Although fears of a repeat of the global financial crisis have been largely assuaged by swift government action in the US and Switzerland, we think it will take time for investor confidence to be fully restored. Tighter lending standards could also precipitate a deeper US slowdown. As a result, we expect global equities to deliver limited returns and exhibit high volatility over the remainder of the year and have lowered equities to least preferred in our global strategy.
But the same dynamics also reinforce the case for quality bonds, which we have upgraded to most preferred in our global strategy. The developments also underscore the case for diversification across regions where we remain most preferred on emerging markets, including China.
Asia’s outlook remains healthy.
Throughout the turbulence in the US and European banking sectors in the past week, the impact on Asian banks was relatively muted. The MSCI Asia ex-Japan Financials Index was down just 5% from peak-to-trough since the collapse of SVB, compared with double-digit declines in the US and Europe. Credit default swap spreads in Asia also did not widen to the same degree as those in the US and Europe.
Much of the resilience displayed by Asian banks is a result of strong solvency, liquidity, and profitability metrics, where held-to-maturity portfolios account for a low share of overall assets and deposit bases are well diversified. Therefore, unlike the US and Europe, we expect credit costs to remain benign as growth reaccelerates in the region, led by China’s economic recovery.
The region’s economic data have been encouraging. Asian exports appear to have found a floor, PMIs are back in expansion, and China’s counter-trend recovery should further support the region’s growth prospects. We think these factors point to compelling opportunities in Asia, even as recent events emphasize the importance of a protected and well diversified portfolio.
Seek opportunities in Asian equities, especially in China and Asian semiconductors.
While we are more cautious overall on equities, we do see close to 10% upside for Asia ex-Japan by year-end as earnings downgrades are bottoming out, the dollar’s strength is fading, and 2H earnings are expected to rebound by 12% y/y. Furthermore, the valuation of Asian equities remains well below that of global equities.
The leading driver will likely be China’s consumption revival, which should propel the country’s economic growth back to a mid-5% range this year after slowing to 3% in 2022. We think that select consumer durables and services, industrials, materials, and the digital economy are likely to be among the main winners of China’s recovery. We remain constructive on Chinese equities, and we see over 20% upside through year-end for MSCI China.
Outside of China, we like select tourism-related names that will benefit from the reopening. We also believe that Asian semiconductors should benefit from improving supply-demand dynamics in 2H23. We favor memory chipmakers, leading-edge foundries, and select fabless chip designers.
Separately, we think leading banks in Japan and Hong Kong now look oversold and are now among our preferred sectors in their respective markets. Longer-term structural prospects for major banks in India, Indonesia, and the Philippines are appealing as well.
Diversify your portfolio into quality bonds, non-USD currencies and high yielders.
In the wake of recent shocks, we believe there is a higher probability that central banks will end their hiking cycles sooner rather than later. That makes the case for bonds more appealing. We particularly like high-quality investment grade credit, where investors can find decent yields and the potential for capital gains in the event of a deeper economic slowdown.
In Asia, we prefer a barbell strategy of short-duration IG bonds for yield and select longer-duration A/AA bonds. High yields and subdued issuance should also provide support from a technical perspective for Asia IG. However, we are very selective on lower quality bonds like Asia HY, which are more susceptible to stress. Income-seeking investors can also consider Singapore REITs which are well positioned to offer relative resilience, backed by sound fundamentals and stable dividends.
We also like currencies which stand to benefit from China’s reopening including the Australian dollar, the Chinese yuan, and the Thai baht relative to the USD. We also think that high-yielding currencies like Indonesia’s rupiah and the Indian rupee look most attractive versus the USD.
