Text on screen: Stephen Chang, Portfolio Manager, Asia

Text on screen: What are the key takeaways from our latest cyclical outlook?

Chang: Russia’s invasion of Ukraine, the US-led sanctions measures, and the gyrations in commodity markets cast an even thicker layer of uncertainty on what already was an uncertain economic and financial market outlook.

In our base case, growth remains supported by the post-pandemic economic reopening and pent-up demand bolstered by previous savings. Inflation may peak in the next few months and then moderate gradually.

Text on screen: Key Takeaways from our latest Cyclical Outlook

• Growth should remain supported by post-pandemic reopening and pent-up demand
• Inflation may peak in the next few months before moderating gradually

However, there are obvious risks to this outlook, especially if the Russia–Ukraine conflict escalates further, leading to disruptions and higher risk of a recession over the cyclical horizon.

The war and sanctions will also likely lead to a greater dispersion of growth and inflation outcomes among countries and regions. Most central banks seem determined to opt for fighting inflation over supporting growth, and we expect relatively muted fiscal policy support from governments over the cyclical horizon.

Text on screen: Key Takeaways from our latest Cyclical Outlook

• Growth should remain supported by post-pandemic reopening and pent-up demand
• Inflation may peak in the next few months before moderating gradually
• Expect relatively muted fiscal policy support over the cyclical horizon

Amid this difficult and uncertain environment, a key plank of our investment strategy will be to emphasize portfolio flexibility and portfolio liquidity to respond to events and potentially take advantage of emerging opportunities. We aim to run a lower level of risk given market vulnerabilities, but we may add to spread risk opportunistically in select investments that we see as more resilient or default-remote.

Text on screen: What are our expectations for China?

Chang: The current COVID outbreak in China has caused notable declines in traffic flows and congestion at ports, pointing to disruptions to supply chains. The impact on exports could still be manageable as long as lockdowns are not synchronized, domestic production remains intact, and losses can be made up in subsequent periods.

However, both the manufacturing and services Purchasing Managers’ Indices (PMI) in March fell below 50 points – the level that separates growth from contraction – for the first time since February 2020. The regions under medium- to high-risk controls comprise a significant percentage of China’s GDP. Beijing has reiterated that the dynamic zero-COVID policy approach will remain, even though the government would like to balance achieving the best results in epidemic control with minimum costs for economic and social development.

As a result, we expect significant headwinds for first and second quarter growth, and have revised our growth expectations lower. The current Omicron wave is hurting consumption and services, as well as production. In our view, growth should rebound in Q3 assuming the outbreak is largely contained. In addition, we expect greater fiscal stimulus in coming months, which should be supportive of growth in the second half of the year.

Text on screen: What is our current view on China’s real estate market?

Chang: While the Chinese government has shown some easing signals since late 2021, we are yet to see concrete follow-up measures at the national level. The downturn may remain intact for the first half of this year but given the sector is highly regulated, we believe the government is likely to create more of an impact via lower volumes, with only a mild and gradual price correction over the coming 1-2 years.

Looking ahead, challenges for the sector include weak housing affordability, slower urbanization, high housing ownership, a supply-demand mismatch, and overhang from worries about property tax. However, it’s worth noting that the market has largely priced in these challenges.

In our view, several factors could help to stabilize the sector’s long-term development, such as increasing demand from consumers to upgrade housing, low loan-to-value ratios and high consumer savings rates, the importance of the property sector to China’s economic growth and local governments, abundant liquidity in the system, and limited investment channels in China.

We group Chinese high yield real estate companies in three categories: Survivors that should be able to weather the current market downturn even amid higher sector volatility; Names on the borderline, whose fate largely depends on how soon the government will ease and how effective the policies are; and weaker ones that are likely to default.

Text on screen: 3 categories of Chinese high yield real estate companies:

• Survivors that should be able to weather the current market downturn
• Names on the borderline, whose fate largely depends on how soon the government will ease and how effective the policies are
• Weaker companies that are likely to default

We favour companies that we identify as Survivors – and many of the bonds are trading in double-digit yields.  We believe these companies have relatively strong fundamentals and are in the best position to survive or even gain share in the current sector downturn given their relatively better liquidity position and prudent financial management.