Waiting to Xi the stimulus
In our mid-year report, we noted that the data in the region had been disappointing, particularly for China and South Korea. We are yet to see real signs of improvement in either country and have seen a deterioration in some other countries. The political unrest in Hong Kong has impacted activity there, and we are closely watching both the Chinese government’s response as well as any spill-over into Taiwan. Trade tensions between South Korea and Japan have also risen, which is of second-order importance relative to the China/U.S. situation. As a result of the risks around trade and regional growth, central banks are responding by cutting rates, which should provide some support moving forward.
The Chinese economy has continued to slow, with the manufacturing sector feeling the most pain. The divergence between services and manufacturing that we’re seeing globally is also apparent in China. Employment indicators are pointing to a slowdown in hiring across the economy, which increases the imperative of the Chinese government to either negotiate some form of trade deal or introduce new measures of stimulus.
On the stimulus front, there have been several announcements from the Chinese government regarding new measures. These have included further cuts to the Reserve Requirement Ratio and reform to the Loan Prime Rate. However, the issue now for credit creation isn’t a lack of funds, but instead a lack of demand. The latter could encourage a pickup in demand, as this reform effectively acts as a reduction in interest rates. Nevertheless, it is concerning that we have not yet seen meaningful signs of stimulus in the data—and as a result, we have become slightly more cautious. We continue to think that the monthly credit numbers will be the first to show signs of stimulus and will be closely monitoring them.
South Korea and Taiwan have seen weak export demand, which has weighed on the economic picture there. This has been driven by the trade war, as well as slowing demand for smartphones, which are major exports for both countries. The South Korean economy is set to benefit from fiscal expansion in 2020, while focus in Taiwan will soon turn to the pending 2020 presidential election, where support for incumbent President Tsai Ing-Wen has picked up due to her tough stand on China in the wake of the Hong Kong protests.
Regarding India, we noted at mid-year the dual headwinds of pre-election uncertainty and some regulatory changes in the autos sector. Offsetting this, government spending has been a positive contributor to GDP. The Reserve Bank of India has cut rates by a full percentage point since the start of 2019, and we think it is likely to provide more accommodation before the end of the year.
The Australian housing market has started to stabilize, as we highlighted in our mid-year report. Despite this, we continue to categorize the outlook as lackluster given households are heavily indebted and there’s a drag from falling housing construction. The Reserve Bank of Australia (RBA) has shown it is ready to act, and we now expect two more rate cuts by the middle of 2020. This easier monetary policy has provided a boost to the local equity market, however, we think any upside is limited, given the soft fundamentals.
A similar story is being seen in New Zealand, where the Reserve Bank of New Zealand (RBNZ) surprised the market by cutting interest rates by 50 basis points in July. The combination of falling interest rates and a depreciation in the New Zealand dollar propped up the equity market, given the high proportion of bond proxies and foreign earners.
It is increasingly likely that both the RBA and RBNZ will need to go down the path of unconventional monetary policy, either before or during the next global downturn. Here, we see an interesting divergence between the two. In New Zealand, where there is not a strong domestic banking sector, we think it is likely that the RBNZ will take the policy rate into negative territory. In Australia, where there is a strong domestic sector, we think the RBA is more likely to look at some form of quantitative easing.
Finally, the Japanese economy continues to stare down the barrel of the increase in the value-added tax (VAT) rate, which is scheduled for October. We have not seen the level of front-running of orders that were observed before the previous VAT increase in 2014. The Bank of Japan (BoJ) are likely to ease monetary policy, however with interest rates already in negative territory, the BoJ have limited room to significantly ease financial conditions. The Japanese equity market continues to look slightly cheap in our opinion.
For Asia-Pacific regional equities, we assess business cycle, value and sentiment considerations as follows:
- Business cycle: We have become more cautious in the near-term on the region, given the risks around trade. However, there are still positive circuit breakers in the form of expected Chinese stimulus and more accommodative central banks.
- Valuation: Valuations in emerging Asian markets and Japanese equities continue to look reasonable to slightly attractive. Despite their strong performance year-to-date, mainland China equity prices also look fair. New Zealand equities stand out as being very expensive. Developed economy bonds also look expensive.
- Sentiment: While trade remains a risk, we think investor sentiment in the region will remain cautious. Positive developments in trade negotiations would spark renewed interest and optimism, which likely would see the region outperform.