In the Battle of the Red Cliffs, a mythologised episode in Chinese history that mirrors David and Goliath, a small navy defeats much stronger opponents by summoning the eastward-blowing wind, setting ablaze entire enemy fleets. Almost two millennia later, ’borrowing the east wind’ continues to be the Chinese expression of choice for smart strategies that leverage external forces to one’s advantage.
For those investing in Asia, the fourth quarter of 2024 may well suit that approach. Risks are compounding outside of the region, from a slowdown in US growth and a pivot in monetary policy, to the prospect of geopolitical shocks to the system. A tactical, defensive posture - constructive on bonds, selective in equities - could help investors make the most of these circumstances and prepare for better days ahead.
Free from the Fed
Asia’s central banks have been constrained by a hawkish US Federal Reserve (Fed) for some time. Cutting their interest rates would have meant widening the gap with the US and risked a sell-off in their respective currencies. That situation changed in September when the Fed finally delivered a 50-basis point interest rate cut. With the exception of Japan, we believe most Asian central banks will feel comfortable trimming policy rates following the Fed’s cuts, given their positive real rates. Indonesia has even moved slightly ahead of the Fed’s decision, reducing interest rates by 25 basis points to 6 per cent in the same week - its first rate cut in more than three years.
The natural conclusion is that investors should feel more confident adding duration in high quality bonds, from sovereigns to investment grade. Any reverberation of US economic pain is likely to be more keenly felt in equities, where earnings of exporters could take a hit. The stock market still has plenty to offer, especially companies that benefit from artificial intelligence (AI), the energy transition, and shifts in supply chain. But we’re putting more focus on valuations and stocks’ margins of safety to withstand further near-term shocks.
Slow down
How Asia performs also depends, of course, on China and Japan, the two largest economies in the region. China is struggling to gain momentum as consumers and homebuyers remain cautious. With just three months to go until the end of the year, the country is around 5 per cent annual GDP growth target looks challenging. We’ve lowered the probability of our ‘controlled stabilisation’ base case (from 65 to 55 per cent) and raised the risk of a serious slowdown (to 35 per cent). Reflation remains a remote possibility (at 10 per cent).
Chinese policymakers have been working hard to restore confidence. In September, China lowered the downpayment threshold for home purchases, cut interest rates further, and promised to provide more liquidity in the stock market. While China continues to refrain from unleashing huge credit stimulus, these measures underscore officials’ focus on domestic demand, which is supportive for sentiment. ‘Lower for longer’ interest rates - which remain positive when adjusted for inflation - will keep the Chinese bond rally going. For equities, defensive sectors such as banks and utilities are more resilient. More change could come in the October politburo meeting or the Central Economic Work Conference towards the end of the year. But don’t expect drastic policy shifts while external uncertainties, such as the US election, weigh over financial markets.
Having escaped the deflation trap, Japan is guarding against inflation, which is set to stay above the Bank of Japan’s 2 per cent target next year. That should lend the Bank of Japan (BOJ) confidence to hike gradually over the coming quarters and draw the country closer to positive real rates. The volatile market reaction to the central bank’s 15-basis point increase in July could slow, but not reverse, Japan’s path on interest rates. In equities, smaller companies that haven’t benefitted as much in the rally over the past year will likely catch up. However, any shift in US trade policy could have implications for Japan, while the change of premiership could present another tail risk for domestic markets.
Structural stories
The promise of structural forces supporting Asia is real, from the demographic dividend in India and Southeast Asia, to the advent of AI and the energy transition. But as markets grow more alive to near-term risks, we expect more scrutiny of these structural stories. We’ve already seen this play out in AI, as investors rotated out of semiconductor-heavy Taiwan and Korea, and into ASEAN markets expecting a more imminent boost from monetary policy.
Likewise, we are hopeful on India’s long-term prospects. Its fundamentals are solid and its pace of growth - forecast at 7 per cent this year - is not to be scoffed at. But after an extended rally, valuations in some corners of the stock market may be too hot to handle. Lurking in the background is the risk from the unwinding yen carry trade, as speculators exit popular - and crowded - stock markets. The outlook for Indian bonds may be more favourable on the back of their addition to global benchmarks and positive real interest rates.
