Investors in Asian equities need to pay close attention to inflationary pressure in the coming months on the back of the recent significant policy support from central banks. Yet despite rising interest rates in some emerging markets, with the days of abundant liquidity and cheap money looking numbered, Axa IM analysis remains positive on risk.
“We see positive scores across equity markets being driven by the growth situation and the implications for corporate earnings,” said Simon Weston, head of Framlington Asia (Axa IM’s equities business).
To date, price increases have been met by continued upward revisions to forward earnings, so the valuation measures have remained mostly stable on the credit side, he explained.
Investors appear to have largely accepted the US Federal Reserve’s position that the current inflationary spurt is only transitory. This means there is no need to adjust its monetary settings, despite inflation being above target – May CPI was +5% year-on-year.
Should an inflationary spiral turn out to be more persistent, however, investors might be forced to make significant changes to the positioning in their portfolios, according to Weston.
He sees some signs of more entrenched inflation. “Shipping costs, copper and soybeans are all different products, but all at five-year [price] highs,” he explained. “The fundamentals behind these prices point to structural shortages – not enough ships built since the global financial crisis, not enough new copper supply coming onstream for all the new infrastructure, and not enough soybeans to satisfy the growing middle class, particularly in Asia.”
As a result, being able to adapt and respond to new information is key. Earlier this year, for example, changing market conditions led to a notable rotation between growth and value in stock selection. “We are at another similar point, this time with inflation,” said Weston.
At the same time, Axa IM believes most of the long-term structural investment themes within Asia remain intact, and have been accelerated by the pandemic.
Asia’s yield premium
In terms of Asian credit, meanwhile, inflation concerns are competing with the uneven recovery story associated with Covid-19, especially amid the slow uptake of vaccines in the region.
“Investment grade is priced to perfection in an imperfect market,” said Jim Veneau, head of Asian fixed income at AXA IM. “High yield valuations are more historically attractive, but vulnerabilities limit relative value and point to potentially high levels of distress.”
More specifically, Asian investment grade continues to offer a pick-up relative to its US counterpart. The caveat, added Veneau, is that this is largely coming from China’s state-owned enterprises and local government financing vehicles, which are providing much of that premium high yield where value remains.
He highlights growing caution on high yield China property given restrictive government policies and shrinking funding channels.
“This focus remains on building conviction for tactical spread compression opportunities, rotating out of the lowest carry bucket into the middle bucket,” said Veneau.