Q3 2020 Asia and China outlook - Virtual media briefing highlights

Thin Ice and Silver Lining

As the global economy is slowly recovering from of a steep recession, the Covid-19 pandemic remains a serious challenge to growth. US-China tensions have escalated beyond trade, penetrating the realms of technology and finance, with rising protectionism threatening to displace global supply chains.

At a media briefing hosted by AXA Investment Managers (AXA IM) on 22 September 2020, three AXA IM specialists shared their outlook for China’s macroeconomy, Asian equity and credit markets, and examined areas where investors could find value and long-term opportunities despite unprecedented uncertainty.

1) China macro – Beyond the V-shaped rebound

Aidan YAO, Senior Emerging Asia Economist

An uneven recovery underneath

  • China has weathered the Covid-19 pandemic better than most other countries, but it is not immune from subsequent mini-outbreaks.
  • Since the unprecedented sharp contraction in Q1, China’s economy has staged a V-shaped rebound, supported by the quick resumption of economic activities. However, this recovery has been uneven across different drivers of growth, with exports and industrial production leading the rebound, and retail lagging behind.
  • We have seen some fine-tuning of China’s monetary policy. There has not been major policy easing such as interest rate or required reserve ratio (RRR) cuts since the end of Q2, and the People’s Bank of China has also become more reserved with liquidity injections. On the fiscal front, we expect China to continue its stimulus as planned to sustain the momentum of infrastructure investment.
  • We expect China’s year-on-year (yoy) GDP growth rate to further accelerate to 5% and 6% in Q3 and Q4 respectively, leading to a full-year growth forecast of 2.3% in 2020 and 8% in 2021.

Deglobalisation and supply chain reshuffle

  • Deglobalisation was well underway before the US-China trade war and Covid-19 pandemic, and it is a trend that will not end anytime soon.
  • We see three types of multinational companies (MNCs) with different likelihood of moving their supply chains out of China:
    • Companies operating in China for its low cost of production: most likely to exit China as factor costs, including labour, land and utilities, have risen significantly over the past decade.
    • Those in China for its large domestic market: most unlikely to leave, as China has overtaken the US as the world’s largest retail market, with higher luxury goods and tourism spending supported by a burgeoning middle class.
    • Those in China for its comprehensive supply chain networks: most uncertain. China’s infrastructure quality, logistics networks and educated workforce are weighed against higher tariffs, potential sanctions, technology restrictions and heightened political pressure.
  • Electronic manufacturing accounts for more than half of Asia’s export value added, with China at the centre of the production ecosystem, the supply chain disruptions of which could mean substantial potential loss to China.
  • However, given that no one in the region can replace China anytime soon, they will be dependent on its provision of inputs. With the right reforms and cooperative mindsets, China could orchestrate a transition from “Made in China” to “Made around China” that accelerates Asia’s regional economic integration when globalisation is in retreat.

The “dual circulation” plan – preparing for an enduring battle

  • Beijing has introduced the “dual circulation” development plan in response to the changing and increasingly complex macro environment.
  • The “inner circulation” aims to unleash China’s domestic growth potential, the elements of which include technology and innovation, consumption upgrades, supply chain enhancements, new urbanisation, and capital absorption.
  • The “outer circulation” aims to further integrate China into the rest of the world. This includes initiatives such as financial liberalisation, RMB internationalisation, trade cooperation, foreign direct investment (FDI) deregulation, and the opening up of capital markets.
  • However, the outer circulation may place less emphasis on the Belt and Road Initiative, investment in sensitive technologies, and M&A in areas of national security concerns.
  • While the inner and outer circulations are devised to reinforce each other, Beijing has clearly placed a heavier focus on the inner circulation.

2) Asian equity market – Where are we in the recovery?

Simon WESTON, Senior Portfolio Manager, Asian Equity

Recovery is underway globally, though largely priced in

  • The uncertainty around Covid-19 and its impact remain very much present, with concerns of a “second wave” in many countries. But several economic indicators (e.g. PMIs, world trade volume) have suggested that a recovery is underway globally.
  • However, markets have largely anticipated and priced in this recovery, although performance has been skewed towards structural growth. Indicators such as fund manager surveys and earnings estimate revisions reveal that investor sentiment has significantly improved over the past months.

Asian equities remain relatively attractive

  • Markets have benefited from a boost of cheap and plentiful liquidity injected through expansionary monetary policies by central banks, especially when such liquidity is typically invested in asset classes instead of the real economy during a downturn.
  • The market rally has also been quite concentrated in the big names, evidenced by the dramatically increasing weight of the top 5 stocks in the MSCI Asia Pacific ex-Japan (MSCI APxJ) index, just as the previous US stock rally was dominated by FAANG.
  • In many cases, these companies have been directly benefiting from the outcome of the pandemic, such as the increasing reliance on e-commerce and technology.
  • While Asia has been ahead on economic recovery, valuations of Asian equities are at a significant discount to other regions. Asian equities continue to look relatively attractive, against both their historical levels and the rest of the globe.

Long-term structural themes accelerated by Covid-19

  • We maintain a constructive outlook for Asian equity markets, although the global economic outlook remains uncertain, and we are cautious about the extent and speed of the recovery.
  • While geopolitical tensions continue to pose some risks, and we have seen their impact on specific industries and companies, there are also new opportunities, such as sectors which are benefitting from China’s continued liberalisation, reduced reliance on external supply chains, and increased investment in technology.
  • And these challenges will not derail most of the long-term structural investment themes, which have in fact remained intact, and in many cases have been accelerated by the pandemic:
    • The increasing role of e-commerce
    • The central importance of technology to modern ways of working and living
    • Rising healthcare spending, both personally and publicly, including insurance
    • Rising investment in automation and robotics
    • An increased focus on food safety and security
    • The rise of fintech and cashless societies, with Asia leading the world in many respects

3) Asian credit market – Rally to recovery

Jim VENEAU, Head of Asian Fixed Income

Rally in Asian high-yield continues, while relative value remains

  • Credit markets have almost rebounded completely. With liquidity back in the market, prices are no longer dislocated, and recovery has extended to almost all sectors.
  • The rally in Asian credits has continued, particularly on the high-yield (HY) front, where spreads have tightened (>100 bps vs -30 bps for Investment Grade (IG)), with distressed names leading the performance.
  • However, relative value still remains in Asian HY over broader emerging markets (EM) and the US. But given the uncertainty around Covid-19, it is unlikely that spreads will drop to long-term low levels anytime soon.

Sector spreads continue to normalise

  • Spread levels continue to normalize, with more sectors near or below their historical levels in September.
  • China HY, back to its historical spread levels, posted solid year-to-date (YTD) positive return, driven by China Property CCC and single-B names.
  • Four sectors still remain 1 standard deviation above their historical mean, namely Bank Cap HY, Hong Kong Non-Rated (NR), Philippines NR, and Indonesia HY.

Market sentiment remains positive on balance

  • There have been encouraging signs of macro recovery benefitting from strong support from central banks and fiscal stimuli, while the coronavirus will remain the big wild card, and its impact will continue to pose a challenge to investment.
  • HY valuations still look attractive, although the rally has made it more difficult to identify cheap names, requiring more research at the issuer level.
  • IG is now closer to its fair value. Bond issuers have been tapping this market since this Spring, taking advantage of the ample liquidity, low rates and investors’ demand for yield.
  • Market sentiment remains positive on balance, despite a fragile dynamic