Asia’s relative stability offers opportunities beneath the market volatility

Below is a commentary I wrote that was published by The Straits Times?here.

Bank failures in recent weeks?have sparked the biggest bout of financial market volatility since the Federal Reserve began its most aggressive tightening cycle in four decades.

It’s the most visible sign yet that rapidly rising rates are having unintended consequences. But it’s also not the first: 2022 saw growth stocks and speculative investments like crypto-linked assets crumble, while even the traditional 60/40 portfolio was not spared.

This time around, emergency intervention from the United States Fed and other state agencies have helped stave off a wider systemic collapse and assuaged concerns of a 2008 repeat. Still, recent events make tackling stubbornly high inflation without plunging the economy into recession a much harder task— policymakers now must also grapple with financial stability as they race to rein in price pressures.

All this means an extended period of uneasy jitters will likely follow the extreme volatility of recent weeks. To us, these dynamics suggest limited returns and choppiness lie ahead for global equities. But they also reinforce the case for quality bonds and gold as a portfolio hedge.??

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Stability in Asia’s banking sector

Amid the turmoil, Asia’s banking sector has emerged relatively unscathed. The MSCI Asia ex-Japan Financial index is down just 5 per cent peak-to-trough since Silicon Valley Bank’s (SVB) demise, roughly a third of the declines seen in the US and Europe. Spreads on Asian bank credit and credit default swaps have not widened to the same degree as well.

Much of that can be attributed to the strong solvency, liquidity, and profitability scores for lenders in the region. Held-to-maturity portfolios account for just 8 per cent of overall assets on average, versus 43 per cent for SVB.

Deposit bases are also large and well diversified, while many lenders enjoy strong government backing. Credit costs, meanwhile, should remain benign as economic growth reaccelerates across the region.

Indeed, Asia’s economy appears to be on steady ground even as the banking tremors raise the likelihood of an earlier and deeper slowdown in other major economies. China’s counter-trend recovery should soften the blow, with a consumer-led revival powering?GDP growth of around mid-5 per cent this year.

Key data points and fresh policy signals over the past month confirm this process is on course. Official January to February activity data, for instance, reveal a strong service recovery that tracks the swift rebound in high-frequency mobility data. Leadership continuity in key economic agencies announced at the National People’s Congress is another plus.?

China’s tide is already beginning to lift other boats in Asia. Regional exports appear to have found a floor and purchasing managers’ indexes are back in expansionary territory. Moreover, local central banks did not have to lift interest rates as much as the US or Europe, and are already on pause or nearing it; this has kept funding conditions benign in the region.?

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Tactical opportunities in Asian equities

Though we are cautious on global equities, we see near double-digit upside for Asia ex-Japan by year-end. Here, improved economic prospects, fading dollar strength, and an expected 14 per cent year on year rebound in second-half earnings are positive drivers.

Among Asian financials, leading banks in Japan and Hong Kong look oversold to us. In Japan’s case, potential monetary policy normalization from the Bank of Japan later this year offers another tailwind. Longer term, banks in India, Indonesia, and the Philippines are growth proxies for the ongoing reset in regional supply chains and foreign capital flows.

For banks in Singapore, robust dividend yields need to be balanced with fading tailwinds from higher net interest margins. Within the market, however, we think Singapore real estate investment trusts (Reits) offer a more appealing proposition as rental incomes rise.

Meanwhile, Chinese equities may see more than 20 per cent upside through year-end with initial reopening winners giving way to recovery beneficiaries. These include select consumer durables and services, industrials, materials, and the digital economy. That said, targeted decoupling between the US and China will likely continue to be an ongoing risk for investors.

Asian semiconductors are another attractive early cycle sector. Supply-demand dynamics and chip pricing remain on track to improve in the second half of this year, and we think Asia IT earnings growth should rebound to 38 per cent in 2024.

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Portfolio diversification is key

In the wake of recent events, central banks will likely end their hiking cycles sooner rather than later. We expect a final Fed hike in May, and markets are already pricing in a policy pivot from July. This makes a strong case for locking in yields in quality fixed income, where all-in yields are attractive and potential capital gains can be had in the event of a deeper slowdown.

While cash is having its moment, the current high yields can quickly roll over once the rate cycle peaks.

By the same token, current levels for the US dollar are unlikely to be sustained as US growth and interest rate premiums erode. That should help Asian currencies stage a near 6 per cent recovery versus the US dollar this year, and in particular, buoy prospects for regional China reopening beneficiaries (AUD, CNY, THB) and high yielders (IDR, INR).??

Gold’s safe-haven qualities have also shined through the volatility, with our year-end targets pointing to prices around US$2,050 an ounce.

Recent shocks are likely to further desynchronise growth around the world, making discipline and diversification, including through real assets, all the more critical. Elevated risks need to be managed, but we believe that compelling opportunities can still be found—including in Asia.

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