Western monetary tightening could benefit Asia assets
Tightening monetary measures in North America and Europe could provide Asian investors with a window of opportunity to buy local and regional assets, due to looser monetary policies in their home countries.
In recent weeks, the US Federal Reserve, the European Central Bank, and the Bank of England have all revealed a shift in monetary policy towards a gradual tightening, after years of low interest rates and quantitative easing programmes.
But Asian central banks are bucking this trend, according to Robert Horrocks, chief investment officer and portfolio manager at Matthews Asia. “Despite the tightening of western central banks, we are seeing much looser policy in Asia,” Horrocks told AsianInvestor.
“This should be a good environment for Asian equity markets,” Horrocks (pictured left) said, “with the prospects of near-term earnings growth being better in Asia than in the West,” he added.
The Fed began unwinding its $4.5 trillion balance sheet in October, starting at $10 trillion per month and gradually increasing to $50 million throughout the next year. In Europe, the European Central Bank announced in October that it would cut monthly bond purchases by half, to €30 billion ($36 billion), starting in January.
While the ECB has no plans to raise interest rates, the Fed has initiated four 25 basis point rate hikes since December 2015, and is widely expected to announce another hike in December. The Bank of England announced a 25 basis point rate hike on November 2, the first such ncrease since January 2007.
But Asia's ongoing period of monetary loosening began with the Bank of Japan conducting aggressive bouts of government bond-buying since 2013, continued with China lowering the amount of capital that lenders needed to set aside last year, and he expects countries across the rest of Asia to loosen their monetary policies in 2018.
Tightening monetary policies in North American and European central banks can also have a positive effect on Asian equities, Jeik Sohn, investment director, Asia, at M&G Investments said.
“The reason why these central banks are raising rates and reducing the balance sheet is because economies are doing well,” he told AsianInvestor. Healthy economies will boost economic growth, he said, thereby pushing Asian equities higher.
Fixed income issues
While rate hikes may be good for equities, it could be a different story in the global and Asian fixed income markets, according to Yerlan Syzdykov, deputy head of global emerging markets and co-head of global emerging markets fixed income at Amundi.
“Bonds could be potentially challenged by increasing interest rates in the US,” he told AsianInvestor.
Better prepared markets may also limit the impact of higher rates, according to Tuan Huynh (pictured right), chief investment officer Asia Pacific and head of wealth discretionary Asia Pacific at Deutsche Bank Wealth Management, as well as improved business fundamentals.
“The impact on both Asian bonds and equities should be somehow muted,” he said, “as the fundamentals in this part of the world have improved substantially over the past few years.”
Huynh expects new Fed chaiman Jerome Powell, who takes the position in February 2018, to continue the gradual hiking cycle. He said to expect about two to three more rate hikes by the end of 2018, as well as the balance sheet reduction, without alarming the markets.
“The appointment of Jerome Powell should ease investors’ fears that a more hawkish candidate would be appointed,” he said.
However, the process of implementing tightening policies is still a concern for Horrocks. “For me, the key risk is still that Western central banks tighten too far, too fast,” he said.
Asset shift
In the short term, Matthews Asia's Horrocks sees asset allocation movement out of the US and European equities and into emerging markets, most of this into passive emerging markets, though things could change if earnings continue to improve.
“If earnings growth in Asia, in particular, continues to strengthen,” he said, “asset allocators will likely move into active funds and more Asia-specific.” He added that it might favour mid and small-cap exposure and moderate growth type strategies over the mega-cap growth biases in recent months.
Longer term asset allocation may swing towards short duration, according to M&G's Sohn. “When I look at our various fixed income fund managers, when I look at our multi-asset fund managers,” he said, “everyone is underweight duration.”
“We’re in a healthier global economy,” Sohn pointed out. “Therefore, less need for such loose monetary policy — you want to be underweight duration.”
There’s been an uptick in interest among both Asian and global clients towards short term bond funds, Syzdykov (pictured left) said, especially emerging market short term bond funds, and he believes this will continue. “You’re foregoing duration, foregoing some yield,” he said, “but in exchange for protecting yourself from any potential losses when interest rates rise.”
He also predicted that investors would put more money into equity and local currency instruments in emerging markets, given that he expects growth there will continue to be stronger.
A November Bank of America Merrill Lynch report showed October inflows into equity markets in Asia concentrated mostly in North Asian countries, with outflows in Thailand, Malaysia, and Indonesia.
When it comes to equities, Huynh prefers North Asia over Southeast Asia, given the better economic outlook in the former. “We especially like those sectors who could potentially benefit from China reforms,” he said, including state-owned enterprise reforms, industry consolidation, industrial upgrades and innovation, and One Belt One Road initiatives.
Looking forward, Sohn believes Asian investors are wary of geopolitical risks, including North Korea.
“You’re seeing this manifest in terms of skepticism around South Korean assets,” he said, “despite South Korea being one of the fastest growing countries in emerging markets from an earnings growth perspective.”
Asian investors are also concerned about equity markets continuing to rally, said Sohn (pictured right), especially in emerging markets.
“Emerging markets is still very cheap versus the US,” he said, “but after two years of 20-plus percent growth, optically it feels uncomfortable for many Asian investors.”
The MSCI AC Asia ex Japan Index is up 37.13% year to date, as of October 31.