Our Opinion: 2018

Year of the Dog starts with a rollercoaster

Our Chinese clients have just welcomed in the ‘Year of the Dog,’ and are hoping for are hoping for a prosperous year ahead. It’s been a rollercoaster ride so far, with Asian (excluding Japan) stock markets achieving the fourth best start ever (+8%) in January, then the worst week since 2011 in early February before recovering modestly. The strongest US average hourly earnings data since 2009 triggered a reappraisal of inflation expectations and the cost of capital. While the 2017 ‘Goldilocks’ environment might be over, signs of an emerging traditional business cycle are positive for equities.

Such adjustments are not that unusual, and investors’ overall risk appetite has not been spoiled. The recent event is unlike previous ones like the “taper tantrum” in 2013, when credit conditions tightened sharply and emerging market imbalances were exposed. Equities are preferred over bonds, but inflation data should be watched closely and, following the US administration’s renewed protectionist rhetoric, the escalating risk of a trade dispute between the US and China needs monitoring.

The sharp gyrations in equity markets seem to have been an overreaction to the beginning of the normalization of inflation and longer-term interest rates in the US and other developed markets. Asian investors should not fear higher inflation, as it will be driven by stronger investment and labour markets, rather than supply constraints. Inflation in Asia is likely to accelerate by a modest 0.5–1.0% this year, and Asian central banks will gradually lift rates; Korea and Malaysia have already hiked once, and the Philippines is likely to be next. China will continue to tighten its regulations, as financial stability is a top policy objective.

The Fed, BoE and ECB have not hit the panic button in the wake of recent market volatility, and the Fed is likely to hike rates four times this year following new tax cuts and an ambitious fiscal spending package. However, this is unlikely to be accompanied by US dollar strength.

Asian equities don’t appear stretched and are yet to peak. Earnings will grow at a low-double-digit rate due to accelerating global growth, improving asset quality, balance sheet discipline, and greater exposure to the strong secular trends of technology and innovation. Markets like Taiwan, Singapore and China, are less sensitive to higher bond yields, and Thailand and Indonesia will be more resilient during this cycle. Cyclicals and financials tend to fare best amid rising yields, and consumer staples, healthcare, and bond proxies the worst.

As I head off for a three city tour of Asia, conditions are looking attractive for local entrepreneurs, as well as investors wanting exposure to the region.

24th February 2018