Asian equities began 2021 with a lot of promise. Favourable long-term trends in demographics and technology, in combination with better containment of the pandemic, provided a strong tailwind for the region (see On the Minds of Investors: Asia’s decade: Getting ahead of the growth opportunity).
Since February, it seems that the tide has turned. Absolute performance stalled, while US and European equities stormed ahead. While part of the story relates to better developed market prospects following President Biden’s massive fiscal stimulus, the relatively poor performance of China since February has been a significant source of the underperformance of Asian equities.
This may seem surprising given that China’s economic outlook for the year appears compelling. Due to its early success in containing the pandemic, China looks on track to achieve more than 8% GDP growth in 2021.
However, three near-term challenges have investors concerned. First, Beijing has begun tightening policy after an expansion during the crisis amounting to growth in credit stock of over 30% of GDP. Second, a number of new announcements about tech regulation have generated worries about Beijing’s reform agenda. And third, in Asia the vaccination programme has been slower than those of many developed economies leading to lingering virus concerns.
We are not overly worried that these headwinds will provide a lasting drag on either economic or market performance. Any tightening of credit will be gradual and measured. Consumer inflation is currently contained, giving China’s central bank little reason to raise policy rates in the coming months. Therefore, current policy measures should be understood as normalising and not as outright tightening (Exhibit 6).
Exhibit 6: Beijing is normalising credit growth rather than outright tightening
China credit growth
While not overly worried about tightening, neither do we believe China’s reform efforts should deter international investors. Faced with monopoly concerns, worries about financial stability and changing public sentiment, regulators are taking a more hawkish approach towards leading tech and financial companies. Recent high-profile fines for companies breaking competition laws, as well as the closing of regulatory loopholes, may signal the end of the highly supportive environment that these firms have enjoyed in recent history. Given the weight these firms have in both Chinese and broader Asian indices, their underperformance has had a significant impact on overall returns. While the market leaders might be constrained by potential new rules in the short term, we believe their long-term growth outlook remains compelling, and valuations are now more attractive.
And on vaccinations, China is now making significant headway in catching up on vaccinating its population (Exhibit 7). In India, meanwhile, only 19% of the population are over the age of 50, so while the current outbreak is taking a heavy toll, it shouldn’t be too long before the most vulnerable have been vaccinated. In some smaller Asian countries, the slower pace of vaccine rollout may lead to ongoing problems with local outbreaks, delaying a full economic recovery this year.
Exhibit 7: China’s vaccine rollout is accelerating but progress is slow elsewhere
In summary, while we acknowledge that President Biden’s stimulus has provided a near-term turbo boost to the US economy, we do not think developed market outperformance will last over the medium term. US and European policymakers will soon face the very same tough questions as their Chinese counterparts today – when and how to normalise the enormous amount of stimulus. So in 2022 and the following years, dynamics are likely to change as the distortions in corporate earnings caused by the pandemic and the policy responses recede. In this environment of more moderate growth, structural themes such as rising household incomes and technology adoption in Asia should gain importance relative to the cyclical stories that dominate today’s market performance. Since we are already in the middle of the year, it will be just a matter of time before investors shift their focus to the earnings outlook for next year, which should be beneficial for Chinese as well as broad Asian equities.
In the second half of the year, the outlook for Chinese local bond markets continues to be compelling. Moderate consumer inflation, solid corporate earnings and a low probability of rate hikes are supportive for the asset class. However, after the 10% appreciation of the renminbi in the past 12 months, we think that investors should expect a reduced tailwind from currency effects.