At GAM Investments’ Weekly Investment Meeting held on 12 June 2019 the speakers were Michael Biggs, who provided his latest macro views, and Amy Kam, who discussed the attractive attributes of the Asian hard currency credit market.
It has been an interesting time for risky assets over the last few months. Materially negative newsflow – such as the US / China trade dispute – has put risk assets under temporary pressure, but the rally quickly reasserts itself as soon as these issues go quiet. This is particularly evident across emerging markets (EM) which are highly sensitive to movement in the US dollar and have therefore been impacted negatively by its strength.
Forecasting the movement of the US dollar is difficult, but the Economic Surprise Index can be a good indicator and the US has surprised to the downside recently – exemplified by the latest Institute for Supply Management’s (ISM) purchasing managers’ index which dropped sharply in May to 52.1 from 52.8. This was reflected in a sharp sell off for the US dollar this month, which provided a boost to EM equities. Despite this weakness, we find it difficult to believe that the US will experience sustained economic weakness as new borrowing is still low and it is therefore unlikely to be susceptible to the falls in borrowing that have preceded past recessions.
Europe enjoyed a significant rebound in growth in the first quarter, benefiting from the unwinding of a series of idiosyncratic shocks that took place in Q4 2018. This boost has now been factored in and we could see growth stagnating in Q2, but the underlying fundamentals are more encouraging which we believe suggests the region should maintain trend growth in the second half.
The fundamentals in China started the year in good health on the back of a revival in global trade. Yet weakness in April suggested global trade had weakened once more and was exacerbated by the re-emergence of trade tensions with the US. We expect the Chinese authorities to protect growth by embarking upon a fresh round of domestic fiscal stimulus to boost spending and drive up imports, offsetting the negative impact of the trade shock. While further stimulus will deteriorate China’s balance of payments, we believe it can handle this pressure as its current account is still in positive territory at present and is being further supported by the fall in the oil prices.
Emerging Asia Fixed Income
The Asian hard currency bond market has undergone rapid growth, and now accounts for 15% of the global hard currency bond market and more than 50% of global emerging market (EM) credit. It is already an important component of the global investment universe; the market was given a further boost in April this year when Bloomberg included local currency Chinese bonds in the Bloomberg Barclays Global Aggregate Bond index for the first time.
The Asian hard currency credit market demonstrates a number of attractive attributes, including higher yielding, lower duration and low default rates. Furthermore, we believe the size of the market, its diversified composition, its strong local investor base and low correlation with global emerging market flows make it an attractive diversifier for fixed income investors. Lastly, our positive view also rests on the market’s long-term secular improvement trends such as positive credit rating migration, favourable demographics, and the fact China and India are the world’s main growth engines.
In December 2018 we shared our view on two key opportunities. The first was China local government financing vehicles (LGFV). LGFV have been and continue to be an important mechanism for China’s infrastructure investments. It is recognised by the International Monetary Fund (IMF) that the vast majority of infrastructure investments happen at local government level. The genesis of our conviction rests on the wide rating-adjusted spread as well as the spread differential between the sector’s onshore CNY (Chinese yuan) curve and its offshore USD curve. This spread differential converged over the course of the last six months following LGFV’s outperformance against the JP Morgan Asia Credit Index (JACI) investment grade credits. We continue to be constructive on this sector but have changed our view from a sector overweight to more of a selective name basis.
The second opportunity was China property. The December 2018 conviction call was based on our assessment of the sector’s deleveraging trend, stable margin and improving liquidity, and most importantly, the severe sell off in 2018 due to a combination of factors. Firstly there was a glut of supply in early 2018 which was induced by the Chinese government’s persistent push for corporate and financial deleveraging – pushing these developers to issue in the USD market; excess liquidity aided the sell off following the crisis in Argentina and Turkey since April 2018, which was then followed by the escalation of trade tensions with the US. At the end of November, this sector was trading outside two standard deviations of rating-implied yields. We derived our conviction using the same investment process. Following the sector’s strong outperformance in the first four months of the year and current risk / reward proposition, combined with the sector’s continued stable fundamentals, we have taken some beta off our positioning.
With trade tension back on the table since May, our view has become more diversified. Overall we have upgraded our average rating, increased our allocation to selective opportunities in India and Mongolia, and we prefer to express duration views via investment grade credits.
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Source: GAM unless otherwise stated.
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