2023 outlook: selectivity to fuel performance in Asia ex-Japan fixed income and equities

After finally emerging from a world-changing pandemic, economies and markets have been subject to an array of stressors: more persistent inflation than expected, rising policy rates, war-induced supply chain and energy security disruptions, escalating geopolitical tension and, to top it off, a looming global economic slowdown. Sizable and front-loaded monetary policy hikes to tame inflation in much of the world, led by the US Federal Reserve (Fed), are now fueling growth concerns.

Monetary policy across much of Asia has followed or pre-empted moves by the Fed. Critically, however, Asian central banks have generally been much less aggressive – and we expect this trend to continue.

To start with, monetary policy in the region was not as accommodative as in the major developed markets. The u-turn is therefore less extreme. Additionally, inflationary pressures in Asia are relatively subdued, and we expect headline inflation to peak by the end of 2022 in most economies.

Our base case is that monetary policy will move closer to neutral but not into restrictive territory for most Asian countries. India, for instance, continues to see credit and real estate growth despite recent rate hikes.
 

Asia’s rate hikes have been moderate

_{Source: PineBridge Investments, as of 31 October 2022. For illustrative purposes only. We are not soliciting or recommending any action based on this material.}

Not surprisingly, these hikes have contributed to the weakening of Asian currencies, dampening returns on local currency bonds. This will have an impact on the issuers’ debt servicing ability. However, our analysis shows that this will not be across the board, especially given that we expect the US dollar’s (USD’s) strength to subside in 2023.

Investing in Asian fixed income

We see select opportunities in the key asset classes in Asian fixed income.

USD-denominated Asian investment grade (IG)

We think Asian IG bonds provide compelling risk-adjusted returns, with higher yield and shorter duration than similar high-quality bonds in other regions. This makes the asset class a strong diversifier for global fixed income investors.

Despite increased government spending for Covid relief and inflation threats to earnings, Asian IG fundamentals have remained broadly strong. Corporate earnings in Asia ex-Japan have generally been revised upwards, in contrast to the declining trend in the US. Export earnings have been robust, and a stronger USD could offer support for exports to grow further. Moreover, any funding cost pressures for corporates are partly met by local debt market access. In particular, China’s onshore corporate bond yields continue to tighten, supporting access among domestic IG issuers to cheap funding.

From a valuation perspective, the Asian IG market has higher yields and spreads than similar markets, but with a shorter duration, making it less sensitive to interest rates. The valuation is the most attractive it has been since the Great Financial Crisis.

Asian high yield (HY)

Understanding the components of the Asian HY market is key to navigating the credit challenges facing this asset class. Following the series of defaults in China’s property sector, the sector’s weighting in the Asian HY index has shrunk significantly – to 8.3% of the JACI HY index currently from 35% in mid-2021.

While the property sector will continue to dominate headlines, its impact on Asian HY will be much lower going forward and highlights the improved diversity of this market. At the same time, corporate default rates have stayed relatively low outside of China’s property segment.

At the same time, any significant loosening of China’s Covid policy could be very positive for certain HY sectors, such as gaming – particularly for Macau, which has yet to clear pandemic obstacles. Notably, we now see promising opportunities emerging beyond Chinese property, including in renewables, short-dated commodities and segments benefiting from post-Covid re-openings, such as airports. Valuations in these sectors have become attractive partly due to the spillover of China’s property sector.

Asian local currency bonds

Based on our view that the USD’s strength will subside in 2023, we expect Singapore dollar bonds to outperform, given the hawkishness of the city-state’s central bank.

We also believe the re-opening theme in Thailand will bode well for Thai baht bonds following a recovery in tourism, in turn helping to bring the country’s current account back to surplus.

Tapping equity pockets for diversification and long-term growth

Meanwhile, Asia’s equity markets have struggled to swim against the tide for most of 2022, weighed down by the risk-off sentiment globally amid inflation and rate hikes.

Yet despite returns year-to-date being negative for the Asia ex-Japan region as whole, India and the Association of Southeast Asian Nations (ASEAN) market have outperformed the global equity benchmark.

The question on the minds of Asian equity investors is how and where can they find diversification and long-term growth in an environment of instability and inflation? We believe patience pays off in the long run, and while the dark economic clouds are unlikely to lift any time soon for the global economy, there are always pockets of opportunity in Asia to uncover.

India

In a year marked by an unwelcome positive correlation between developed market equities and bonds, Indian equities offered a rare diversification opportunity for global investors.

The domestic economy has been growing steadily, drawing strength from its macroeconomic fundamentals and buffers. Supported by time-bound and targeted monetary, regulatory and fiscal policies, the economic recovery amid a volatile global background has been broad-based and resilient.

Today, India is uniquely benefitting from a confluence of various factors. With a reconfiguration of supply chains for global manufactured goods, India is now also establishing itself as a credible supplier. An effective and responsive monetary policy stance also provides confidence about the potential to maintain financial and economic stability, even during the global financial volatility. And the availability of low-cost risk capital as evidenced by several successful initial public offerings (IPOs) is helping businesses to scale-up rapidly.

In short, we believe high-quality companies that can take advantage of these trends and expand their market share will continue to outperform. Market valuations remain high, though this is not uncommon for India. In such a dynamic market with multiple competitors rising in each niche sector, we cannot overemphasise the need for careful stock selection – a thorough company-by-company assessment to uncover hidden value.

China

In contrast to India, economic activity in China has slowed, Further, due to the relative low visibility over Covid’s future, the market has been cautious about pricing-in significant expectations on policy relaxation.

Should the status quo continue for the next few months, we do not see further downside in equities in China, in turn creating an opportunity to build exposure to high-growth sectors. Should the opposite happen, however, the upside might be significant.

In general, we believe China’s A-share market offers tremendous opportunity for value seekers as valuations which have significantly fallen for high-quality companies are expected to bounce back quickly once controls ease. In addition, we expect continued policy support, though calibrated to avoid repeating the bubbles of the past.

As the government continues to deleverage the property sector and redirect resources to other parts of the economy, there are structural opportunities in sectors such as advanced manufacturing, areas where China is seeking technological self-sufficiency, consumption and others. Invested well, we believe these areas could offer solid investment returns in the future.

ASEAN

After India, ASEAN represents the second best-performing market in the region year to date. Still at an early stage in the post-pandemic recovery journey, high-quality companies in ASEAN are still trading below historical averages.

These businesses are taking advantage of pent-up demand in the short term (for example, travel and tourism) and secular growth drivers such as digitalisation, consumption, sustainability and urbanisation over the long run.

Investing through the trough

As long-term investors, we back our convictions that the fundamentals of the companies we have in our portfolios will stand the test of time.

We have seen economic slowdowns and inflationary periods before in Asia, and our experience has yielded two lessons. Firstly, remaining invested through the troughs will yield larger rewards when the market swings back again, and today’s market challenges may (in hindsight) turn out to be mere speed bumps while an investment continues to compound. The second lesson is that while the market overall may be trending down, price dislocations and a mismatch with fundamentals may present opportunities over the long-term, making selectivity more important than ever.

For more viewpoints from senior investment leaders at PineBridge Investments, visit the 2023 Investment Outlook: Five Themes Driving Global Markets in a Year of Pivots.

AUTHORS

• Omar Slim, CFA, Portfolio Manager, Fixed Income
• Andy Suen, CFA, FRM, Portfolio Manager & Head of Asia ex-Japan Credit Research, Fixed Income
• Elizabeth Soon, CFA, Head of Asia ex-Japan Equities
• Huzaifa Husain, Head of India Equities
• Cynthia Chen, CFA, Portfolio Manager, Asia ex Japan Equities