What could go wrong?

Considering the experience of the last two years, we want to focus on the potential challenges facing investors in the Asia Pacific region, instead of the possible upside to investing.

Let’s start with the risk of a sharp recession in the U.S. and/or broader developed economies. This could be brought by central banks keeping monetary policy tight for too long and neglecting signals of weakening growth and tightening financial conditions. This scenario would require central banks to reverse their monetary policies, implying lower government bond yields.

While earnings could be adversely impacted by weaker growth, the turnaround in monetary policy could start a valuation re-rating. Historically, data on industry fund flows indicate that investors were often late in participating in equity rallies, as they demand more evidence of economic and earnings recovery, hence sacrificing return in the early stages of the market rally. Accordingly, it may be sensible for investors to rotate into equities once the deterioration in economic data begins to show signs of stabilizing.

A more challenging situation would be a stagflationary environment, where economic growth is cooling on the back of tighter monetary policy but inflation remains stubbornly high. The unyielding focus on inflation could mean that central banks would opt to keep rates high to cool inflation, instead of cutting rates to boost growth. This could create a scenario where stock-bond correlations once again turn positive with negative performance across both asset classes. In this scenario, short duration bonds can provide income, especially given current elevated yields, while limiting the duration risk. This also provides the advantage of daily liquidity compared with time deposits. Alternative assets, such as infrastructure and real assets, can help manage downside risks during inflation due to the nature of their inflation-linked revenue contracts.

China’s real estate sector has yet to show signs of recovery and concerns remain about the potential spill-over contagion impact on the non-bank financial sector, and subsequently the broader economy. The risk of default with LGFV could be another source of financial risk in China. The Chinese authorities have started to address the LGFV issue with debt swaps. In addition, the government has relaxed policy restrictions on the property market. We believe support measures could be stepped up if systemic risk emerges. Nevertheless, we would urge caution on being too opportunistic toward assets that have direct exposure to these trouble spots.

Elections and geopolitics are likely to capture headlines in 2024. The ongoing conflict in Ukraine and the Middle East ought to have limited impact on the global economy. If tensions in the Middle East escalate, we could see higher oil prices due to concerns over supply disruptions. The U.S. and China have stepped up bilateral dialogue, which can help reduce the tail risk of military friction due to accidents or errors. Any rise in tensions between the two biggest economies in the world could prompt investors to seek safe-haven assets, such as gold, as well as liquidity assets, such as developed market government bonds. 

Exhibit 12:

Source: Bloomberg, FactSet, MSCI, J.P. Morgan Asset Management. Returns are calendar year. Portfolio returns reflect allocations of 60% in the MSCI AC World Index and 40% in the Bloomberg Aggregate Bond Index. Returns are total returns. Past performance is not a reliable indicator of current and future results.
Guide to the Markets – Asia. Data reflect most recently available as of 30/09/23.

Conclusion

The economic environment in 2024 is likely to be more challenging, alongside unknowns such as geopolitics, policy errors and extreme weather events. A well-thought-out asset allocation can help investors to generate return, whether via income or riding on structural trends, and manage market volatility. The key here is that our portfolio construction needs to be ready for not just the core scenario but also for other contingencies that could come. This cannot be done with a single asset class, but instead requires a diversified portfolio of stocks, bonds and alternative assets.