Beijing’s latest easing cycle could set scene for market rebound
China offers a safe bet as policy headwinds subside and investors seek value in places where asset prices are not so stretched
Global investors ended 2021 with mixed feelings. While a strong economic recovery, coupled with generous central bank liquidity, helped propel markets higher, there are still questions that leave many people apprehensive about what lies ahead.
As Omicron spreads, many governments around the world have reimposed social and mobility restrictions, hindering consumer spending and travel during the holiday season.
Then there are the issues of inflation and impaired global supply chains. The hawkish message from US Federal Reserve chair Jerome Powell last month indicated a clear policy pivot towards combating inflation pressure that was no longer viewed as transitory.
What could help the Fed in this effort is a faster resolution of supply bottlenecks in areas where price increases have been the most rampant. The latest purchasing managers’ index numbers in Asia showing shortening delivery times and robust export growth of semiconductors are encouraging signs.
However, the raging pandemic could still dash those hopes.
Sky-high asset prices are leaving investors with a thin margin of error for their rosy expectations of the future. US and European equities are trading well above historical average valuations, while credit spreads in most developing markets are at near-record lows.
Financial markets are pricing for perfection. This leaves little room for upsetting events such as another disruption from the pandemic, significant central bank mistakes and political or geopolitical conflicts.
Notwithstanding these uncertainties, the outlook appears constructive for the global economy in 2022. The broadening of economic recovery, with many emerging market countries catching up on production normalisation, should help alleviate supply chain pressure and normalise prices of semiconductors, shipping containers, raw materials and more.
This will in turn ease pressure on the Fed and other central banks, allowing them to gently take their feet off the gas pedal without triggering another tantrum as many fear.
As for the pandemic, a continuous move towards “living with the virus” should allow countries to scale back social restrictions and return their economies to normalcy.
Such a benign macro scenario is supportive of risky assets, but high valuations mean 2022 is unlikely to repeat last year’s stellar market performance. Investors could be better off focusing on structural, as opposed to aggregate, opportunities and discovering value in places where asset prices have not become so stretched.
One of these places could be China. Compared to the United States, China is at a different stage of its economic, policy and market cycles. Economic growth in the world’s secondlargest economy decelerated worryingly in 2021.
Asset markets were hit by a double whammy of slowing growth and tightening regulations in 2021, but 2022 could be a year of redemption for Chinese assets. With the risk of a hard landing for the country’s economy rising, the Chinese authorities have started to ease policies.
The recent cuts in the reserve requirement ratio and the loan prime rate, coupled with various fiscal support measures, are signs of a new easing cycle under way. With more pro-growth measures forthcoming, the turning of the policy cycle could help lay the groundwork for a market rebound this year.
Also, valuations of Chinese equities and offshore bonds are cheap. Stocks of mainland companies listed in Hong Kong are trading at seven times earnings on average, compared to 28 for the US market.
The credit spreads of many offshore Chinese bonds reflect concerns of policy tightening, particularly in the property sector. As so much bad news has already been priced in, investors could find value in some distressed assets as policy headwinds subside.
Finally, household expectations of steadily rising property prices are starting to wane as structural woes in the sector unfold. As more people question property as an investible asset, liquidity could start to flow out of real estate into financial assets.
A structural reallocation of household wealth could create a strong impetus for an equity and bond market rally this year.
2022 could be a year of redemption for Chinese assets
Aidan Yao is senior emerging Asia economist at AXA Investment Managers