H1 2022 Asia and China outlook - Media Briefing Highlights (with playback)

Global Inflation Pressures Ease As Central Banks Adopt Tighter Stance

AXA Investment Managers (AXA IM) says that while inflation is currently the main theme and will remain so for the coming year, the underlying upward pressures have peaked in western economies and where never that great in Asia, suggesting that the Federal Reserve’s tighter stance on interest rates will not be mirrored in all the other major markets.

At a media briefing on 15 December, four AXA IM specialists discussed inflation, interest rates and economic environment in Asia and China, in a global context, with some post-COP26 views and perspectives on China’s “zero-Covid” strategy.

1) Global economy – Themes for 2022

Chris IGGO, CIO, Core Investments

Inflation at generational highs, but looks to have peaked

  • Consumer prices in the US rose 6.8% year-on-year in November, the highest level since the early 1980s, while in the UK, retail prices for November hit 5.1%, the highest in a decade.
  • Supply bottlenecks are easing, reducing inflationary pressures in the coming months:
    • Upstream price pressures in commodity markets, such as crude oil, copper and aluminum, and shipping freight costs are starting to ease.
    • Delivery times and inventory management are starting to return to normal.
    • Globalization, digitalization and automation, plus demographics, all point to a lower rate of inflation.

Looking to 2022, central banks’ responses:

  • Fed Chairman Jerome Powell has taken a more hawkish view about tackling inflation, possibly contributing to the US market’s underperformance since his appointment in November.
  • Excessive monetary growth in some markets, plus changes to supply chains and climate change measures all have the potential to push up inflation.
  • AXA IM forecasts US consumer prices to rise 3-4% in 2022, above the Federal Reserve’s target of 2.0-2.5%. While that will be tolerated to an extent, the US market is pricing a rate hike.
  • In Europe, inflation is forecast to settle at around 2% with the ECB expected to sit on its hands and not raise rates.
  • AXA IM expects the Fed to start tapering bond purchases as early as January, which is already priced in. This will mark the start of a tighter policy cycle.
  • AXA IM expects the Fed to hike rates three times in 2022 to around 0.75-1.0%, with the first hike around mid-year.

What it means for the markets

  • For investors, the standout risks at present relate to inflation and COP26.
  • US 10-year Treasury Bond yields are around 1.4%, while inflation is at 6.8%, which represents a huge misalignment. As the gap closes, bond yields could rise, creating a risk for investors.
  • There is also misalignment on the equities side with the average P/E on Nasdaq 20 times earnings. If bond yields rose to 2.5%, it would result in a 2.3% drop in the P/E ratio.
  • However, AXA IM does not expect a big jump in bond yields and sees fixed income offering flat returns.
  • Equities will be all about earnings following strong earnings in 2021. This is likely to continue in 2022 with high single-digit returns from global equities.

COP26 did not alleviate climate risks

  • At COP26 (31 October – 12 November) there were plenty of bold statements and ambition, but the world is not yet on a path to limit global warming to just 1.5°C, so more policy action is needed.
  • COP26 saw positive developments on deforestation, methane and updating National Determined Contribution Plans.
  • But the Big Four commitments[1] are still in doubt. There was not global commitment on carbon pricing, mixed messaging on coal, and most studies suggest the 1.5°C target is unlikely to be met.
  • There are two forms of risk associated with climate change:
    • Physical risks in the form of extreme weather patterns.
    • Transition risks for companies transitioning to become low-carbon businesses.
  • Many companies buy carbon offsets to address their own carbon footprints. Yet, since the beginning of the pandemic, carbon prices have more than quadrupled from around EUR 20 to around EUR 90, meaning that all businesses need to have a low-carbon strategy in order to avoid the spiraling carbon costs.
  • Environmental, societal and governance (ESG) compliance overlaps with some of the carbon reduction initiatives, but remains very important for listed companies, which will have to meet regulatory and disclosure requirements.
  • Equity and bond fund strategists will need to transition away from fossil fuel industries towards low carbon sectors.
  • AXA IM also expects to see more companies focusing more on social strategies, using various metrics including the UN Sustainable Development Goals (SDGs).
  • There will also be more green bond issuance to finance green projects.

2) Asian credit – Recovery to extend into 2022 with fund inflows set to continue

Jim VENEAU, Head of Asian Fixed Income

Market overview

  • The economic recovery in Asia should continue due to a strong rebound in domestic demand rather than exports in 2022. While Chinese growth is expected to slow going forward, the Chinese government still has ample room for policy easing, which underpins a stable growth outlook.
  • In the high yield space, a potential recovery in the China property space offers some capital return opportunities. We recommend to position in good quality developers that are likely to survive more policy fine-tunings, which appear oversold.
  • Away from China, Indonesian corporates offer attractive total returns – the best in Asia.
  • In India, fallen angel risks have diminished with the downgrade risk on Indian sovereign recently removed. Asian credit fundamentals also remains largely stable in the investment grade space.
  • US rates are biased towards the upside. Asia credit could minimize negative capital return from further rise in US rates given its wider spread cushion and shorter overall duration.
  • Technicals for Asian credits remain strong. The asset class has benefited consistent inflows (c.a. US$1 billion per month) driven by the search for yield by global investors. As such, foreign demand has trended up in both 2020 and 2021, and that is likely to continue in 2022.

Outlook and positioning

  • The current sell-off is different from previous cycles because it originated within the Chinese high yield property space due to policy tightening targeted at Chinese real estate. The tightening in 2021 is more about stricter regulation on developers’ project company bank escrow account in local banks.
  • Right now there are some encouraging signs, but risks abound. Areas to focus on to achieve a turnaround include:
    • Further loosening on mortgage and construction loans;
    • Some policy fine-tuning in the release of cash in banks’ escrow account; and
    • Relatively soft property tax policies.
  • While the downward pressure on property may weigh on economic growth, the direct impact on Asia credit is relatively limited. For banks, the risk of systemic banking system stress is extremely low.
  • Property’s upstream sectors:
    • On the real economy front, a potential negative impact is conceivable on the property’s upstream sectors.
    • We expect the negative impact on these sectors to emerge in the second quarter of 2022, due to the lagging effect.
    • The property’s upstream sectors only account for a small fraction of the Asia credit universe.
  • Elsewhere, China government bonds are now part of a number of large international bond indices, which means that funds are now flowing into them. CGBs are going through a form of catch-up period at the moment, which presents opportunities.
  • 2022 will be a strong year for fund inflows to CGBs on technical factors alone, although they are of course a rock-solid investment.

3) Asian equities – Constructive outlook for 2022

Simon WESTON, Head of AXA IM Equities Asia

An end to cheap money

  • AXA IM is constructive on its outlook for 2022 following a tough year for equities in Asia in 2021.
  • Discussion about inflation globally is an important one, but it is important to recognize that, in Asia, inflation is pretty subdued – not like other emerging markets, such as South America and Eastern Europe.
  • Korea, New Zealand and Pakistan have all raised rates already, which reflects an end to cheap money. Experience tells us that such a transition in the interest rate policy cycle can have quite an impact on equities.
  • The last time Asia went into a tightening cycle, back in 2013, some markets – notably India and Indonesia – were exposed to deficit issues; but that is no longer the case. The economic fundamentals look healthier now, despite the pandemic.
  • China has had a tightening bias for the past few years, interrupted by Covid-19.
  • In terms of China equities, there is a weak recovery taking place, while the government provides more fiscal and monetary support, which will benefit the whole region.
  • Relative and absolute outperformance in Asia and China are likely in 2022.

4) China’s macro economy – Drivers for 2022

Aidan YAO, Senior Emerging Asia Economist

GDP outlook for Asia and China

  • Asia GDP growth, excluding China, is forecast by AXA IM to rise 6.1% in 2021, compared to a decline of 4.8% in 2020. It is forecast to rise 5.0% in 2022 and 4.8% in 2023.
  • The markets with the highest levels of fully vaccinated people are forecast to be the strongest performers. Standouts here include Singapore (80%), Korea (72%) and Malaysia (74%).
  • For China, the economic growth target of 6% in 2021 was very achievable, but the 5% target for 2022 presents more of a challenge, given the policy balancing act required. AXA IM expects China to blend lenient regulatory implementation, easier monetary policy and active, front-loading fiscal policy to reach its GDP target.
  • AXA IM forecast China’s GDP growth to be 5.0% in 2022 and 5.3% in 2023.

Homemade headwinds

  • The headwinds being experienced in China are largely engineered by policy, notably policy to curb property market excesses and for decarbonization across industry and the economy. Policy is a source of the slowdown.

Three key drivers

  • Looking forward, China has three key drivers:
    • Transitory
      • There are transitory pressures, notably in the energy and power sector, which are being addressed by the government.
      • Coal production and stocks are back on the rise, although heavy-user industries such as steel and cement still experience rationing.
    • Persistent
      • These pressures refers in part to the property sector, where fundamental change is afoot. The recklessness of the sector is incompatible with China’s economic development, because the property bubble increases the rich-poor gap which is inconsistent with “common prosperity”.
      • Residential property also has little economic value once built – it creates no jobs and has no productivity. A factory would be different. So, the property sector as it stands does not fit in with China’s strategic view.
      • Real estate accounts to 25-30% of the economy, so a two-steps-forward-one-step-back approach is favored to dispel panic and ringfence troubled players. This helps to manage the risk.
    • Uncertain
      • The export outlook is uncertain owing to varying levels of demand, Covid, global recovery and revived supply chains.
      • A very big factor here is China’s “zero-Covid strategy” to counter the correlation between outbreaks and economic slowdown.
      • AXA IM believes China will keep with the zero-Covid strategy because the spread of Covid countrywide could lead to possibly millions of cases a day. That, in turn, could lead to social instability.
      • It would take another major medical breakthrough to change strategy.

[1] The four main COP26 goals: 1. secure global net-zero by mid-century and keep 1.5C degrees within reach; 2. adapt to protect communities and natural habitats; 3. mobilise finance; and 4. work together to deliver.

Source: AXA Investment Managers, as of 15 December 2021.