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The ox is the second animal in the 12-year cycle of the Chinese zodiac. Its arrival on February 12, 2021, a year after COVID-19 came to light across the world, comes at a time where there is elevated uncertainty among investors over the pace of global growth. While a full global recovery is unlikely, we think there are some potential bright spots in Asia.
Transition from Crisis Measures to Supporting Recovery Shines New Light on Asset Allocations
The global pandemic has pushed the global economy into a deep recession, though the market has widely factored in the expectation of a sharp economic rebound. There’s a huge divergence over the pace of global growth. The recovery path will likely be uneven, especially between the East and the West. We believe Asia is on a better path of recovery and that China in particular should be on track for a strong rebound and on-trend growth over the mid to long term. This is a reflection of the ox’s diligent role in Chinese agriculture.
Central banks around the globe remain accommodative and maintain a “whatever it takes” attitude to keep interest rates low. We’ve been impressed at the targeted stimulus measures, particularly in China. The People’s Bank of China’s (PBOC’s) prudent response to the effects of COVID-19 last year freed up billions in reserve requirements for banks, which in turn funded loans to help the worst-hit companies from the virus outbreak.
That said, it’s unlikely Chinese equities will lead the way alone, and we think the winners and losers may change depending on how quickly and effectively a vaccine can be rolled out. We’d expect opportunities to arise for some undervalued names.
On the fixed income side, we’ll have to be more selective. A combination of low term premiums in contrast with continued easy monetary policy maintains a challenging environment for fixed income investors. But, emerging market fundamentals, especially within Asia, have improved in recent months as foreign demand offsets continued domestic weakness in certain economies. In our view, emerging market local currency bonds could become more attractive.
Bonds Have More Room to Run
One might consider 2020 to be the year of the poisoned rat, but as we enter the year of the ox, we have reasons to think we’ll see a stronger year marked by hard work. We generally have strong convictions on Asian currencies and local currency bonds. While flows into Asia dollar bonds had taken off significantly throughout last year, local fixed income bonds and equities have lagged, and we think they have room to catch up.
A number of Asian economies are net-creditor nations, those that invest more in other countries than others invest in them. As major Western economies monetize their debt to support their economies from the financial effects of the global pandemic, local Asian economies and their currencies will likely be a sweet spot for 2021—particularly currencies that are linked to countries with strong export growth, in our view. Container prices have surged, particularly in Chinese ports—which illustrates this strength in exports. While pandemic-induced supply bottlenecks have played a role, this growth is due to overwhelming demand. Despite the encouraging evidence, we believe emerging market local currency debt remains underappreciated by investors, as seen in the chart below.
Emerging market investors should be aware of the bipolarization of the investment landscape. China is not your average emerging market—it is the second-largest economy in the world.
The sheer size of the Chinese bond market has led to demand for dedicated Chinese bond funds to provide market access for foreign investors to trade, settle and hold bonds tradable on the China Interbank Bond Market and Bond Connect (HK). However, given what happened in the United States under former President Trump, who sanctioned a list of Chinese companies, some investors remain hesitant on emerging market global indexes and prefer to consider China as a separate allocation within an emerging market portfolio. That said, Chinese bonds offer strong yield pickup for investors; the 10-year Chinese government bond today yields more than 3%, compared to the 10-year US Treasury at just over 1%.
Fertile Ground for Patient Stockpickers
As market expectations for a sharp rebound continue, geopolitics present an ongoing headwind for business investment decisions. In the United States, Joe Biden’s presidency seems to have calmed financial markets as investors enjoy much-needed clarity on many issues, along with the easing of US-China tensions. We saw a bit of a rebound in markets in January when Biden announced that he is open to “meeting China halfway,” with the general realization that China is a major strategic rival.
In our view, China has handled the pandemic very well, and the strength of its economic recovery is unparalleled. The skill and speed at which authorities dealt with the pandemic resulted in a V-shaped recovery that we believe bodes well for continued strength in the year ahead. Chinese economic policy will likely focus on normalization throughout 2021, through monetary, fiscal or regulatory policy.
In my 30 years of experience as a stockpicker, I’ve been amazed at the opportunities the Chinese equity market has presented to investors—the depth and breadth of the market has grown exponentially. China is relatively unique in that although it does not follow a liberal, market-oriented Western policy script, it nonetheless offers investors a diverse opportunity set.
Digitization, adoption of technology and further consolidation across certain industries should all feed into the long-term opportunities that we’ve long been watching unfold in China. More recently, the government’s commitment to achieving a carbon-neutral footprint within the next decade could throw up some interesting opportunities in the renewables space, as well as the new energy and electric vehicles sector.
We’re particularly interested in so-called “new economy” stocks. The trajectory of companies that have harnessed technology to create online platforms from traditional brick-and-mortar businesses has ticked off some Chinese government initiatives—from lower transaction costs to reaching segments of society that previously did not have that access to goods and services. Looking ahead, the concept of digitization extends beyond the consumer section in terms of how we consider fifth-generation (5G) technology, as we think it could become a tailwind for other sectors to capture this opportunity, particularly in the industrials sector.
While the ox can be stubborn, as we head into the new year, we’ll take a healthy dose of the ox’s most well-known quality: patience. As we continue to keep an eye on quality businesses with sustainable business models, we also anticipate ongoing Chinese initiatives that could bring fertile investment opportunities.
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What Are the Risks?
All investments involve risks, including possible loss of principal. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size and lesser liquidity. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments. China may be subject to considerable degrees of economic, political and social instability. Investments in securities of Chinese issuers involve risks that are specific to China, including certain legal, regulatory, political and economic risks.
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