In the first half of the year, Russia’s invasion of Ukraine sharply exacerbated the inflation pressures that are depressing economic sentiment and raising expectations of more aggressive monetary policy tightening. That, in turn, is driving rising recession concerns that are weighing on global financial markets.
On the flip side, a weaker growth outlook also means fewer rate hikes and less restrictive monetary policy. We would need to see a more sustained market rebound, and a turnaround in inflation, to lead to a pause in the rate-hike cycle and fading risks of recession. China is the only major economy cutting rates. But the Covid-19 pandemic and continuing woes in the property sector are complicating attempts to use traditional stimulus tools such as increasing credit supply or cutting interest rates.
Asia ex-Japan Equity: cautious positioning
Key to market stabilisation in Asia is the region’s recovery from the Covid-19 pandemic. We believe this hinges on three interlinked phases. The first is reaching high rates of vaccination to protect populations from severe illness. This, in turn, feeds into the second phase, in which the level of confidence about living with the virus rises, as demonstrated in Singapore. In the third phase, as the virus becomes endemic, economies would return to normal. That said, we expect a multi-track return to normal in Asia, with countries like Singapore ahead of the pack, while Hong Kong and mainland China continue to follow dynamic zero-Covid-19 policies.
While China has lifted some restrictions, the pressures on energy and commodities arising from the Ukraine conflict have not eased. We remain cautious, expecting volatility to persist for the rest of the year. Yet, we also anticipate attractive opportunities to arise from the bottoming of the cycle.
China equity valuations are attractive again
China’s policy easing is supportive of equities, adding to the reasons China cannot be ignored in global allocations when most of the rest of the world is tightening. We remain overweight on Hong Kong and China, as we have been since the start of the pandemic, as we see signs of a bottoming of the cycle. Some of our investments in manufacturing have not been left unscathed by the lockdowns in China, but because these companies have diversified their locations across China and Asia, the downsides to their business have not been as significant as those for their competitors. Therefore, we continue to focus on the fundamentals of individual companies in making our investment decisions.
We are cautiously optimistic about China equities into the second half and beyond. Current valuations offer reasonably attractive opportunities despite challenges to find the bottom of the market. Hence, investors could look beyond the near-term uncertainties and position for mid- to long-term recovery. That said, however, we do not expect China equities to rebound to the valuations seen at the beginning of 2021, as the Covid-19 outbreak may have structurally changed China’s growth trajectory. We believe investors should not lose sight of the underlying secular trends that could drive future earnings, such as digitalisation, ESG-related imperatives, and rising middle-class consumption.
Asia Fixed Income: on a firm foundation
Asia credit fundamentals remain largely steady, anchoring the asset class against volatility. Unlike most of the developed world, further policy easing is on the cards in China as authorities seek to moderate the economic slowdown and stabilise the property sector. We believe this presents an opportunity to surgically select higher-quality issues in the high yield (HY) segment.
Credit fundamentals have held steady despite pressures from rising US and regional rates and concerns about inflation’s impact on earnings. Given the short duration profile of Asia bonds in general, we think the interest rate trajectory in the US will have minimal impact on the asset class. Nevertheless, we remain underweight on duration. We believe recent volatility in the Asia HY market will subside in the next several months on the back of steady credit fundamentals for non-Chinese issuers. China's delayed recovery from the Covid-19 pandemic means more defaults are expected in the Chinese property sector before stabilisation measures take wider effect. This, together with Sri Lanka’s default in May, indicates that the expected decline in the Asia bond default rate will be pushed to the first half of 2023 instead of this year. Meanwhile, some non-China HY credits are benefitting from strong commodity prices and steady credit fundamentals. We continue to favour commodity names as inflation becomes a tailwind for the sector. We expect this strong commodity cycle to last longer because of geopolitical tensions and the reopening of many major economies post-Covid-19.
The reopening theme is strengthening, with Thailand and Indonesia among the latest investment grade (IG) sovereigns to announce significant relaxation to border measures. Economic momentum broadly remains healthy, with inflationary expectations uneven across Asia. Flexibility and selectivity will remain the watchwords for the rest of the year. With strong fundamentals anchoring the market, Asia fixed income should offer investors the stability that may be lacking elsewhere.
For more viewpoints from PineBridge’s senior investment leaders, visit 2022 Midyear Investment Outlook: Inflation Surges Amid a Perfect Storm for Markets.
This article was written by Ms Elizabeth Soon, Head of Asia ex-Japan Equity, Ms Cynthia Chen, Equity Portfolio Manager, and Mr Andy Suen, Head of Asia ex-Japan Credit Research at PineBridge Investments.
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