Asia Pacific CIO of Credit Suisse, John Woods, on what investors can expect for Asia in the second half of the year.
John Woods, Chief Investment Officer Asia Pacific at Credit Suisse, recently presented his investment outlook for the second half of 2017. He expects global growth to remain robust in the next six months and core inflation to gradually edge higher in developed markets (DM). Nevertheless, DM central banks appear unfazed and have signaled their intention to continue with policy normalization. In emerging markets (EM), activity growth is softening, especially in Asia. We expect China's growth to slow in H2 due to spillovers from recent regulatory and monetary tightening measures.
The financial markets mirror this positive backdrop, with equities making a solid start to the year. Yet bond yields have risen year to date, especially in longer maturities, reflecting investor concerns over potential monetary policy normalization by the US Federal Reserve (Fed) and the European Central Bank (ECB).
Global Monetary Policy Outlook
Monetary policy remains very accommodative in DM with the ECB likely to maintain its negative deposit rate and to continue its ongoing asset purchase program until at least year-end 2017, the Bank of Japan likely to keep its yield target in place, and the Fed likely to raise rates gradually over the course of the year. EM policy rates should remain largely stable, with Brazil and Russia being the main exceptions on the easing side. China's deleveraging and The People's Bank of China's hawkish stances will likely continue.
Commodities on the Rise
For oil, speculative positioning is now much lighter and the extension of OPEC supply cuts should accelerate the inventory normalization process, especially through summer. We see tactical upside into the mid-USD 50s but note that uncertainties loom in 2018.
Equities: Maintain a Neutral View on Both Global and China/Hong Kong Equities
Global equities opened on the back of strong economic momentum, high expectations of fiscal expansion under the new US administration, and favorable political outcomes. EPS growth expectations over the next 12 months remain too optimistic, in our view. Additionally, valuations have become expensive since the rally and technical indicators have turned neutral, but low volatility and better liquidity are supportive.
China and Hong Kong Equities
Despite the market concerns around tightening liquidity onshore, we believe policymakers are focused on active management of financial markets ahead of the political reshuffle at the 19th People's Party Congress later this year, which should provide downside support. Therefore, we expect the market to remain range-bound in the near term, despite decelerating macro momentum. We expect banks and insurance sectors to outperform the market amidst higher bond yields.
USD to Strengthen Against Asian Currencies and to Stabilize Against CNY and EUR
The political risk premium in foreign exchange has shifted from Brussels to Washington. In this context, the USD has had one of its sharpest six-month dips in recent decades. This has helped US exporters and propelled the Nasdaq to new highs. Yet, the lack of an outright sanction of recent EUR strength by ECB President Mario Draghi may embolden buys. This weakens the conviction that the next interest rate differential moves will again be in the USD's favor. Therefore, we have a neutral view towards the USD against EUR, AUD and CHF.
We maintain the tactical neutral view on CNY as the PBOC supports the currency by a "counter-cyclical adjustment factor" in order to stabilize the currency ahead of the leadership reshuffle later this year. We expect CNY to slightly appreciate over the next three months and forecast USD/CNY at 6.70 while retaining our 12-month negative view with a revised forecast of 7.20.
Fixed Income: Prefer Asian Investment Grade over High Yield
Asian fixed income posted solid total returns YTD and continues to benefit from domestic search for yield. Within Asian USD corporate bonds, we forecast lower returns compared to H1 and continue to prefer investment grade over high yield credits based on fundamentals and valuation. In this environment, we prefer to keep duration short in USD bonds. USD preferred shares have posted a strong performance since we recommended them as a diversifier to Asian USD HY Corporates.
Concerns about US-China trade policies and monetary policy are contributing to increased market volatility. We believe that the equity bull market is moving into a different phase, but attractive investment opportunities remain, including in emerging markets (EM).
As the brinkmanship continues to intensify, so too will the obfuscation and misdirection. Until this fog of war dissipates, it is perhaps more useful to consider the range of possible outcomes and their divergent implications, which we have delineated here. Our base case expects the USA and China to ultimately reach a negotiated settlement in the following 6–9 months. Chinese equities could rally 15% over 6 months and USD/CNY should be capped at 7.0.