• Illiquidity concerns prompted a flight to safety, causing US stocks to fall. The forward price-to-earnings ratio has edged down, making US equities attractive on a stand-alone basis.
• But the risk is of a slowdown that will last longer than anticipated and there can be a fall back in capital inflow. The Treasury bailout plan help stabilize financial markets but it may take longer for the underlying credit problem to be solved.

• The forward price-to-earnings multiple, at 9, has become more attractive after European stocks fell 10% last month.
• But risks to the downside are significant during this period of economic and credit distress. Actions by central banks and governments, e.g. the rescue plan for Fortis, are positive developments, but a reduction of the underlying credit problems is likely to take time.

• Valuations have come down significantly though Japanese equities continue to trade at a premium to developed markets.
• The anticipation of economic slowdown is impairing earnings prospects. A significant contraction in the Japanese economy would cause weakness in equities, due to slowing exports.

• The drop in the US had a significant impact on the key Asian exporting markets. The contraction in the price multiple for Asia ex Japan to 10 appears to be in line with the slowdown risks associated with the region and versus other countries such as the US and UK.
• Asian equities are also at risk from a sharp and prolonged global slowdown.

• Emerging market stocks declined dramatically last month, as lofty earnings expectations are at risk from a sharper US slowdown.
• Following the recent correction, the improved valuation makes Emerging Markets more fairly priced versus other risky sectors. Therefore, we have switched to a neutral position on Emerging Markets relative to developed markets. However, a global recession is a key risk for emerging markets.

• The region is hostage to the global financial crisis.  Whilst fundamental conditions are deteriorating, relative to the rest of the world HK and China are in a much stronger structural position. Chinese government announced several supportive measures to stabilize the domestic stock market including a reduction in stamp duty on stock transactions. Markets are heavily oversold and are attractively valued; however as investor confidence has been so thoroughly destroyed, any rally for a while is unlikely to be sustainable.

• The current negative trend in the oil price is expected to continue as the global economy slows, thus weakening demand.
• Upside to oil prices could come from renewed growth in emerging markets or one of the industrialized nations, and once risk appetite increases when the financial crisis recedes.

• US bonds returned 1.2% in August, performing well in part due to renewed concern on credit, which sparked a flight to safety.
• Concerns on the credit market continue to support yield of government bonds at the current low level. And due to the difficult growth environment, we expect the Fed to keep their rate on hold at 2%, despite the elevated inflation. The main risk is higher inflation.

• The credit turmoil caused a rush-to-safety into government debt, thus pushing yields on Eurozone government paper lower.
• The asset class remains unattractive from a valuation standpoint and this is a negative for its long-term outlook. However, the flight-to-safety is likely to continue providing support to the asset class in the short term.

• The deterioration in global economic conditions is likely to lead to a more severe slowdown in Asian growth than previously envisaged. Overall Asian bond spreads are unlikely to decouple from the global trend. As we are still very cautious on all credit bonds. We therefore expect limited returns in the near term.

• The flight-to-safety hurt the performance of high yield debt. Valuations have fallen to attractive levels, but poor sentiment, strains in the banking system and risks to growth weigh negatively on its short-term outlook.
• Emerging market bonds lost as it was not immune from the global sell-off of risky assets. A US$100 billion backlog of bonds needs to be refinanced over the next year. But given the low appetite for risk, it may be difficult to roll over maturing debt. Economic weakness and falling commodity prices also weigh negatively on EM debt.

• The currency markets were characterized by significant volatility and the sheer lack of a clear direction due to the difficult market environment and short-term capital flows. The revised bailout package may provide the USD with some short-term support. A hard-landing scenario remains a key risk for the USD as it could trigger a sell-off of US assets with negative consequences for the currency.

Canadian Dollar (CAD) – Driven By Capital Flows and Commodity Prices

• The strong global economy over the past 2-3 years has been positive for commodity prices. However, as concerns grow over the impact of slowing global growth, commodity prices have been weak of late. A further slowdown in domestic economic growth, weaker commodity markets, and narrowing interest rate differentials with the US would be negative for the CAD.

Euro (EUR) – Rate Cut Would Reduce Attractiveness of the Currency

• Slowing economic activity and increasing risk of recession continued to depress the EUR. Inflation is expected to decline over the next 12 months, giving room to the ECB to cut rates. So, the currency may receive less support from the lower interest rate differential. The EUR is now at a fair level versus the USD, thus suggesting the currency will be range bound for the foreseeable future.

Sterling (GBP) – Threat of Recession Could Extend Weakness of the Currency

• After the sharp correction, the currency appears to be at fair value relative to the USD. We expect the 50bps cut in rates could support economic growth. Given the fair valuation and the uncertain macro picture, we expect volatility to continue but no clear trend developing.

Japanese Yen (JPY) – Undervalued Versus USD, But Weak Macro Unsupportive of Currency

• The JPY gained substantially during the month against all the major currencies. This was mainly driven by the unwinding of the carry trade due to the strong risk aversion in September.
• From a valuation standpoint, the JPY is undervalued relative to the USD. And sell-off of Japanese assets due to slowing overseas demand and anemic domestic spending, could have an adverse outcome for the JPY. So on balance, we maintain a neutral stance on the JPY on a 6- to 12-month view.

AUD & NZD – Suffer from Risk Aversion and Unwinding of Commodity Currencies

• The collapse in investor confidence has caused a flight out of carry trades as well as economically sensitive asset classes, which includes the AUD and NZD.  The push to risk reduction is likely to continue for a period of time which will be negative for AUD and NZD.