Security selection and duration management are key on the road to recovery
Much of investors’ focus has been on the recovery in the US and its implication to financial markets. Indeed, the US equities market continued to deliver strong returns thanks to the monetary and fiscal policies support. However, investors should also be reminded that China, was in fact, the only major country with positive GDP growth in 2020. Moving onto 2021, we expect China to continue leading global growth, delivering around 9% GDP growth this year on the back of low base effect as well as continuous re-opening of the economy. As China is the biggest economy in Asia, its growth trajectory will have significant impact to Asian financial markets.
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. For instance, consistent with the “value” rotation in the rest of the world, “old economy” sectors such as industrials and financials are able to play a catch-up role in investors’ portfolio, benefiting from the more attractive valuation and trends such as increased infrastructure spending on old town renovations, as well as the opening up of the Chinese insurance market. On the other hand, “new economy” sectors such as consumer and technology continue to benefit from the structural trend of digital transformation and automation. As investors are well aware, recently there has been increased regulatory scrutiny in the segment. Therefore, we believe that a stronger focus is required on security selection, and a barbell approach to asset allocation in both new and old economies is warranted.
Zooming out to the broader region, there has been a divergence in market performance between South East Asia and North Asia, where the latter was able to benefit from the pick-up of technology cycle. However recently, the pick-up of confirmed cases in North Asia has caused some bumps in the market. That said, structurally, we are positive on the medium term outlook of these markets given the low semiconductor inventory coupled with high global demand.
Elsewhere in the region, countries like Thailand and Singapore have seen sporadic and isolated clusters. 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 emphasise careful security selection as well as duration management are essential for portfolios.
*Source: MSCI China Index, April 2021.
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