Laws of motion

A monthly guide to investing in Asia Pacific financial markets

Once an object starts moving, inertia takes hold and the momentum will continue until enough external forces intervene.

Newton’s first law of motion is remarkably applicable to economic conditions today. Macroeconomic dynamics in recent months have pushed the Chinese and US economies in different directions, with China’s recovery sinking below our expectations and US growth rising above. So far, neither the pull of Chinese policy easing nor the friction from the Federal Reserve’s tightening has been forceful enough to reverse the economic momentum.

Markets have responded with a year-to-date run-up in US stocks and yields, and a rollover in Chinese equities and APAC currencies. Though many of our investment calls have still generated positive returns for portfolios, the market movements have pressured performance in several of our tactical positions. We update our thinking and expectations this month.

Forceful policy needed in China

In China, deleveraging and deflation continue to undermine the economic recovery. Data for July has proven far weaker than we had expected, with new loans plunging to a 14-month low as households prioritized repaying mortgages, and CPI turning negative for the first time since 2009 (excluding COVID) amid weak demand. The liquidity crunch exhibited by Country Garden, a leading private developer with four times as many projects as China Evergrande, is another reminder of the stress in the property sector.

We still believe policy easing can be the exogenous force to turn the recovery around and support a bounce in Chinese equities. But the macro deterioration means forceful measures must be delivered within weeks, in our view, to achieve full-year growth targets, boost earnings, and revive investor sentiment, which remains particularly fragile. Indeed, after outperforming every equity market in July (+10%), China has given up these gains in August.

Softish landing in the US

Meanwhile, economic surprises in the US are beating China by the widest margin since the start of the pandemic. Inflation and wage pressures continue to trend lower and growth remains positive. We now see the US economy heading for a “softish” landing, where growth slows below trend, but a recession is avoided over the next six-12 months. A lot still must go right for such an outcome—only three soft landings have occurred in the post-war US economy (mid-1960s, mid-1980s, and mid-1990s) versus 12 recessions.

Our updated outlook means we think the risk-reward profile for equities is now more balanced; hence, we move the asset class to neutral from least preferred in our global strategy. Though we ultimately expect both US yields and the dollar to fall, the country’s economic strength could mean they stay elevated in the near term.

For the yen, a widening yield differential between the US and Japan has already made it the worst-performing Asian currency this year. But as Treasury supply falls and inflation cools, we still expect US 10-year yields to decline (to 3.5%) and Japan 10-year yields to creep up (to 0.8%) by year-end, allowing the JPY to stage a modest (if shallower than previously expected) recovery to 142 against the USD (vs. 128 previously). That said, we neutralize our most preferred view on the yen this month given the high costs of carry for investors.

Tech and financials power Asia’s structural wheels

A softish landing in the US is a positive macro development for Asia’s economy overall, where we expect a mild lift in exports and industrial production in the months ahead. As external and domestic demand firms, we forecast regional GDP growth will accelerate by 50–100bps in 2H from 1H.

Complementing the cyclical improvement are positive structural forces across the rest of the region. We expect India, for example, to account for a fifth of global economic growth from 2022 to 2024, and see GDP per capita double by 2030. This shift in spending power is only rivaled by ASEAN nations like Indonesia, which is expected to have the world’s fourth-largest consumer class (those spending more than USD 12/day) by the end of the decade (with India and China taking the top two spots).

As spending moves into discretionary goods and services, we also see compelling opportunities in tech and financial services.

Global tech valuations are rich overall, but earnings are resilient, and we continue to see opportunities in select quality compounders in software and internet. Three major opportunities stand out in India in particular: Leading internet platforms, consumer electronics, and IT services. We estimate that India’s internet economy will reach USD 1 trillion by 2030 (up from USD 155–175bn in 2022), while growth in consumer electronics could mirror China’s extraordinary surge during 2005–15.

Investors are recognizing the scale of the opportunity, with Developing Asia ex- China on track to record its biggest annual foreign inflows since 2016, and MSCI Indonesia is up 29% over the past two years, compared to a –20% return for Asia ex-Japan. Banks for the next billions (largely financials in India, Indonesia, and the Philippines) remain most preferred in our regional strategy. We also continue to like the high-yielding IDR and INR—the best performers in Asia this year—given the more conducive carry trade environment as central bank hiking ends.

Remain most preferred on bonds

Meanwhile, we continue to hold a relative preference for bonds, where we see better returns and an attractive entry point compared to the flattish performance expected for equities. We stick with quality segments such as Asia investment grade (currently yielding around 5.75%), and remain cautious on high yield, given negative headlines and likely continued pressure in China property. We take profit on emerging market bonds—downgrading the segment to neutral from most preferred—given that valuations are not as cheap as before.

We also shift our view on gold to neutral from most preferred. Higher US real yields and a stronger dollar are likely to weigh on prices in the near term, but the metal remains a potentially effective portfolio hedge against financial and geopolitical risks. Across other commodities, we think oil will rise to the upper range of our USD 85–95/bbl forecast, underpinning our move to most preferred on the global energy sector this month.

Much like objects in motion, financial markets and economies have to deal with different forces, making them vulnerable to changes in direction. But in such an environment, it becomes even more important for investors to overcome their investment inertia. Doing so can ensure portfolios are positioned to capitalize on the opportunities we highlight in this month’s edition.

Written with?Mark Haefele, our Chief Investment Officer.

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