Great shift in expectations
We are constructive on Asia for the year, but recommend being very selective with asset allocation. In equities, our most favored markets are China and Singapore. Taiwan replaces India as our least preferred market. In fixed income, short-duration investment grade corporates continue to offer the best risk-adjusted return. Among local currency sovereign bonds, we are negative on Thailand and among hard currency sovereign bonds, we are negative on the Philippines. Moving to currencies, we have closed our negative view on the INR but retain our negative stance on the PHP. Our USD/CNY forecasts have been shifted to 6.85 and 7.00 in 3 and 12 months respectively.
After a very difficult December, conditions for Asian markets have improved significantly. The US Federal Reserve (Fed) has signaled that it will likely pause its rate hike cycle sooner than expected. The USA and China report that they are making progress on a trade deal. China has announced new fiscal and monetary stimulus measures to arrest the slowing in growth in its economy.
This mix has driven the S&P 500 and the US 10-year Treasury yield to rise 10% and 14 bps, respectively, from their December lows. The MSCI Asia ex-Japan has bounced 4.8% from its low at the start of the year to be up 1.8% at the time of writing. Most Asian currencies have rallied against the USD, as the more dovish Fed stance has weakened the USD. Oil has helped as well because even after Brent crude’s recent bounce to just over USD 60/bbl, it is still well below its average price of USD 67.24/bbl in Q1 2018.
All of this sounds very good for Asia and, to be sure, we are constructive on the region for the year. However, we recommend being very selective with asset allocation because we expect several key themes to assert themselves in the coming months.
US interest rates are still likely to rise further. The Fed’s earlier-than-expected pause may cap short-term rates for now, but as it works to refresh expectations for US growth and inflation, it should gradually push up longer-term yields and resteepen the US interest rate curve. Ultimately, as the US economy regains momentum and market confidence recovers, we expect the Fed to return to 50 bps of rate hikes in the second half of the year. This leads us to be cautious on longer duration, lower yielding Asian bonds in favor of shorter-term, higher yielding instruments and floating rate structures.
Within Asia, the first half of the year also comes with meaningful political uncertainty in some countries in the form of national elections in Thailand in late February or perhaps March, presidential elections in Indonesia in April, and national elections in India in April or May.
Summing up, as encouraging as recent developments have been, we expect both economic and political trends this year to remain volatile. Investors will need to be prepared to adjust to changes as they emerge.
Asian equities: Opportunities amid tough macro environment
After a brutal 2018, Asian equity markets have begun the New Year on a positive note with a dovish Fed, policy easing from China and progress in the US-China trade dispute supporting risk-on behavior. We remain constructive on Asian equities and believe a confluence of stabilization in China’s macro environment, agreement in the US-China trade conflict, and stable Asian currencies should support the market recovery. In addition, in the wake of the 2018 sell-off, Asian equities are trading about one standard deviation below historical average. Foreign investor positioning also seems underweight after last year’s USD35 bn in outflows from Asia ex-China. This combination of valuation and positioning could lead to a relief rally if the USD remains stable and trade tensions ease.
However, we acknowledge that low consensus earnings growth of 7.5% for 2019 constrains our constructive outlook. Given a slowing in regional economies and the expected slump in global industrial production growth, earnings downgrades could continue, particularly in the tech hardware sector.
Important Information:
This part of the material: (i) aims to provide macro-market commentary; (ii) does not contain any statements or advice in relation to any specific marketable security or financial product; and (iii) does not take into account your personal circumstances and should not be treated as any form of regulated financial advice, legal, tax or other regulated service.