For investors, the last decade was dominated by US market performance. The period brought 10 years of standout returns from US assets and an appreciating US dollar. In our view, the next decade may be the Asian markets’ time to shine.
Crises often lead to secular shifts in market performance. The end of the dotcom boom in 2000 marked the end of US growth outperformance, and was followed by a period of strong performance for value, emerging markets and European equities. After the global financial crisis, the pendulum swung back in favour of the US.
Our expectation that we may see a similar shift this time is based on our macro outlook and structural changes that are taking place as Asia’s capital markets mature. The north Asian economies (China, Korea, Taiwan), which represent the bulk of the investable universe in Asia, have been more successful in containing the pandemic than the rest of the world. New daily Covid-19 cases per million people, even at peak infection rates were just a fraction of those in other regions. Due to the limited outbreaks and the ability to keep track of infections, these economies appear to have put Covid-19 behind them. While Europe and the US still face significant restrictions to contain the spread of the virus, China is already back to pre-crisis levels of activity (Exhibit 1).
Exhibit 1: China’s bounceback has been extraordinary
Real GDP levels
Index level, rebased to 100 at 1Q 2006
Despite the fast-growing consumer base, the Asian economies and markets are still highly dependent on the dynamics in global manufacturing and trade. But what has been a disadvantage for the region in the recent years of trade conflict has been a relative strength recently as the global consumer diverted its spending from services to goods.
The yield opportunity
Due to the success in controlling the outbreak, the fiscal and monetary response to the Covid-19 crisis was significantly smaller in Asia than in Europe and the US. As a consequence, central bank balance sheets are less bloated and bond yields fell less than US Treasuries.
Structural changes in the region’s bond market are further increasing its appeal for global bond investors. In the past, restricted access and limited currency convertibility prevented Asian bond markets from playing a major role for global investors. But with the rising financing needs of the region, this is changing rapidly. Following the opening of the USD 15 trillion local renminbi bond market to overseas buyers, yield-starved international bond investors now have the opportunity to invest in Chinese government bonds with yields north of 3%. As well as offering higher yields, local renminbi bonds have a relatively low correlation to developed market bonds and zero return beta to global equities, potentially boosting portfolio diversification and enhancing risk-adjusted returns.
In the past 12 years, monthly return correlations between renminbi bonds and global developed market bonds have been 0.1. With China’s early success in containing the Covid-19 pandemic knocking its economic cycle out of sync with the rest of the world, we would expect correlations to remain low for the time being. The fact that the renminbi remains to some degree managed by the authorities, reducing currency volatility, also increases the appeal.
The growth opportunity
North Asian equity markets outperformed many of the developed world indices in 2020, in large part thanks to their economic outperformance and relatively high weighting of tech and online companies. We expect this outperformance to continue for two reasons. In the near term, the outperformance reflects the fact that developed world activity will remain constrained until the vaccines are widely distributed and life can return to normal.
In the longer term, structural growth prospects in Asia are underpinned by urbanisation and the growth of the middle class. These trends are set to continue in the next decade in three of the most populous countries in the world – China, India, and Indonesia – creating large domestic and consumer-led markets. The new free trade agreement (Regional Comprehensive Economic Partnership) covers 10 ASEAN countries and China, Japan, Korea, Australia and New Zealand. These 15 nations represent almost a third of global GDP. This should further support the long-term growth outlook. The agreement is expected to eliminate 90% of tariffs between the trading partners if all components of the product are manufactured inside the free trade area. This rule of origin provision could deepen the supply chains inside the region since it incentivises the signatories to build the full supply chain inside the new free trade zone.
As a result, Asian companies will be provided with plenty of opportunities to grow in the coming years. China’s push to move further up the value chain, presented in the latest five-year plan, should facilitate its transition to a high-income economy and help it to weather the negative impact of deteriorating demographics. Asian equities had a strong run in 2020; nevertheless, our 2021 Long-Term Capital Market Assumptions suggest Asian equities still have the potential to outperform developed markets by 2.2% a year over the next 10 to 15 years (Exhibit 2). Mounting signs that the 10-year-old US dollar bull market is fading further reinforce our view that the next 10 years might go down as the Asian decade.
Exhibit 2: Asian stocks look favourable on our long-term projections
2021 Long-Term Capital Market Assumptions expected returns in coming 10-15 years
%, annualised returns in EUR