Global review: Advantage China as uneven recovery, fading stimulus pressures US
Covid-19 has upended human behaviour as we know it. Because of lockdowns and circuit breakers, economic growth has taken a hit. To revive the US economy, the US Federal Reserve is committed to unlimited quantitative easing, with other central banks such as the European Central Bank and Bank of Japan taking similar steps. With the exception of China, governments in developed and emerging economies have unleashed trillions of dollars in stimulus spending. In Singapore, the government announced four budgets comprising $93 billion to support households and jobs.
The result of “QE to infinity” and the various government stimulus measures have caused interest rates to plunge, equities to rise and leaving investors looking for better returns and higher yields. While local homeowners with mortgages have cheered lower mortgage rates, low interest rates have other far reaching impacts. Savings rates have fallen, finding yield is a challenge, and banks — which in Singapore are the bedrock of several widely-followed market indices — are likely to experience margin pressure.
“The post-Covid world looks different from the pre-Covid world. Investors need to reassess how they think about allocation. Yields have moved even lower and developed markets are likely to return very low or negative returns,” says Ben Powell, chief investment strategist, Asia Pacific, BlackRock Investment Institution, during a webinar on June 30.
Powell says BlackRock prefers credit over equities. This includes overweights in investment-grade credit with a bias towards quality, high yield and Euro area peripheral debt. The common thread, Powell indicates, is renewed asset purchases by central banks, a stable interest rate backdrop and attractive income in a world where decently yielding assets are hard to find.
In terms of geography, North Asia is likely to be the most resilient economic area because it was the first region to deal with Covid-19. China, Korea and Taiwan managed to control the spread, and hence stimulus measures from their government have been less than the rest of the world which had to shut down their economies for a longer period of time. These economies are also likely to recover faster.
“We believe Asia has greater resilience and capacity to adapt to the future rushing at us. Within Asia we have a preference for North Asia. China has significantly more room to engage in monetary and fiscal policy if that proves necessary and China’s economy seems to be recovering rather well,” Powell adds.
In terms of Asian credits and sovereigns, Powell likes the Chinese market. “Relative to where global bond yields are at 1.5% and developed market bonds are likely to provide negative returns in the next five years, Chinese government bonds would have a much higher relative yield for global investors who do not have exposure to China’s capital markets,” Powell says.
Another trend that has developed during global lockdowns also benefits China and North Asia in general. The upshot of Covid and working from home (WFH) and buying from home (BFH) trends is people are embracing the “virtual”, Powell says. “This change towards WFH and BFH was already happening but we’ve accelerated that over the last couple of months,” Powell notes. And the beneficiaries will be North Asian tech companies.
These companies have the technology that China seeks as it creates its own technology supply chains in the wake of a new US-China Cold “techno” War. Sean Taylor, Asia Pacific CIO at DWS, says semiconductors could be at the centre of the US-China battle. “That whole area is going to be much more difficult and China is going to form its own supply chain and the US is not part of it but it highlights how good Korean and Taiwanese tech companies are and that is where investment opportunities arise,” he says.
All about China
Powell says China was first in, first out of the Covid crisis, and BlackRock is forecasting Chinese GDP growth of 5.5% this year. That implies a sharp rebound for the Chinese economy in 2H2020.
“I continue to look at China with interest because, firstly, the economy seems to be recovering rather well; secondly, implied nominal GDP growth which China conveyed at its National People’s Congress (NPC) should be 5.5% in China this year or US$700 billion ($978 billion) of incremental GDP, the size of Switzerland, which is remarkable given the Covid-19 shock; thirdly, there was commitment to a notable increase in credit at the NPC and that’s a lever for China if necessary,” Power elaborates. If China can recover, that would have a bearing on North Asia in particular, he adds.
Taylor of DWS is somewhat more cautious. He is forecasting Chinese GDP growth of just 1% this year, rebounding sharply to 9% in 2021. Whatever the case, clear signs of a recovery are emerging. On June 30, it was announced that China’s official Purchasing Manager’s Index (PMI) rose 0.3 percentage points to 50.9 in June, above forecasts of economists polled by Bloomberg and Reuters. Non-manufacturing PMI rose 0.8 ppt to 54.4 in June, well above expectations and the highest reading since November 2019 when it was at the same level.
“The better than expected PMI readings for both the manufacturing and services sectors point to a stronger recovery in China’s economy in June as the country keeps its second wave Covid-19 in check and global demand picks up with more economies exiting their lockdowns,” notes UOB Global Economics and Markets Research in an update.
“At the end of the first quarter, China was the only country coming out of lockdown and earnings were not as bad as we feared. Hence, within our Asian portfolio, we were overweight China, Japan and Korea’s tech sector,” Taylor says. Within emerging markets, China has distinctly outperformed, and their ADRs (American Depositary Receipts) have done particularly well, Taylor adds, referring to Chinese ADRs which were listed on the NYSE and Nasdaq but are now seeking secondary listings in Hong Kong.
Last September, US President Donald Trump rattled markets when he threatened to delist Chinese stocks from US exchanges. In May, the US Senate passed a bill that could ban many Chinese companies from listing their shares on US exchanges, or raising money from American investors.
“We don’t know how the rules will change going forward. With dual listing you’re more protected and it’s more convenient to trade in Asia. Those with secondary listings will end up in the index of stock connect stocks, and these are all fully fungible,” says Taylor , who remains positive on China.
Globally, DWS expects earnings downgrades of 20–35% this year, followed by a rebound of 12% in 2021. “In Asia, these downgrades aren’t as bad as the rest of the world because China is holding up well. Valuations are average. So, at the moment, you’re paying average rates for the hope that earnings will recover next year, except for Japan which is looking very cheap,” Taylor says.
Uneven recovery
The biggest risk, according to Powell of BlackRock, is a second Covid-19 wave of infection that could trigger a second lockdown. That already appears to be materialising in parts of the US. The sunshine states — Florida, Arizona and Texas — have paused their reopenings and are beginning to walk back on bars and restaurants that had opened in May and June. In Florida, several cities and counties have reimposed restrictions on bars, beaches, restaurants and other social gatherings. In Arizona, the governor paused operations of bars, gyms, movie theatres and water parks for 30 days and banned indoor and outdoor public events or gatherings of 50 or more people. Elsewhere, Texas, one of the largest US states, has paused its reopening.
As a result, BlackRock has downgraded US stocks to neutral after a strong run of outperformance. Risks include policy fatigue, a re-emergence of the virus, intensifying US-China tensions, and a turbulent election season. Add to that a fading fiscal stimulus, and equities begin to look tired.
“A key risk is for localised flare-up and a broader flare-up. Governments and economies are very determined to open up their economies. The longer they are shut the longer the damage, especially on longer term unemployment, and damaged balance sheets. Hence, we expect openings to be supplemented by policy revolution and we will be watching the danger around flare ups all over the world,” Powell says.
On a positive note, the global financial system remains healthy, unlike during the Global Financial Crisis (GFC). The US Federal Reserve acted early, in particular to ensure that there was ample liquidity in the credit markets. That, according to Taylor, is a great differentiator between the Covid crisis and the GFC. “Most financial institutions are in a far better position now than in 2008. They are better capitalised and balance sheets are less levered, given the Fed acted very quickly,” Taylor notes.
On the other hand, banks will come under pressure. “In the short term, there is going to be pressure on dividend payments because we’re going to be in a lower growth world and we’re going to have lower interest rates globally as well, so it’s going to be harder for banks to make money from interest income,” Taylor explains. “But this is not a systemic problem; it is a growth issue and it is going to depend on which area the bank is operating in.”
What looks cheap?
While the earnings of Chinese banks may not decline that much, they could be under social pressure from the government to support SMEs and the community. Already, regulators in the UK and Europe have recommended that banks suspend share buybacks and are discouraging dividend payments so that banks can have sufficient capital to lend to the community.
“Financials are cheap and Asian banks would benefit from the current pick-up in GDP. They are very attractive valuation-wise,” Taylor observes. DWS is positive on healthcare and Taylor suggests the best way to play healthcare is through insurers which is part of the financial institutions complex.