Security selection and duration management are key on the road to recovery
Given the “first-in, first-out” effect of COVID-19, China equities have registered strong returns of 30%* in 2020. As China has continued to top the growth chart, investors have now shifted the focus to the potential tightening from the central government. Indeed, while there is evidence suggesting normalising credit impulses, we still believe there are pockets of opportunities from an investment point of view.
The path of recovery will continue to depend on the pace of vaccination across countries. However, if we focus on fundamentals such as earnings growth, our view is that earnings revisions have bottomed out, and consensus are forecasting double-digit earnings-per-share growth across the different countries this year. In terms of valuation, headline valuations such as the price-to-earnings ratio are now towards expensive levels with large divergence across sectors. “Old economy” sectors such as financials, energy and materials may present more opportunities given the more attractive valuation.
With respect to asset allocation, our models continue to point to a “recovery” phase, which is the basis for us to form the overweight stance in equities. However, at the same time, we are cautious of the rising bond yields and the potential spillover effect to equities. We believe that corporate earnings are strong enough to protect valuation. On the contrary, with the volatility in base yields and the expectations of yields grinding higher driven by economic recovery, we have become cautious in fixed income. Valuation of Asian credit, relative to other markets, are no longer cheap despite solid fundamentals. Therefore, we continue to emphasize that careful security selection as well as duration management are essential for portfolios.
Investment Tips: Inflation
In Q1 last year, we witnessed a collapse in oil prices. Given the low base effect, this year we are seeing a pick-up in inflation. Generally speaking, as inflation will erode the purchasing power of fixed assets’ future cash flow, higher inflation is typically negative for nominal bonds as investors would demand higher yields to compensate for the inflation risks. This is also why we saw a spike in yields this February, which caused bond prices to decline. On the contrary, assets such as REITS (Real Estate Investment Trusts) and commodities are typically considered as “inflation hedge” assets.
As a component within the CPI (Consumer Price Index) which measures inflation, costs can flow through to end consumers, hence providing some level of inflation protection for investors. Certain sectors within the equity space can also keep up with inflation. Investors can consider investing in companies that can pass through the rising costs to consumers within the asset class.
* Source: MSCI China Index, April 2021.
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