H2 2021 Asia and China Outlook - Media Briefing Highlights (with playback)

Global Inflation Pressures Weigh on Post-pandemic Recovery

AXA Investment Managers (AXA IM) observes that as the global economy emerges from the pandemic, it is buoyed by strong economic growth but must also confront the accompanying inflationary pressures. Tackling inflation while maintaining the recovery is the major challenge central banks and policymakers now face.

At a media briefing on 28 June, four AXA IM specialists discussed the new post-pandemic environment in Asia and China, in a global context, and particularly looked at where China is in its economic cycle. They also delve into the growing importance of responsible investing.

1) Global economy – Strong recovery underway

Chris IGGO, CIO, Core Investments

Robust global economic growth into 2022

  • A very strong economic recovery is underway with global GDP growth rates set to stay well above the long-term trend into 2022.
  • Growth drivers:
    • Reopening economies, facilitated by the rapid rollout of vaccination programs.
    • Strong policy support allowing households and businesses to retain a level of income.
    • Pent-up demand reflected in strong consumer spending and corporate investment.
  • Some downsides to note:
    • Disruption to supply chains and production is pushing up inflation in the US and Europe.
    • Inflation pressure will continue for a few months, but it is transitory and should settle back down by the year-end, closer to central bank targets – around 2%.
    • Inflationary pressure has increased the likelihood that the US Federal Reserve will bring forward an interest rate hike to 2022.

2) China’s macro economy – Pace of recovery to slow in H2 2021

Aidan YAO, Senior Emerging Asia Economist

China – first in, first out

  • After suffering a severe blow in Q1 2020, by Q4 China’s economy had returned to its pre-COVID level of growth. In the US, according to AXA IM forecasts, the economy will only get back to its pre-COVID trend by around Q4 this year – about a year behind China.
  • Strong external demand has caused China’s export growth to normalize faster than domestic demand. It means that the strong headline growth has been unequal in strength across the different parts of the economy. However, there are signs that it is beginning to even out.

GDP growth to fade in H2

  • Sequential economic growth is set to peak, with rising headwinds slowing momentum in H2. Global economic recovery and resumption of supply chains will see production in other countries rise thereby reducing demand for Chinese goods.
  • Industrial production, exports and housing investment have been the front runners of the recovery, but these weakened slightly in May. However, the retail sales and services sectors saw some sequential improvement.
  • The impact of Beijing’s policy move to slow credit in Q4 2020 will be evident in Q3 2021, contributing to a slower GDP growth.

No inflation insulation for China

  • Rising global commodity prices have impacted China’s producer prices index (PPI), which is right now at the highest level since 2008 (May +9.0% year-on-year). However, unlike in the US and other developed economies, there has been little pass through from producer prices to consumer prices in China.
  • The transmission between China’s PPI and its consumer prices index (CPI) is weak for two reasons:
    • First, food prices account for about 30% of China's CPI basket and food prices have been falling – notably pork prices. This services as a counterbalance to other inflationary factors such as commodity prices.
    • Second, consumer demand has been sluggish, making it difficult for firms to pass on upstream employment and other cost increases.

Beijing’s policies

  • Beijing may be starting to turn a little more cautious about continuing the current pace of policy normalization. The policy will persist, but it could become a lot more targeted and nuanced.
  • It will very likely make fiscal policy a more active tool to put a floor under the economy in the remaining months of this year.

RMB outlook

  • The renminbi (RMB) has gained about 3% against the US dollar in the year to date, mostly during Q1 and mostly on the back of dollar movement. Against the basket of currencies, the RMB has remained steady.
  • In the near term, uncertainty around the dollar may create some volatility, but our expectation is for RMB trade in the 6.4 to 6.5 range against the dollar near term. Beyond that, the RMB is biased towards appreciation in the medium term.

3) Asian equities – Rising inflation puts policy support in spotlight

Simon WESTON, Head of Framlington Asia

Policy support

  • Significant policy support from central banks, with ample liquidity and low interest rates, has been a very beneficial backdrop to equity markets and to credit markets.
  • Our analysis continues to present a very positive picture for risk. We see positive scores across equity markets being driven by the growth situation and the implications for corporate earnings. Thus far, price increases have been met by continued upward revisions to forward earnings, so the valuation measures have remained mostly stable on the credit side.

Day of abundant liquidity numbered

  • Interest rates have begun to rise in some emerging markets, the days of abundant liquidity and cheap money are numbered. Those conditions gave rise to all sorts of wonderful business models, not all necessarily as robust and sustainable as they might be. As liquidity gets withdrawn and the cost of money rises, these weaker models will struggle and may create volatility in the markets.
  • Understanding investor positioning in the event of new information is key. Earlier this year, changing market conditions led to a rotation between growth and value in stock selection – a significant change. We are at another similar point, this time with inflation.

A critical point with inflation

  • Investors appear to have largely accepted the Fed’s position that the current inflationary spurt is only transitory, meaning there’s no need to adjust its monetary settings, despite inflation (May CPI +5.0% y-o-y) being above target.
  • Should an inflationary spiral turn out to be more persistent, it could force investors to make significant changes to the positioning in their portfolios.
  • US inflation has just spiked to its highest level in the past 25 years. Some of it is transitory, but there are signs of more persistent inflation.
  • Shipping costs (Baltic Dry Index), copper and soybeans are all different products, but all at five year highs. The fundamentals behind these prices point to structural shortages – not enough ships built since the global financial crisis, not enough new copper supply coming onstream for all the new infrastructure, and not enough soybeans to satisfy the growing middle class particularly in Asia.

Long-term structural trends intact

  • Most of the long-term structural investment themes within Asia remain intact and have been accelerated by the pandemic.
  • Asia continues to offer significant yield opportunities in an income-starved world.

4) Asian credit – At the halfway point, 2021 is proving to be a grind

Jim VENEAU, Head of Asian Fixed Income

Market overview

  • Inflation concerns compete with the recovery narrative COVID surges, while slow vaccine uptake remains problematic.
  • China's deleveraging focus has been disruptive.
  • Investment grade priced to perfection in an imperfect market; high yield valuations are more historically attractive, but vulnerabilities limit relative value and point to potentially high levels of distress.
  • Asian investment grade does continue to offer a pickup to US investment grade. The caveat is this is largely coming from China's state-owned enterprises and local government financing vehicles, which are providing much of that premium high yield where value remains.
  • Market sentiment is clearly flagging while technical pressures are evident on both the demand and supply side.

Outlook and positioning

  • Maintain Duration Times Spread (DTS) near neutral in high yield and slightly overweight in short duration bonds as non-distressed spreads will be stable - average ratings and rating cohort distribution remain on target.
  • Caution growing on high yield China property given restrictive government policies and shrinking funding channels, otherwise continue to seek diversification outside China in favor of strong ESG positioning.
  • Focus remains on building conviction for tactical spread compression opportunities, rotating out of lowest carry bucket into middle bucket; caution on high carry bucket, pre-emptive trimming upon concern.

5) Integrating ESG in investments

Chris IGGO, CIO, Core Investments

ESG increasingly important to asset management

  • ESG is a huge topic in the financial markets and Europe as a region is leading the way because of the regulatory framework that has been put in place. The framework is being designed to ensure that asset managers are able to offer responsible investment products to their client base, without the risk of greenwashing.
  • There is no trade-off between responsible investing and generating good risk-adjusted investment returns. When we take a longer-term view, we want to invest in the best companies with the best earnings growth potential, but also the ones that were able to manage their risk most effectively.

2050 carbon neutrality targets forcing change

  • In Europe and North America, and more recently China, there has been an extension of emissions trading systems, which governments can use to limit the amount of CO2 being emitted into the atmosphere. And if a company can't stick to its limit for CO2 emissions, there is a financial penalty.
  • All countries are now pledging to achieve a net zero carbon economy by 2050 and companies have to align their own operating models to that ambition.
  • The companies that will survive and do the best are the ones that are on top of those risks and are committing to a transition plan to lower emissions in the future, and investing in the technology that will allow them to do that.
  • ESG scores from different asset managers are never the same, because the methodologies are all very different. But increasingly there is a move towards greater transparency and standardization.

Source: AXA Investment Managers, as of 28 June 2021