2023 Mid-year Investment Outlook: “Out of Sync”
Increasing divergence in economic performance of different countries
Halfway through 2023, HSBC Asset Management (“HSBC AM”) believes the global macro outlook will be characterised by increasing divergence in the economic performance of key markets, resulting in a prevailing “Out of Sync” theme. Western economies remain under pressure with persistent underlying inflation and restrictive monetary policies, but emerging economies may benefit from relatively lower inflation, China’s continued reopening and a weaker US dollar. Reflecting the “Out of Sync” theme, HSBC AM believes complex, divergent economics in the context of a more fragmented global order creates unsynchronised markets and thus, new opportunities for diversification and relative outperformance. HSBC AM also believes many Western markets look “Out of Sync” with macro leading indicators which are beginning to flash red.
Looking ahead, HSBC AM believes that inflationary pressures from Western economies will continue to ease as housing and labour markets cool. Meanwhile, financial stability concerns imply central bank policymakers have limited room for further rate hikes. The combination of restrictive monetary policy settings, tighter credit availability, and the exhaustion of pandemic-era excess savings will push the US economy into recession by year-end. This will mop up residual inflationary pressure and allow the Fed to start cutting rates at around the same time. A scenario like the early 1990s recession.
Growth in Asia will be adversely affected by the slowdown in global trade as Western economies lurch into recession, but the region will also benefit from strong tailwinds to boost activity. Benign inflation amid a trend of US dollar weakness and a Fed pivot leaves room for central banks to ease monetary policy in a meaningful way. China’s economic reopening still has scope to boost domestic demand in the context of high household savings, a bottoming-out property sector, and government efforts to support job creation. We still expect targeted policy easing and front-loaded fiscal support to maintain growth momentum and boost confidence. GDP growth should easily exceed the government’s 5.0 per cent target this year.
Meanwhile, India continues as a bright spot in the region, with strong growth momentum expected to continue into the second half of the year. This is spurred by deflationary pressures, higher government investment, and the government’s expanding subsidy programme. Elsewhere in Asia, tourist destinations should continue to see a significant pick-up in Chinese arrivals.
Cecilia Chan, Chief Investment Officer, Asia-Pacific, HSBC Asset Management said, “Heading into the second half of the year, the significant downside risks to Western economic and corporate profits growth make us adopt a cautious and defensive positioning in US and European risk assets. This is in the context of market pricing which continues to embed a benign growth scenario going forward. We have a preference for shorter-duration high quality fixed income asset classes which can benefit from rapid disinflation and Fed rate cuts. There is also evidence that bonds have regained their status as a reliable portfolio hedge. Investment-grade credits offer decent income opportunities amid solid corporate balance sheets and a fairly benign default outlook.
Having been unloved for a time and with performance lagging, we think investors should extend Emerging Markets exposure at this juncture. This is in a backdrop for better growth, lower inflation, and lower valuations. Emerging Markets central bank easing, a Fed pivot, and a reliable weakening of the dollar means that Emerging Markets liquidity conditions are improving. Emerging Markets assets also exhibit lower country correlations, providing a potential boost to portfolio diversification. Emerging Markets allocations can also lower portfolio volatility. Finally, we see a role for alternative assets as a return enhancer in portfolios in an environment of subdued expected returns among more traditional asset classes.”
Asian Fixed Income: Attractive diversification benefits
Asia fixed income continues to be an attractive asset class for investors seeking diversification benefits especially in the current global economic environment. Asia’s overall growth momentum remains intact despite signs that China’s reopening impulse is fading. China is set to focus on targeted easing measures to address credit transmission while fiscal support intended to boost consumption has yet to play out. In the ASEAN region, the economic outlook is supported by structural reforms, strong domestic demand, increased intra-regional trade, and return of tourism from China’s reopening. Amid the divergent growth trend between East and West, Asia bonds’ return potential and relatively attractive yields stand out. The asset class is further supported by the reversal of US dollar strength and the eventual ending of the rate tightening cycle in medium term.
Alfred Mui, Managing Director, Head of Asia Fixed Income Investment Management, HSBC Asset Management, commented, “Asian bond markets are currently enjoying a rare combination of macro tailwinds and good valuations. With much lower levels of inflation than the West and better prospects for growth, default rates in this part of the world should be well contained. In the US dollar investment grade space, Asia bonds trade at wider spread levels and lower duration versus US bonds, while issuers in this universe are of relatively high quality. Within the high yield market, ASEAN bonds look compelling and are supported by improving fundamentals and loosening local credit conditions while we remain selective on investments in China’s real estate market. Lastly, the solid macro backdrop favours Asian local currency bonds, as we see prospects for currency appreciation and opportunities in relatively high-yielding markets such as India.”
Asian Equities: Asia markets attractive in the context of resilient macro trends
Asian equities are in a better position in terms of relative values, compared to equities in developed markets as it is still early in the earnings downgrade cycle with earnings estimates being revised and beginning to stabilise. Foreign investor positioning remains light, suggesting room for further foreign buying. We expect the information technology sector to recover in the second half of 2023, while the outlook remains positive on Taiwan and South Korea.
On the other hand, India and ASEAN economies are relatively well-placed within Asia and emerging markets, with favourable dynamics, increased foreign direct investment and positive reform prospects. Despite relatively high valuations in India as equity investors are focused on selective bottom-up opportunities, demand remains strong in the real estate sector where we see improving affordability, while real estate launches, sales and pipeline remain robust.
Caroline Yu Maurer, Head of China and Specialised Asia Strategies, HSBC Asset Management, said, “For China, we may see some short-term volatilities given concerns around the increasing youth unemployment rate, weakening property market momentum and high local government debt level. We do expect targeted policy easing and front-loaded fiscal support to maintain growth momentum and boost confidence. Low inflation will be a basis for monetary policy easing via RRR or benchmark rate cuts. There is also room for increased CNY flexibility and mild depreciation which can help offset deflationary fears and boost exports. We also expect targeted measures such as tax incentives to sustain growth in sectors such as electric vehicles and high-end manufacturing as well as increased measures to boost the property sector. The MSCI China Index is now trading at 9.7x 1-year forward P/E, around 1 standard deviation below its 10-year average and at a 17 per cent discount versus the broad MSCI Emerging Markets. The current valuation is around the lowest levels recorded since 2019. We believe that the investability of Chinese equities has improved in recent years, helped by a reasonably accommodating liquidity environment, easing of COVID-19 and ADRs delisting concerns, with the view that most major regulatory changes have been made. Investors may currently be too bearish on the China economy and have priced in too much risk or downside.”
Conclusion: New investment playbook with renewed focus for 2023
An increasingly divergent economic outlook and fragmented global order will require a renewed focus on country and regional allocations in portfolios. Country idiosyncrasies can translate to diversification opportunities. In the West, we expect an environment of “choppy markets” over the next 12 months as economies navigate hurdles coming from restrictive monetary policy, recession, and downgrades to the growth outlook. This challenging outlook for many Western economies, contrasts with a better outlook for many Emerging Markets, which are well positioned to outperform relatively.
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