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

Recovery bright spots still rotating

Overview

• The global economic recovery continues but the bright spots are now the U.S. and Europe. Asia could be next if vaccination rates increase, facilitating the reopening of economies and borders.

• The Fed is on track to begin winding down its asset purchase program by the end of 2021. Other central banks could also consider reining back emergency measures.

• China’s regulatory environment, the United Nations Climate Change Conference (COP26) and supply chain bottlenecks are risk factors to be mindful of in 4Q 2021.

Recovery spotlight shifting back to Asia?

The global recovery is still on track albeit at a varying pace, driven by the fallout from the pandemic and vaccination progress.

• China was one of the first major economies to recover, but its economic momentum has slowed due to policy normalization and sporadic outbreaks, which have cooled consumer sentiment. China’s economic momentum should stabilize as fiscal policy becomes more supportive and monetary policy shifts from tightening to neutral.

• Europe and the U.S. have enjoyed a summer of firm rebounds as their economies reopen. The latest outbreak in the U.S. has put some temporary pressure on services, and the winter months could be more testing.

• Vaccination rates are increasing in Asia. Several economies, especially in Northeast Asia, should reach a 60%-70% vaccination rate by the end of 2021. This would allow for a more sustained recovery of domestic demand.

Rolling back the emergency measures

The Fed is expected to start winding down its asset purchase program before the end of 2021. Other central banks could also selectively rein back their ultra-loose monetary policies.

• The Fed has strongly hinted that QE will be reduced in 2021. We expect the process to take place over 8 to 10 months.

• Other developed market central banks are also normalizing policy, but at a more gradual pace considering their fiscal stimulus has been less aggressive and the immediate inflation pressure is more benign.

• Select emerging market central banks have already started to raise interest rates. In Asia, the Bank of Korea was the first to raise its policy rate in August 2021. The rest of the Asian central banks could be more patient. China has already reached the peak of its tightening cycle.

China regulations, climate change and supply chain bottlenecks

In addition to economic recovery and monetary policy normalization, a few market events could continue to influence sentiment.

• China regulatory changes and a drive to improve income equality could continue to affect investor sentiment. We see policy tailwinds for some sectors, such as carbon neutrality and import substitution in technology.

• COP26 should refocus market attention on policies to reduce greenhouse gas emissions, while raising the risk of new trade barriers for products that fail to meet emission standards.

• Logistics and supply-side bottlenecks, especially for semiconductors, are hindering the global economic recovery and potentially introducing more inflation pressure. The general expectation is for this to tame over time, but so far it is taking longer than expected.

Investment Implications

• The global economic recovery continues to support risk assets, including equities, corporate credit and emerging market debt.

• The tapering of central bank bond purchases is important, but not the only factor dictating investment returns. The COVID-19 pandemic, inflation outlook and earnings growth are still key considerations for asset allocation. Asian central banks are likely to keep interest rates low for an extended period of time, implying the continuing need for income.

China: Awaiting clearer policy signals

Overview

• The latest resurgence and the implementation of strict lockdowns point to the Chinese government’s determination in pursuing the zero-COVID-19 strategy.

• This implies potentially a more volatile growth outlook for China as economic activities may act as the shock absorber to prevent any resurgence in infections.

• Regulatory reforms also remain on the cards for some of the “new economy” industries where the Chinese authorities see the need to achieve better social outcomes.

• We remain cautious on the earnings growth of these sectors until there are clearer signals of a more stable regulatory regime.

Effective control of the pandemic comes at a cost

China is one of the economies with the high vaccination rates [?]. Together with stringent control measures aimed at achieving zero-COVID-19, reported domestic infection cases have been kept at low levels. However, this might imply higher economic and social costs than the other economies.

• China has accelerated its vaccine distribution program since 2Q 2021. As of September 18, 76.2% of the population have received at least one dose of vaccine. China also began vaccinating children in 3Q 2021.

• To suppress the virus, social distancing measures have been maintained even as infection rates stay low. Partial lockdowns and large-scale virus screening are launched whenever new cases are discovered. These measures are aimed at curbing widespread transmissions.

• However, the current strategy comes at a high cost to the government, as well as unexpected disruption to economic activities.

Short-term headwinds from escalating regulation

With gradual recovery from COVID-19, Chinese policymakers are introducing various schemes to address the challenges of long-term growth.

• To curb the downward trend in the birth rate, property market controls have been ramped up to lower housing cost and off-school tutoring services have been restricted to relieve the education burden on families.

• Internet-related sectors are under continuous pressure from anti-trust investigations, which are deemed as a necessity to improve competition and support small and medium-sized enterprises.

• These measures are necessary to achieve sustainable growth in the long run. However, short-term uncertainties are rising, particularly in terms of consumption and private investment.

Structural fine-tuning expected

When policymakers adhere to their long-term reform plans, the fine-tuning of monetary and fiscal policies is also necessary to offset the shocks so as to smoothen the short-term growth trajectory.

• The PBoC announced a 50 basis point (bps) reserve requirement ratio (RRR) cut on July 9, 2021, which released about RMB 1trillion long-term funds to replace the outstanding medium-term lending facility (MLF). One or two more such measures could occur before the end of 2021, alongside structural interest rate cuts to support small businesses.

• In addition, fiscal policy may do more of the heavy lifting to support growth, especially as the 2021 government bond issuance is running below this year’s quota and could be stepped up.

• These operations may help improve liquidity conditions and provide some tailwind to the manufacturing sector.

Investment Implications

• Given the economic cost and difficulty in eradicating COVID-19 within the community, especially as more Asian governments start to reopen their economies, we believe Chinese policymakers may also evaluate their zero-COVID-19 strategy in the near term.

• The loss of momentum in the economic recovery simply strengthens policymakers’ case to act in a timely manner to stabilize growth. Fiscal policy will likely take the lead as monetary easing may remain targeted.

• This should help buffer some of the short-term reform shocks. A marginal improvement in liquidity conditions for the rest of this year would be a policy tailwind for the manufacturing sector. Meanwhile, after a prolonged correction, the consumer sector could also benefit from policy easing and more resilient sentiment.

• We still believe China remains an integral part of any investor’s portfolio, both in equities and fixed income. However, flexibility and selectivity are crucial.