“We recommend raising fixed income allocations adjusted for volatility. Investment grade bonds pay a yield above low or negative yielding government bonds, and are not so vulnerable to price volatility as high yield sub-investment grade bonds when sentiment turns more anxious about the prospect of a US recession,” Tai Hui, the US fund manager’s Asia chief market strategist told a breakfast meeting.
He favours US investment grade corporate bonds, hard currency emerging market sovereign issues and selective Chinese dollar-denominated bonds.
In equities, high dividend stocks provide protection in a broad market down-cycle, he said, reiterating the cautionary message he delivered two months ago.
Hui, who forecasts one more 25 basis points interest rate cut by the Federal Reserve this year, also reckons that the current era of negative government bond yields is likely to force some institutional investors, such as insurance companies and pensions funds with longterm liabilities to match, to seek alternative fixed income assets in foreign currencies or to move down the credit curve.
In Asia, Hui sees value in China government bonds yielding around 3%, but warns that the market – despite its $13trn size – can be illiquid because the domestic banks who dominate the market tend to adopt buy-hold strategies. Furthermore, foreign investors must also be prepared to take the currency risk because of the expense of hedging and the lack of depth in the offshore (non-deliverable forwards) foreign exchange market.
“However, the Chinese authorities are likely to main their policy of managed, gradual renminbi depreciation, so investors could be fairly confident about currency risk in practice,” said Hui.
Equity market caution
Global equity markets are not in a structurally bear phase, but are in effect range bound – fluctuating as investors make tactical allocations or withdrawals based on transitory perceptions about the geopolitical outlook, and recessionary fears, and periodically encouraged by attractive valuations when markets slide, according to Hui.
“Markets could rally during the final quarter of this year if corporate earnings are stronger than expected, and besides, investors are often more risk-on in the fourth quarter after the summer holiday period,” he said.
Although he is generally cautious about equities, Hui thinks China A-shares should maintain their strong performance this year, buoyed by domestic consumption, which should be fuelled by stimulative fiscal and monetary policies.
Elsewhere in Asia, Hui advises focussing on stocks paying high dividends, including unfashionable Hong Kong property and bank shares. This a view shared by several global asset managers, including Alliance Bernstein, who recommend high yielding equities and real estate investment trusts as an alternative to fixed income.
“It is perhaps a time to invest tactically rather than strategically, although that is typically not my nature,” said Hui.
“The problem is there is so much uncertainty and potential for instability,” he addeed.
Hui doesn’t expect that any of the headline-making issues will be resolved soon, including the Sino-US trade dispute, the Brexit process or its ramifications, the Hong Kong protests and aftermath, the recent upsurge in Middle East/Iran and the effect on oil prices, or even the sudden escalation of a simmering trade dispute between Japan and South Korea.