DWS has revised this year’s overall growth outlook for Asian emerging markets downwards as the region continues to struggle against a surge in Covid-19 infections driven by the Delta variant. The German asset management firm downgraded its growth forecast from 7.9% to 7.3%. Underpinning this is a lower 2021 growth forecast for China at 8.2%, down from 8.7% previously. According to Sean Taylor, chief investment officer APAC and head of emerging markets at DWS, the trimmed forecast reflects the uncertainties looming over investor sentiment in China after it rolled out a series of tightened regulations for its internet, education and real estate sectors.
The lower forecast also takes into account softer economic data that came out of China in July, which potentially points towards a faster-than-expected slowdown. China’s y-o-y retail sales growth slowed to 8.5% in July, lower than the consensus forecast of 11.5% according to analysts polled by Reuters. Other key indicators such as industrial production and fixed asset investments also missed market expectations.
China’s zero-tolerance approach towards Covid-19 is also expected to stifle recovery momentum as border controls and sporadic lockdowns dampen business activity and consumer confidence.
Elsewhere, DWS has also cut 2021 growth forecasts for India and Asean to 9.3% and 4% respectively, down from 10% and 5.3%, in view of the new Covid-19 wave affecting the countries in 2Q.
Despite the lower forecasts, Taylor is quick to point out that there’s light at the end of the tunnel as Asian countries kicked vaccinations into a higher gear. China, in particular, has raced to vaccinate citizens with more than two billion doses administered as of end-August. Over 60% of its population has now been fully vaccinated, putting it ahead of, or on par with developed countries like the US and the UK. China is also looking to introduce a third booster shot for its citizens for higher protection.
For the rest of Asia, Taylor believes a predominantly vaccinated population will also be key, supported by a pandemic approach that, unlike China, moves away from the “Covid zero” stance that sees lockdowns and strict border controls employed to mitigate infections. Citing the UK and the US as examples, he notes that countries with high vaccination rates and less restrictive policies have seen more openness, and anticipates the same progression for Asia.
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“With continued progress on vaccinations, we expect further re-opening of these economies in the later part of the year which should result in a catch-up in consumption and gradual recovery in badly hit service sectors,” he comments.
As such, he anticipates China and other Asian emerging markets to rebound in the coming year and points out that DWS’s 2021 growth forecast cuts have been channelled into upgrades for next year’s estimates. “We simply delayed that growth,” he remarks.
Positive on equities, but in the medium term
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In terms of equities, emerging markets in Asia have lagged the rest of the world this year. Year to date, the MSCI AC Asia ex-Japan Index has underperformed the MSCI World Index by 26%, mainly driven by the 30% underperformance of the MSCI China Index.
In addition to the resurgence in Covid-19 cases driven by the Delta variant and a tightening in monetary policies by the People’s Bank of China (PBoC), China’s underperformance was propelled by a huge correction in the market following a regulatory crackdown by the Chinese government, with the tech sector particularly hard-hit.
Following a series of anti-monopoly legislation, data privacy laws, and cybersecurity regulations rolled out in the last few months, billions of dollars in market value have been wiped off China’s listed tech giants as investors got spooked.
“While the regulations are arguably backed by clear policy intentions and social merits, the unexpected scope and velocity of the announcement of regulations left investors thinking that the Chinese government has declared war on its private sector,” Taylor explains.
Year to date, the MSCI China Index has fallen 12%, while the MSCI China Tech 100 Index has declined 19%. While the market remains concerned over further crackdowns, Taylor argues that the regulatory efforts, part of China’s push for “common prosperity”, will be fundamental for driving more sustainable and balanced growth, fairer competition and lower systemic risk in the longer run.
He anticipates any regulatory overhang should remain for the next 12 months but with less negative impact on the Chinese equity market as investors have started to factor in the regulatory uncertainty.
Nonetheless, while valuations look attractive compared to a year ago, he remains cautious and underweight on Chinese tech equities as the outlook for the Chinese internet sector is likely to “remain murky” in the next six months.
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“For Chinese equities, we prefer A shares to MSCI China as they are less exposed to regulatory risk and could benefit from upcoming policy easing,” he says. Policy-friendly sectors such as renewables, electric vehicles, semiconductors, and industrial automation which are aligned with the national development objectives should also continue to enjoy government support and are likely to face less regulatory risk.
Beyond China, Taylor remains positive on Asian equities overall in the medium term, as the region has accumulated less debt relative to developed countries during the pandemic, while accelerating digitisation trends also point to a solid foundation for future performance.
“US equities had an incredible run so far leading to almost 35% premium over Asian equities, higher than the average discount over the past 20 years. We could see a reverse in trends next year with the rest of theworld moving towards tighter monetary policy driven by strong recovery and inflationary pressure while China increases fiscal spending with more liquidity provision,” he opines.
He expects new economy stocks to gain more attention as investors shift their attention from China, while the stocks could also benefit from a pick-up in US growth. DWS is forecasting growth of 6.2% for the US in 2021.
Asian credit still offers better returns
Taylor also remains positive on Asian fixed income assets, which continues to offer better returns compared to developed markets. While DWS forecasts US 10-year Treasury yields will slowly rise to 2% in the next 12 months, real yields are expected to remain negative.
To that end, Taylor believes the Asian credit market, which is supported by attractive carry and high global liquidity, remains a good structural opportunity, especially in view of the recent sell-off following uncertainty relating to China’s regulatory situation. “Regulatory overhang, along with idiosyncratic risks within the Chinese property and financial sectors, have led to an adjustment of risk premia recently,” he says.
Given attractive valuations, some tightening is expected in the coming months, which could drive volatility in the credit market. In view of this, Taylor maintains his preference for investment-grade and shorter-duration fixed income assets.
Taylor also remains constructive on Chinese government bonds despite the recent volatility in the Chinese market given its higher yields compared to US Treasury bonds as well as its low correlation to a wide range of asset classes, which provides investors diversification benefits.
Nonetheless, when it comes to Chinese credits, being selective will be key. “On the one hand, market volatility within the Chinese property market is likely to remain high and susceptible to negative news on individual credits in the near-to-medium term,” he remarks.
On the flip side, Taylor points out that the Chinese government has been guiding resources towards sectors that play important roles in its strategic priorities such as green development and self-sufficiency as outlined in its Five-Year Plan which sets out the country’s socio-economic and political priorities. “Hence, we believe selected credits from these policy-friendly sectors should remain supported in the foreseeable future,” he adds.
Photo: Bloomberg
