Asian equities ended the first quarter slightly better than from where it began, but the statement belies the journey that markets took. Worries over diverging monetary policies across major central banks, a hard landing scenario in China, and continued fall in oil prices erased, at one point, almost 13% off the MSCI Asia Ex-Japan index during the first quarter of 2016. Risk appetite reversed in March, as the index pared losses to inch 1.3% gains over the three-month period, leaving investors asking, “Where are we now?”
Over the quarter, China garnered most of the market anxiety. January’s circuit breakers triggered investors to believe that state intervention was moving away from much advertised reforms promised by Beijing. But most investors fretted over the direction of China’s currency and the pace at which the RMB would devalue against the USD. Fears were further instigated as the People’s Bank of China Governor Zhou did little to guide the market in a fashion similar to central banks in the G3. At its trough, the MSCI China lost almost 19% during the first half the quarter, before gaining 11.6% in March to close 4.7% lower over the three-month period.
Risk sentiment returned as Governor Zhou became more visible. The Governor’s interview in China’s financial media outlet Caixin was Zhou’s first public statement following the RMB’s August devaluation in 2015. In the article, Zhou’s comments that China would not significantly devalue the RMB to promote a trade advantage would become the tenet reiterated at both the G20 meetings in Shanghai as well as during the National People’s Congress in Beijing.
Around mid-February, high frequency macro data also assuaged worries that China was in the midst of a hard-landing scenario. Beijing reported economic growth of 6.9% in 2015, in-line with the government’s target of “around 7.0%,” underlined by a rising contribution of service sector industries. Stabilization in foreign exchange reserves was also well received by the market amid concerns that a surge in capital outflow would further depreciate the RMB. China’s foreign exchange reserve settled to $3.2tn in February, after monthly declines averaged nearly $100bn between November and January.
The turnaround in China’s economic outlook came amid a backdrop of a recovery in oil prices as OPEC members look to refrain from increasing global production. Commodities climbed as major central banks maintained accommodative monetary policies. The Bank of Japan surprised the market by introducing negative interest rates while the European Central Bank further lowered their deposit rates. Dovish comments by the Federal Reserve Chair Yellen followed, where the US central bank pulled back its hike guidance from four to two.
With Yellen’s comments now overlapping market expectations, the near-term environment remains positive for risk appetite, particularly Asian equites. But challenges still linger. Though a job recovery in the US further lowers the risk of a global recession, there is little evidence of a renewed acceleration in the world economy given evidence of sluggish trade data.
Within Asian equity, continued strength in domestic driven economies should help offsets external sluggishness, in our view. Rising intra-regional trade in ASEAN supports the bloc nations, where a recovery in fiscal spending has been evident thus far in Indonesia, Thailand and the Philippines. Pickup in public spending should lead to a ‘crowd in’ effect for private investments to spur growth. India’s economy continues to expand without the assistance of political will, which should play a growing part throughout the year as Prime Minister Modi looks to reestablish party credibility.
For China, growth drivers will continue to migrate into higher value service sectors. The country’s economic pace is in-line with the government’s target to expand the economy “between 6.5% and 7.0%.” Economic policy will move tangent with its job creation goals, which suggests that the lower end of the range would be acceptable to Beijing. Supply side reforms have commenced, which should address overcapacity issues that galvanize deflationary pressure that have plagued the economy for a record 48 months.
The main risk in our view is volatile movement in the USD caused by political anxiety and further downside to global growth. Worries over a Brexit scenario, a migrant crisis, or populism rhetoric in US presidential campaign election would see investors moving back into the USD amid heighted volatility. Hopefully, policy makers in Asia do not confuse the March rally as renewed risk appetite and continue to implement policies that strengthen economic objectives. However, as more attention now falls onto the Federal Reserve’s June meeting, market patience is likely to be tested.
Assistant Fund Manager - Asia