiently appreciated and understood,” El-Erian, co-chief investment officer at Pacific Investment Management Co., wrote today in an article on the Financial Times Web site. The potential damage is “at present being viewed primarily — and excessively — through the narrow prism of Greece,” he wrote. Shahani’s team in a December report forecast investors would realize by this month that the U.S. recovery was “of poor quality, of less intensity, and most disturbingly, still requiring heavy fiscal and monetary stimulus.” Federal Reserve Chairman Ben S. Bernanke told congress on Feb. 25 that the U.S. economic recovery was still “nascent” and likely to require “exceptionally low” interest rates for an extended time.

Inflation Risk

The case is building for an interest-rate increase in China, the world’s fastest-growing major economy. Inflation accelerated to a 16-month high of 2.7 percent in February and real-estate prices in 70 cities climbed at the fastest pace in almost two years, according to government reports in the past two days. Inflation is also gathering pace in Europe’s largest economies, increasing the likelihood that the European Central Bank will raise interest rates, HSBC said. Germany yesterday revised its estimate of last month’s gain in consumer prices to 0.5 percent, from 0.3 percent, and France last month reported a 1.2 percent increase for January, the biggest in a year.

‘Susceptible to Shocks’

“All these things have come earlier than expected so people have been caught out being overweight,” Shahani said. “What is telling is that volumes are starting to drop off in the equity markets and also in the credit markets. There are more and more people standing on the sidelines and that makes the market more susceptible to shocks.” Rising volatility amid declining volumes and continued macro-economic risks undermine current market levels, heightening the chance that long positions will be “taken out,” Shahani said. A long position is a bet that a security’s value will rise. “You just need a few people to decide to get out and then it drops to a new level,” Shahani said. “And then the real money, the wall of money that everyone talks about will come in and lift it back up. But clearly this is not that level.”


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