Heads we buy Asia, tails we don't sell.
That is the choice investors in Asian markets are making in the face of what would be the biggest inflection point for markets since the 2008 financial crisis, the prospect of U.S. super-loose monetary policy being reined in soon.
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Since it was cheap Fed funds that fuelled the rally of the past four years in emerging stocks, bonds and currencies, most investors had reasonably assumed that a tapering off in the U.S. stimulus program would see funds flow out of emerging markets.
But Asian flow data suggests the contrary. Portfolio money is still pouring into Asia, driven by hope the Fed will tighten policy at a modest pace and only when the U.S. economy is strong enough to lift global growth.
"We're not really seeing people switching out of Asia," said Guy Steer, head of research with Society Generale in Hong Kong. "So far, we haven't seen people switching money even within the region."
There are no major signs investors are shifting positions, barring some hedging of the risk that the Fed eventually reduces the $85 billion it provides each month through bond purchases.
Analysts recommend 'defensive' trades, such as buying protection in currencies that would suffer against dollar strength, such as the Indonesian rupiah and South Korean won. Forward markets in these currencies have moved in line with those hedging flows.
"The fact that people are being a lot more proactive in hedging their currency risk shows that the market is now starting to think about the dollar in a different manner," said Mirza Baig, head of currency and rates strategy at BNP Paribas in Singapore.
Even as of May 27, several days after Fed Chairman Ben Bernanke spoke about stimulus withdrawal, Asian markets with the exception of China were all receiving investment flows.
To position for the Fed risk, strategists suggest investors should sell assets that would be undermined by a turn in U.S. policy. They should also avoid assets at risk from further weakness in the Chinese economy, whose strength has been the pivot for investment strategy since the financial crisis.
This sell list would include currencies such as the Australian dollar, whose high yield and exposure to China because of demand for Australian commodities had made it appealing for investors.
It would also include high-yielding dollar bonds in Asia, whose yield is directly pegged to U.S. Treasuries, and dividend-paying stocks which provided a good buffer during a time of low global yields.
There are already some signs of early selling. The Aussie dollar is at 19-month lows and Philippine bonds maturing in 2037 have seen yields climb 65 basis points this week to 4.2 percent. The MSCI's index of Asian utility stocks <.MIAPJUT00PUS>, which includes high-dividend counters, has fallen more than 6 percent over the month.
Still, other measures show 'cyclical' stocks, such as banks and utilities that do well in periods of stronger growth, are nowhere near overvalued, suggesting there will be no rush to sell them.
Besides, if the Fed manages to temper its policy shift by communicating early, removing stimulus slowly and ensuring corporate earnings have recovered before it acts, then global equities would still outperform bonds, analysts say.
Citi strategist Markus Rosgen says global portfolio managers are already underweight emerging markets, particularly Asia. "I don't think people are necessarily going to increase their underweights within an Asian portfolio," Rosgen said.
Some stocks, such as Chinese and Singapore financials, the technology sector in north Asia and industrials, are cheap too and pricing little to no earnings for years to come, Rosgen said. That suggests investors are being too pessimistic, he said.
DANGER IN HIGH YIELDS
The riskiest Asian assets to a tapering of Fed stimulus would be bonds. Flows into bond markets have dwarfed flows into equity markets over the past four years.
Inflows into Indonesian government bonds so far this year are $3.4 billion, on top of $5 billion in 2012. Foreigners own a record 34 percent of Indonesian government bonds, and have driven yields there to less than a third of 2008 levels. As of March, they held 36 percent of Malaysian government bonds.
Asian corporates and governments have also taken advantage of low yields in euros, yen and dollars to borrow massive amounts of debt, raising a record $133.8 billion in 2012, and another $87.6 billion so far this year.
"It is a good time to take some risk off the table," said a Hong Kong-based hedge fund manager, adding there was "danger lurking" in the high-yield bonds market because leveraged investors are bleeding money as U.S. yields rise.
U.S. 10-year yields are now close to 2.2 percent, up about 60 basis points this month alone.
That is why bonds with little correlation to U.S. yields, such as Indian debt and those of economies likely to cut policy rates such as Australia and Korea, appeal to the defensive investor.
Still, the currency view could decide if investors run or stay. Already, the cost of hedging investments in markets such as Indonesia exceeds the returns on the bonds.
And the one thing analysts seem to agree on is the view that the dollar will rise, be it because of a more hawkish Fed or a return to risk aversion if the global economy deteriorates.
"What people are concerned about is more the currency side rather than the interest rate correlation," said Stear. "If people don't think the currency is going up, there is not much reason to keep holding Southeast Asian debt."
(Additional reporting by Umesh Desai in HONG KONG and Viparat Jantraprapaweth in BANGKOK; Editing by Neil Fullick)