J.P. Morgan Asset Management is pleased to present the latest edition of Quarterly Perspectives. This piece explores key themes from our Guide to the Markets, providing timely economic and investment insights.

THIS QUARTER’S THEMES

Diverging recoveries, diverging policies

Overview

• Variations in vaccination progress and economic stimulus have delayed synchronisation of the global economic recovery. The U.S. is expected to lead the recovery in 2021, and Europe should follow. China’s economy has normalised and is expected to expand along its trend growth.

• Global inflation has accelerated as expected, but there is little clarity whether a series of one-off factors, such as supply-side bottlenecks, semiconductor shortages and commodity price volatility, could prolong this trend.

• Desynchronised recovery implies diverging paths for global monetary policy. Some smaller central banks have already become more hawkish. China has started to normalise with slower credit growth, and the U.S. is still being patient, despite a pick-up in inflation. Meanwhile, the priority of most Asian central banks is to get through the latest wave of infections.

Uneven global recovery

The next phase of recovery should be determined by the progress of vaccinations, which in turn will boost consumption and business investment.

• The U.S. and the UK have been the leading major economies in vaccinations. China and Europe have also accelerated the pace of inoculating their populations. However, Asia and other emerging markets are lagging due to vaccine hesitancy and insufficient supply.

• Locations with better progress on vaccinations can re-open their economies on a more consistent basis, attracting consumption and business investments. This is already happening in the U.S., alongside sizeable fiscal stimulus.

• For the laggards, the recovery will likely be delayed until 2022 or beyond. For Asia, the export outlook is still favourable, but the outlook for domestic demand and travel is subdued for much of 2021.

Inflation is driven by a series of one-off events

Global inflation has accelerated as expected. But a few one-off factors in the U.S. are driving prices higher.

• The U.S. labour market distortions could push up wages in the near term. Businesses are struggling to hire despite the still elevated unemployment rate. But the situation may ease in 3Q 2021 as supplemental unemployment benefits come to an end.

• Nonetheless, supply-side bottlenecks, such as rising shipping costs, could continue to assert pressure on prices. A shortage in semiconductors and fuel could also prolong elevated inflation in the coming months.

• We still expect U.S. inflation to revert to the Fed’s 2% long-term target in 2022. However, investors will remain focused on whether more one-off events would delay the return to normality, and whether the Fed will be pressured to raise rates earlier than expected.

Central banks are going their separate ways

The varying pace of recovery could prompt global central banks to adopt different strategies in normalising their monetary policies.

• The Fed is still a kingpin given its influence in global markets. We expect the Fed’s asset purchases to slow in early 2022, and it has indicated the first rate hike may come in 2023, should the inflation momentum persist and the unemployment rate continue to fall.

• The People’s Bank of China has already pared back credit growth in the first several months of 2021, with an emphasis on constraining corporate leverage and the real estate market.

• Asia’s central banks are lagging the rate-hike cycle amid new waves of infections in several Asian economies, despite the recent pick-up in inflation. This could also limit the strength of Asian currencies in 2H 2021.

Investment Implications

• The economic recovery should continue to be positive for risk assets. However, the varying pace of the recovery implies investors should take a more active approach when allocating by region.

• The U.S. and China are still leading in terms of economic performance, even though the strongest period of their rebound has probably passed. Europe is starting to benefit from a higher vaccination rate and the implementation of the European Recovery Fund.

• Asia’s domestic demand remains challenged by further waves of infections, but its export sector is recording strong demand.

• Ongoing inflation worries and future policy normalisation could push bond yields higher, which require fixed income investors to be agile. Yet, higher inflation would raise demand for income, pushing investors to other income-generating assets such as high-dividend stocks and alternatives, alongside high yield (HY) debt and emerging market (EM) bonds.

Asia down but not out

Overview

• Hopes of a quick recovery in Asia are being dashed by a resurgence of COVID-19 cases and the slow vaccination rollout across the region. Recent spikes in infections remind us that even locations that have done well in controlling the pandemic previously are not immune in the absence of higher vaccination rates.

• The U.S. and Europe may be ahead in vaccination rates, but we expect their recovery to benefit Asia as global demand rises.

• The recovery has been uneven and this is likely to continue. China has led the way, but other Asian economies will follow as they benefit from pent-up consumer demand and the pandemic eventually recedes once more.

Asia is lagging behind but this won’t last forever

Asia has been lagging DM performance as resurgent COVID-19 cases dragged down the economic outlook and investor sentiment for several Asian markets.

• Asia has been falling behind economies such as the U.S. and UK because of the region’s relatively slow vaccination rollout. Equity performance compared to other DM economies has suffered, but this situation should improve as vaccination rates increase with supply over the course of the year. We expect the growth differential to developed markets to narrow and Asian equity performance to close the gap.

• A possible peak in credit and activity in China, alongside regulatory uncertainty, has weighed on the Chinese markets. But we still believe China will lead the recovery in Asia. The overall global recovery and pent-up demand is a positive for Asian exports and trade in general.

How worried are we about inflation?

Rising inflation, especially in the U.S., has led to worries that ultra-accommodative policy support will soon end.

• Despite some higher-than-expected inflation numbers from the U.S. recently, much of this inflation is transitory and normal for a recovering and growing economy. However, if inflation remains elevated, driven by a strong labour market and rising wage growth, this may renew the focus on the pace of policy tightening.

• In Asia, inflation is a minor concern, with most of the pick-up coming from base effects and higher commodity prices.

• Rising input prices are likely to put cost pressure on businesses. However, this currently does not appear to be the case. Profit margins in Asia are rising, which is normal in the early part of an economic recovery and should lead to higher earnings and performance.

Other factors to keep in mind

Other drivers of Asian equities still look favourable, but there are some risks.

• Valuations are currently not cheap at this level on a P/B basis, but they are still relatively undemanding when compared to the U.S. and European markets. Current levels are above long-term averages but not extremely so.

• EM and Asian equities tend to be inversely correlated with the USD. A stronger USD would suggest poorer relative performance. Our outlook is for the USD to weaken on the projected increase in U.S. spending, but there is a risk of USD strength if we see an unexpected early start to the Fed’s tapering and a shift in interest rate differentials.

Investment Implications

• Asian markets will likely catch up but diverging intra-region performance will continue. China and other locations involved in electronic supply chains, or with an electronic product bias, are deriving a greater benefit from increasing global demand. Although the share of U.S. and European demand for Asia’s goods is not as high as it once was, it remains an important driver.

• Earnings are expected to improve. Profit margins are rising despite worries over inflation and higher input costs.

• Asian equity valuations are not outright attractive from a historical perspective, but relative to the U.S. and other major regions, they are undemanding.