UBS Asset Management's China investment experts got together with over 100 clients from banks and financial institutions at our exclusive Viewpoints Luncheon in Hong Kong on June 25th to chart the outlook for H2 2019 and outline investor opportunities.
- The US Fed will likely make one-to-two interest rate cuts in H2 2019
- US-China tensions not just limited to trade, rivalry will continue and make for lasting market volatility
- China's property sector is in good shape: demand is outstripping supply and we're still positive on larger developers
- Stimulus measures have put a base under the economy and we see an improving growth outlook for China in H2 2019
- Further policy support likely, such as cuts to interest rates/RRR
- Long run-drivers for China's economy remain intact, China equity valuations reasonable by historical measures
- Tweets are driving newsflow - particularly on the trade issue – but investors should cut through the noise and remember that fundamentals drive economies and the above factors offer many compelling reasons to be long-term positive on China
China macro: the L-shaped recovery
Hayden Briscoe, Head of Asia Pacific Fixed Income, started proceedings by reiterating his view in a L-shaped recovery for China in H2 2019. Policy stimulus has put a support under the economy and he expects the real effects of the stimulus will become clear in headline macro numbers in H2 2019.
Going further, Briscoe expects China to provide further support in the coming months, most likely via cuts to interest rates and reserve requirement ratios, and these will be important policy moves because of the likelihood that US-imposed trade tariffs will hit the trade sector, and also because of a likely slowdown in global growth.
China fixed income: strong case for government bonds; high yield offers attractive relative valuation
How should investors react to the slowing global backdrop? Briscoe explained that China's government bond markets offer investors some of the highest nominal and real yields in the world, in stark contrast to negative yields on German and Japanese government bonds.
Briscoe also showed that China high yield looks good on a relative value basis to US and European high yield. Looking at real estate sector - which dominates Asia high yield - Briscoe favors large Chinese developers, many of whom are seeing improving revenue and interest coverage.
Bin Shi: US-China rivalry likely to continue
Bin Shi, Head of China Equities, warned investors not to be overly focused on a solution to US-China trade issues at the G-20 meeting at the end of June. Bin repeatedly explained that US-China tensions are not just limited to trade tariffs, but are part of a rivalry that will continue and make for lasting market volatility.
Bin also stressed that though the US is pressuring China, the pressure may push the Chinese government to accelerate market liberalization and structural reforms, which could be positive for China in the long run.
Bin Shi: good companies unexposed to trade tensions available at reasonable valuations; All-China approach makes sense
Bin also emphasized that the current environment means it is even more important to focus on finding the right companies. Bin reasoned that there are many companies in China who have very little exposure to US markets and who will continue to do well in a very uncertain environment.
Long-run drivers, like urbanization, ageing and R&D-driven innovation, still remain intact – despite US trade policy pressure – and that means it is possible to find good companies attached to these trends. Additionally, many of these companies are trading at reasonable valuations.
Moving onto strategy, Bin explained that when accessing the best opportunities on China's equity markets, taking an All-China approach to equity investing may be the best strategy. Such an approach flexibly allocates to the best China equity opportunities, whether onshore or offshore, now that China's onshore markets have become accessible to overseas investors.
Gian Plebani and the multi-asset view
Gian Plebani, Portfolio Manager for UBS AM multi-asset portfolios, explained that he's bullish on China assets over a six-to-twelve month time horizon. Plebani cited two key factors: firstly, the improvement in global liquidity as central banks across the world turn more dovish and, secondly, the stimulus that the Chinese government is putting into the economy.
Looking at China's stimulus in more detail. Plebani cited looser monetary policy, infrastructure investments, and tax cuts for companies and individuals, as amounting to strong policy support for the economy. Going further, Plebani pointed to a turning point in leading indicators that he has seen during the past six months, which indicate to him that it is time to start allocating to risk assets.
Trade issues are complicating the outlook though. Hence Plebani is keeping a short-term neutral allocation to overall risk in the portfolio until there is more clarity on immediate trade developments. Plebani favors A-shares because they are more sensitive to the stimulus the Chinese government is providing to the domestic economy. Additionally, high-yield fixed income is a favored asset class, mainly because of improving liquidity conditions in China. Finally, Plebani said he was underweight on the RMB because of the risk of a devaluation in the currency.
What's the outlook for Fed policy?
Entering into a Q&A, our experts discussed their expectations for Fed policy and here are the stand-out quotes:
"We expect one-to-two cuts from the Fed this year. That's good for China because it gives the Chinese authorities room to also cut interest rates, and they have had limited room to do that in the past couple of years. If these cuts happen, we will see a reflation in risk assets both globally and in China."
"We also expect one-to-two cuts from the Fed. However, we doubt the efficacy of rate cuts right now, with interest rates globally at such low levels. We wouldn't be surprised to see the debate about global macro shifting quickly to currency policy."
In China's property sector, demand is outstripping supply, large developers look fundamentally stronger than smaller developers in the current environment. Relative to other markets, China high-yield real estate fixed income looks good value.
A risk is a risk if you are not prepared for it. We are focused on two things: companies with strong fundamental support and companies with good valuation support. If we do a good job with these, the companies we select will likely stand a good chance of enduring trade-tension-driven market volatility and growing over the longer term.
We need more certainty around trade negotiations. If there were no trade issues, we'd say now is a good time to increase risk allocations to China because we are now seeing the effects of the recent domestic stimulus improving the momentum of the most leading indicators.
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