Learn To Invest
Stocks Special Reports LICs Credit Funds ETFs Tools SMSFs
Video Archive Article Archive
News Stocks Special Reports Funds ETFs Features SMSFs Learn
About

News

Investors are worried about a US recession, could Chinese equities be a buffer?

Kate Lin  |  27 Jun 2022Text size  Decrease  Increase  |  
Email to Friend

Global talk of a recession has been on the rise. Red-hot inflation and successive interest rate hikes from the US Federal Reserve and other central banks including the Reserve Bank have weighed heavy on the capital markets.

Keiko Kondo, head of Asia multi-asset investments at Schroders, has data to support the notion that we are approaching a higher-than-average chance of the US economy ending up in a recession. Her model corroborated 20 indicators that examine inflationary, monetary, and near-term macro and financial markets trends.

“As of the end of April, nine of those indicators are flagging recession risks. Two-third of the inflationary measures, which are early recession warning barometers, are signaling recession risks. In the coming months, the monetary variables are the ones to watch as the Fed tightens monetary policy,” she notes.

What are the imminent risks of a recession?

Inflation indicators have longer lead times, meaning it is typically more than 12 months before a recession arrives. Kondo notes that historically, when recessionary indicators go up to higher than a 45% level, the recessionary risk turns imminent. There were seven instances where at least 45% of the indicators point to a recession in the past 32 years, and five of those occasions were in the middle of a recession, if not leading to one.

“When we think about [the economic outlook] in scenarios, it’s very hard for us to come up with events that fall into the ‘reflationary’ and ‘productivity boost’ brackets.” In her analysis, scenarios like supply-side inflation, a downside in Russia-Ukraine war, rolling lockdowns in China and consumer recession could end up in ‘stagflationary’ or ‘deflationary’ outcomes.

Is Asia insulated from a US recession?

A spillover of recessionary risks from the US and Europe to the rest of the world seem inevitable. Some of the Asian economies that could be more susceptible to these risks would be trade-heavy South Korea and Taiwan. However, portfolio managers believe that a large part of Asia stands to be in a better shape.

When looking at the broader Asian economy, Thomas Poullaouec, head of APAC multi-asset solutions at T. Rowe Price factors in a bigger share of China influence. “Asia is very sensitive to China, where we are not talking about rate hikes but a further policy loosening and support. The country is likely to be one of the first global economies to reaccelerate from that downturn that could lighten the effect of slowdown in emerging Asia.”

Investing Compass
Listen to Morningstar Australia's Investing Compass podcast
Take a deep dive into investing concepts, with practical explanations to help you invest confidently.
Investing Compass

Which begs the question – is China a hedge?

Can China serve as a hedge?

Schroders’ Kondo and Matt Wacher, chief investment officer for Asia Pacific at Morningstar Investment Management, also see value in betting on a turnaround of China tech.

Sydney-based Wacher finds the sector attractive because of the valuations and the margin of safety available there after the deep corrections over the past couple of years. “There’s a reasonable position of China tech in our portfolio. And as some of the regulatory risk abates, we would probably add to that position,” he says. At this point, the only thing stopping him from adding to his positions in China tech is the uncertainty around the changes to regulations, both domestically and from abroad, where, for example, the US regulators are after the non-compliant Chinese ADR listings on the US exchanges, for instance.

He continued: “If we were to get clarity on more of those things, we would certainly we see the sector as a good opportunity. The likes of Alibaba (BABA) and Tencent (TCHEY) are very focused on China. They offer the rest of the portfolio an exposure that has different drivers, so we see those stocks as quite insulated from a US recession.”

Kondo, who manages Bronze-rated Schroder China Asset Income fund and Neutral-rated Asian Asset Income Fund, thinks China is one market in the world where the firm won’t shy away from owning more growth stocks. The reasons behind a stock market correction in China were not directly tied to  higher interest rates in the US, but policy initiatives. While volatility may persist, Kondo thinks growth stocks in the offshore China space will see a much bigger upside potential.

If not China, where else to find safety in a recessionary environment?

Another market Kondo likes is Japanese equities, which she describes as ‘under owned and unloved’ by investors. “Japan is among very few markets where policymakers welcome inflation. Thus, headwinds from the central bank would be less noticeable,” explains Kondo, as the country calls to ‘break the deflation mindset’. The macro environment is supportive of Japanese companies as a weaker yen should bolster profits derived from trade exports.

Higher interest rates don’t allow for current equity multiples to sustain, and also raise questions about future growth outlook. As a result, the markets have corrected – US equities plunged 21.8% year-to-date. Using the Morningstar US Market Index as proxy, these was no worse January-to-June periods than this. To add to the overall gloom, the US 10-year treasury bond was down 14.1% year-to-date, marking its worst six-month run in history.

Poullaouec believes a key question is whether the spike in stock/bond correlations seen in early 2022 was just temporary or reflected a structural regime change that could keep correlations high for an extended period.

“If the latter explanation is correct, alternatives to the traditional 60/40 stock/bond allocation that include dynamic hedging and other defensive strategies could offer advantages to some investors,” he says.

Within equities, he has been adding to his holdings of real assets-related equities, bringing the position to overweight, to provide a hedge should inflationary pressures persist longer, or settle higher, than expected. For the fixed income part, he increased his exposure to Asia credit, as its yield spread is at the widest it has been in 10 years.

Kondo turns more to gold as a diversifier, compared to bonds and commodities, as the latter has stretched valuations and comes with volatile nature. “Gold tends to do well at the early stage of a tightening cycle, where we are at.” While she avoids aggressively buying bonds which she thinks are fairly valued now, gold offers a way to hedge the recession risk. Agriculture-related equities are also a way to capture the inflationary benefits while getting around the difficulties of accessing commodities market directly.

is a Data Journalist for Morningstar Asia, and is based in Hong Kong

© 2022 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

Email To Friend