3, 2, 1 – getting ready to invest in Chinese bonds
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Key takeaways:
- The acute respiratory pandemic appears to be subsiding in some locations and among the topmost concerns are 1) how the outbreak could end, 2) when the global economy could restart, and 3) the depth and speed of an economic and asset market recovery.
- With these questions in mind, we have summarised the economic impact of three scenarios alongside key asset allocation considerations.
A guiding principle in our analysis is that asset markets will react first and foremost to the peak in infection rates, with economic data the next to turn and employment data the last to follow.
Already, some recent data1 showed the global economy has entered a recession. As the pandemic prevails, the question has quickly shifted from whether there will be a global recession to how severe the recession will be. Will it be severe but short? Or severe and prolonged?
Global PMI for manufacturing and services1
Global real GDP growth1
Estimates, forecasts or projections are indicative and may or may not come to pass.
The reopening of economies, and staying open, requires delivering on a range of measures. Investors could consider some potential outcomes on how this disease and the social distancing recession could play out in the months ahead.
Three case scenarios for the expected economic and asset market recovery:
Downside – a prolonged recession
- The scenario assumes the spread of the disease could persist well into 3Q 2020. The economic and market recovery will have to wait for a vaccine to be developed, which is expected to take 12 to 18 months2.
- Governments have difficulty curbing the spread, while the lifting of quarantines in some locations could spark new waves of the outbreak.
Central – a gradual but accelerating recovery
- The scenario assumes social distancing measures could force a flattening of the infection curve.
- Sizeable fiscal and monetary stimulus could mitigate the economic fallout, allowing sentiment to improve in 2H 2020.
- Other policy tools used by central banks have also been implemented to help support corporates and to keep banks supplied with liquidity to try to avoid a new banking crisis. In this scenario, the recovery could begin in 2H 2020.
Upside – quick recovery
- The scenario assumes better treatment and stringent lockdown measures could curb the spread of the disease, leading to a quicker recovery in 2H 2020 to pre-pandemic levels.
- Treatment therapies begin to produce successful results and healthcare systems are able to cope with severe cases.
- Certain Asian economies could reopen relatively quickly, helping to cushion the fallout. Strong stimulus measures support the recovery and avoid lasting economic damage. Growth and investor sentiment rebound sharply and central banks prove willing and able to hold down bond yields, increasing the relative attractiveness of risk assets.
Stylised quarterly profile for US activity data in each scenario
(4Q 2019 = 100)
Our central, upside and downside scenarios translate to different levels of gross domestic product (GDP) but a similar trajectory. In any event, US GDP dips into recession.
In our base case, we see a gradual but accelerating recovery starting in 3Q 2020.
In our upside case, this occurs more rapidly.
In our downside case, the virus lingers through the summer and delays a rebound until early 2021.
What are the asset allocation considerations3 under these different scenarios?
Downside case
- Conservative for equity, partial towards defensives versus cyclical markets
- Conservative on credit, partial towards higher quality securities
- Preference for duration4 across all developed market bond markets, negative on inflation
- Preference for cash
Central case
- Modestly conservative for equity, partial towards defensives and the US; look to raise equity exposures as infection rates slow
- Modestly conservative to credit, partial towards higher quality securities
- Preference for duration4
- Preference for cash
Upside case
- Preference for equities, partial towards cyclical equity markets versus defensive, and equity markets outside the US
- Preference for credit exposure, partial towards non-US markets
- Neutral on duration4, partial towards the US, and positive on inflation
- Neutral to cash
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Conclusion
Uncertainty over the economic impact of the pandemic will likely persist even as the infection curve is flattening in some locations. Whatever the eventual recovery scenario, the sharp rise in market volatility and the distortions created by central bank intervention are increasing the opportunities for skilled active managers to add value across equity, fixed income and multi-asset portfolios3.
Provided for information only based on market conditions as of date of publication, not to be construed as investment recommendation or advice. Forecasts/ estimates may or may not come to pass.
Source: J.P. Morgan Asset Management; as of 31.03.2020. Scenarios defined by Multi-Asset Solutions and Market Insights teams. For further reading please see the Market Insights bulletin “Monitoring the global impact of COVID-19” and “Q2 Global Asset Allocation Views” from Multi-Asset Solutions.
1. Source: J.P. Morgan Asset Management; (Global PMI chart) Markit; (Global real GDP growth chart) J.P. Morgan Global Economic Research. PMI is the Purchasing Managers’ Index. Global gross domestic product (GDP) growth is a GDP-weighted measure of real GDP at US dollar market exchange rates. *2019 is an average of the four quarters and 4Q 2019 is a forecast, and 1Q 2020 is a forecast. Data are as of 22.05.2020.
2. As of Q2 2020.
3. For illustrative purposes only based on current market conditions, subject to change from time to time. Not all investments are suitable for all investors. Exact allocation of portfolio depends on each individual’s circumstance and market conditions.
4. Duration measures the sensitivity of a bond’s price to a change in interest rates. When interest rates decline, a longer-duration bond enjoys a relative capital gain versus a shorter-duration bond. When rates fall and new, lower-yielding bonds are issued, older bonds with higher coupons gain value. So in a falling interest rate environment, an investor ought to lengthen duration.
Investment involves risk. Not all investments are suitable for all investors. Past performance is not a reliable indicator of current and future results. Please refer to the offering document(s) for details, including the risk factors. Investors should consult professional advice before investing. Investments are not similar to or comparable with fixed deposits. The opinions and views expressed here are as of the date of this publication, which are subject to change and are not to be taken as or construed as investment advice. Estimates, assumptions and projections are provided for information only and may or may not come to pass. This document has not been reviewed by the SFC. Issued by JPMorgan Funds (Asia) Limited.
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