Gregory Choy Head of Wealth Advisory, OCBC Bank
Member of OCBC Wealth Panel
Amid US interest rate hikes and concerns of a slowing economy in China, OCBC tells investors not to turn away from the region just yet
INVESTORS are wary about Asia ex-Japan, understandably owing to the negative sentiment that has surrounded the region.
First, the United States Federal Reserve is planning a series of interest rate hikes, which would ultimately lead to a rally of the US dollar. Investors who are drawn by the prospect of attractive yields will direct their funds out of emerging markets and into US-denominated assets. This move will put pressure on Asian equities.
Second, China’s robust growth is tapering off, with mounting debt and foreign exchange instabilities causing concerns. Investors believe that Asia’s macro-economic fortunes are intertwined with China’s economic development — as long as China is showing record growth, export-driven economies in Asia would continue prospering.
A surprise devaluation of the Chinese Yuan (CNY) in August last year, coupled with Chinese officials mulling another devaluation, shook investors’ confidence. On top of that, stock market circuit breakers imposed by authorities gave investors another reason to give Asia a miss.
Amid the unfavourable views held by investors towards Asia, Mr Gregory Choy, OCBC’s head of Wealth Advisory, Wealth Management, and a member of the OCBC Wealth Panel, remains positive on the region. “Interest in Asia has started to grow, albeit rather slowly,” he says.
Fundamentals remain intact
A healthy mix of current account surpluses, depressed exchange rates and Asia’s net commodity importer status contribute to what Mr Choy thinks is the region’s bright spark amid a dull global growth background.
The past few years of economic stability in Asia despite problems in China also lead us to believe that the region is well-placed to cope with a Chinese slowdown contrary to conventional wisdom, Mr Choy wrote in an OCBC Premier Banking Strategy Focus report dated May 3.
The ASEAN 5 — Indonesia, Malaysia, the Philippines, Thailand and Singapore — have shown encouraging growth over the years, Mr Choy notes. “We find that ASEAN 5 growth continues to run at just under 5 per cent, which is only marginally slower than the average seen since 2000. This is despite the significant economic slowdown in China from double digit growth to below 7 per cent and against a struggling global trade environment,” he explains.
Asia’s place as a net commodity importer means the region is a beneficiary of current low oil prices environment. Furthermore, with its strong balance sheets and considerable foreign reserves, it is in a sound position to deal with further tightening in US monetary policy and potential volatility in currency markets, Mr Choy notes. He adds that Asia still has room to ease fiscal policies, providing much-needed catalysts for its risk assets.
Asia ex-Japan equities are also looking inexpensive these days, opening up some buying opportunities. Valuations of Asia ex-Japan equities remain at multi-year lows, says Mr Choy. The MSCI Asia ex-Japan Index is still trading one standard deviation below the 10-year average price-to-book-ratio, while 12-month forward price-to-earnings valuations. Continue to trade below the 10-year average as well, he notes.
China to manage its risks
The Federal Reserve may intend to hike interest rates but it has taken a more cautious stance on it, says Mr Choy. It delayed a rate hike in March and reduced the number of interest rate hikes expected this year from four to two, owing to global growth concerns.
The surprising turn in Fed rhetoric halted the US dollar rally, offering temporary reprieve to emerging market risk assets as funds started flowing back to these markets. “Fears of a one-time large devaluation have somewhat receded and capital outflows declined, in a large part due to more effective capital controls,” says Mr Choy.
However, he cautions that this trend is likely a temporary reprieve, as the Federal Reserve would still proceed with monetary tightening as early as June. “Devaluation fears may resurface once again,” he says. “We may have to confront the uncomfortable reality that funds may flow out of emerging markets, thus putting pressure on Asian risk assets.”
Stability in the CNY in recent months afte a tumultuous January, as well as a pick-up in manufacturing and non-manufacturing Purchasing Managers’ Indices (PMI), have helped to support global risk sentiment, leading to gains in equity markets, says Mr Choy.
China’s official manufacturing gauge rose in March for the first time since August 2015 to 50.2 from 49 and has since stabilised, he noted in the strategy report.
However, investors should also be aware that the Chinese recovery comes at the expense of rapid credit growth, a trend that is not sustainable in the long run.
“China’s private sector credit-to-gross domestic product ratio is up by 54.4 percentage points since the third quarter of 2011 — a growth that is typically associated with credit bubbles,” says Mr Choy. “Finding productive investment opportunities will be hard and borrowers will face a higher probability of default,” he adds.
In response, policy-makers in China are taking steps to protect the banking system. This involves the government taking some problem loans off the banks’ balance sheets, assisting in restructuring of some problem borrowers and allowing the banks to make lower provisions for bad loans.
Mr Choy says: “China’s transition to a domestic, service-sector driven economy will be a difficult and unavoidably bumpy process, so we must expect future periods of concern over Chinese growth, even if they are faded for the time being. Hence, investors should still remain judicious and prudent when seeking exposure in Asia ex-Japan.”
What’s to be done
OCBC believes that volatility remains a likely event in the current investment climate. But that does not mean that investors overlook attractive opportunities in Asian equities.
It advises a multi-asset investment strategy to diversify investment risks in the region.Amid potential volatility ahead, diversification and active management can be useful, says Mr Choy. OCBC recommends the JP Morgan Asia Pacific Income Fund and the Schroder Asian Income Fund.
Investment recommendation
With over 200 years of collective investment experience, the OCBC Wealth Panel is well recognised in the industry and sought after by the media for its invaluable insights.
Now its insights are available to help guide your investment decisions. Here are the bank’s recommendations:
For investors who favour a mixed or multi-asset income strategy to mitigate potential downside risks while maintaining participation in Asian risk assets:
- JP Morgan Asia Pacific Income Fund
- Schroder Asian Income Fund
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