by Chloe Shea – Investment Director, Multi-Asset
After a tough year for both equity and bond investors in 2022, investment opportunities are starting to emerge with markets beyond the US looking more and more compelling. Asia is a diverse region with many different economies, of which each market is in their own economic cycle. This means that selectivity in terms of markets and sectors is key.
In particular, we believe there are three main factors that are steering the Asia Pacific (APAC) investment markets in 2023:
- China’s reopening and potential growth;
- Recessionary risks in developed markets; and
- US dollar strength moderates.
Service-driven recovery to support growth as mainland China reopens
Early indications are that mobility and economic activity have started to rapidly normalise following the easing of Covid restrictions in mainland China. For instance, we have already seen strong uptick in travel activities within and from mainland China. The return of holidaymakers is expected to bring about positive knock-on effects to various sectors around the region, with companies from the hotel, casino, airlines, as well as consumer discretionary retail industries set to benefit. The release in pent-up demand may also appear in the form of “revenge spending” and the impact may funnel to property companies that own shopping malls.
In contrast with much of the rest of the world, inflation is not a concern for mainland China. The headline rate was 1.8% year-on-year in December 2022, below the 3% target rate. Low inflationary pressure has given the People’s Bank of China the room to cut its policy rate and the loan prime rate over the past year.
Separately, since the fourth quarter of 2022, government authorities have started to lend support to the domestic real estate market, with an aim to encourage healthy development within the sector. Besides rolling out measures to ensure a timely delivery of presold homes, different governmental bodies have introduced coordinated policies to expand financing channels for stressed private property developers in order to ease their financial pressure.
Since the economic outlook for mainland China has clearly improved, its service-driven recovery could drive GDP growth of 6.2% in 2023 and 4.5% in 2024. With China’s sheer size, stronger economic activity may mechanistically lift overall GDP in Asia, and the overall growth globally (forecasted at 1.9%. for 2023).
Recessionary risk in developed markets could mean opportunities for Asia
Although our latest forecast has pointed to a less pessimistic outlook, uncertainties over growth and inflation in the US and other developed markets persist.
We continue to believe that the US is heading towards a recession in the second half of 2023 due to tighter monetary policy, even though the degree will not be as grim as previously thought. Whilst we do expect the US Federal Reserve (Fed) to continue its rate hiking cycle in 2023, the pace would be more moderate for rates to reach a trough of 3.25% by mid-2024.
After a prolonged period of strong execution, underlying US margins are now at record levels. As negative operating leverage kicks in, companies may start to feel the pressure on their earnings, which may lead the Asia Pacific investment markets to outperform.
Elsewhere, in the UK, a recession is also still on the cards as higher inflation and interest rates, along with austere fiscal policy, dampen the outlook. We expect its economy to see an outright contraction of 0.8% in 2023. Potential risks include high energy costs, labour shortages and disruption to supply chains. Meanwhile, the eurozone economy is likely to be largely stagnant, although it is expected to avoid recession because of the relief on household incomes and inflation should fall back more quickly within the year.
Yet, it is not all bad news. Historically, the best opportunities for equities have occurred in the midst of recessions. From a valuation perspective, Asian equities is currently outshining its peers in the West. Improved market sentiment as well as China’s economic recovery are also likely going to lend support to the markets regionally. These factors combined have led us to hold a more positive view towards Asian investments.
Asian currencies to find more stable footing as USD softens
Given the importance of the dollar for global investments, it is important to also look at where the currency is heading. We believe that the US dollar has reached its peak and divergence in global central bank policy is likely to put pressure on the currency to depreciate further.
Although there are signs that both headline and core inflation in the US is on a downward trend, its domestic labour market is still tight, which supports restrictive monetary policy for longer. If the Fed shifts to a less aggressive tightening pace and pivots to a pause, there could be some softening in the US dollar. In turn, Asian currencies will be able to find a more stable footing, and therefore provide a more favourable environment for Asian bonds, especially those in the local currency space.
The Reserve Bank of Australia raised borrowing costs to a 10-year high in February 2023 and New Zealand’s central bank. On the other hand, the Bank of Korea may be one of the first central banks in APAC to halt its hiking cycle.
For APAC markets that are still in a phase of raising interest rates, it would favour investors to select sectors with a positive correlation to bond yields, such as banks and in some cases, selected consumer names.
A flexible investment approach remains key in times of regime shift
We are entering a new regime in policy and market behaviour after a 40-year cycle of deflation. With risks associated with recession, geopolitics, inflationary pressure and the global energy crisis continuing to add to macroeconomic uncertainty, investors will need to change how they value assets, find investment opportunities, and manage risks.
To navigate through market uncertainty, we believe holding safe haven assets such as US Treasuries and cash can help cushion any potential volatility, whilst alternative assets like gold can act as a diversifier.
Nonetheless, taking a flexible approach that accounts for growth and income should help investors build a more resilient portfolio that can shield them from potential headwinds.
