Europe and US combating persistently high inflation
Early this year, BEA Union Investment has already foreseen inflation to become a long-term trend in 2022. The United States (US) Consumer Price Index unexpectedly surged to a 40-year high in June, up 9.1% year-on-year, after an increase of 8.6% in May . The 75 basis-point rate hike in June was the biggest increase since 1994, bringing the latest Fed funds rate to the range between 1.5% and 1.75%. Fed chairman Jerome Powell indicated that another hike by 50-75 basis points in July would very well be in the cards. The US was on track to shrink its balance sheet in June , offloading as much as US$95 billion worth of bonds on a monthly basis. This pointed to a more aggressive monetary tightening policy in the next few months to curb its four-decade high inflation, implying US economic growth.
Source: Federal Reserve Board of Governors.
Source: Bloomberg, June 2017-May 2022.
Global markets continued to be roiled by uncertainties in the first half of 2022: the Russia-Ukraine war, global supply chain disruptions, food exports restrictions in select regions, and surging commodity prices. This litany of uncertainties propelled global inflations higher, prompting central banks to take aggressive tightening measures. Eurozone's Consumer Price Index rose 8.6% year-on-year in June . To combat inflation, the European central bank has shifted from the "normalisation" path towards a more hawkish stance. Even if it meant downward pressure on Europe’s economic growth, the central bank has already pointed to a 25 basis-point rate hike in July and the end to its 7-year bond buying programme.
Europe unlikely to reduce its dependence on Russian oil in short term
The potential risk of Europe’s embargo on Russian oil has further pushed up energy prices. Albeit western countries have been actively securing energy supplies, the eurozone's REPower EU plan could only cut its dependence on Russia fossil fuels by 2030. This unlikely will relieve pressure on high energy prices in the short run. We believe inflation concerns will linger and affect market sentiment, inevitably causing volatilities to both equity and bond markets.
The US was resolute in suppressing inflation by aggressive rate hikes. Coupled with the anticipation of balance sheet reduction, risk aversion boosted. However, BEA Union Investment believes the market has already priced in the impact of the balance sheet reduction. If the scale of reduction meets market expectations, its impact should be manageable. Sectors that are benefited from inflation such as energy and materials, industries that could generate strong cash flow including non-discretionary consumer, telecommunications, select internet companies as well as cyclical stocks are expected to perform better.
China expedited economic measures implementation, becoming market pivot for a turnaround
China’s National People’s Congress announced its 2022 GDP growth target at 5.5%. The GDP growth was 4.8% for the first quarter. At the State Council’s executive meeting on June 1, Premier Li Keqiang indicated the need for plans to support economic growth, guiding the country’s economy back to the normal track. Proposed measures included 140 billion yuan of VAT tax rebates by July. Markets pinned hope on a potential rebound of third-quarter economic data, such as retail sales. This may become a pivotal point for the market, which in turn could improve sentiment.
Markets remained hopeful towards China’s 20th Party Congress scheduled in October, expecting the government will implement financial policies at a faster face, increase fiscal spending and propose more relaxed monetary and housing policies. Our investment teams believe these potential measures could support the property market and stimulate the economy, driving up stock markets and improve the overall economy.
China consumer, low carbon economy sectors see opportunities
China continued to adopt zero-Covid policy in face of the epidemic. Shenzhen and Shanghai started to lockdown since March, and the number of cases reduced substantially by early May, with signs of the pandemic being under control. Our investment teams believe the worst has been over. If the situation continues to improve, the consumption sector could rebound and the pressure on supply chains may be lifted. Companies with strong brand effect will have a competitive advantage due to their ability to improve cost burden or even shift it to end consumers.
China aims to peak carbon dioxide emissions by 2030 and be carbon neutral by 2060, with a strategic goal to lead a low carbon economy. Market demand has been strong for solar energy, electric vehicles and lithium-ion batteries. Electrification is particularly crucial to the development of a low carbon transportation system.
Moreover, the overall development of the Electric vehicles (EV) industry was generally good, but the penetration rate remained relatively low. EV had a penetration rate of 19.3% in the first quarter, suggesting ample room for growth as shown by China Academy of Information and Communications Technology. Demand has also been mounting for electric vehicles' downstream supply chain of lithium-ion batterie, prompting the acceleration of the production for separators, the critical component in lithium-ion batteries. China, home to the world’s largest separator maker, therefore presents compelling investment opportunities. Our investment teams favour sectors along the whole EV value chain. Long-term growth potentials of these related companies should not be overlooked.
China’s property sales remained weak as lockdowns impacted buyers’ sentiment. As the cash flow of some developers was tight, default cases might continue. China’s Fintech industry had been a major driver in the past, but growth momentum was hindered due to tightened regulations, pandemic restrictions and sanctions, among other factors. Hence, Investors were also recommended to adopt a cautious stance towards China’s property and Fintech sectors.
P/E ratio of APAC equities is relatively low, see long-term value
In spite of the fact that global economies are still facing lots of challenges, International Monetary Fund’s World Economic Outlook report in April showed Asia's GDP growth could reach 5.4% this year, which is higher than that of the US and Europe, implying corporates within the region still offer attractive growth opportunities. In addition, the price-to-earnings (P/E) ratio of Asian equities has been relatively low, presenting a favourable case to long-term investors. Within the region, Australia’s economic development was stable. The country had been enjoying decades of economic growth before Covid sent it into a mild economic contraction, reflecting solid demand from domestic consumption.
Source: IMF, World Economic Outlook, April 2022.
In terms of sector, companies that are benefited from demand-supply imbalances would see better growth prospects. Among them included blue-chip commodities firms with strong pricing power, and companies that are related to carbon neutrality. We see opportunities in Australian commodities and materials companies, Indian energy and resources corporates as well as non-bank financials, including financial leasing operators in the APAC region.
Hong Kong market sees short term volatility but gets support in medium term
Impacted by external factors, Hong Kong market will not be immune from short-term volatility. Hong Kong’s economy recorded significant decline in the first quarter. Real GDP shrank 4% year-on-year. Cross-border financial and fund-raising activities were weak. We believe the correction in China and Hong Kong markets in the first half of the year has largely priced in the unfavourable factors. In our views, current valuations could provide support to the equity market in the medium term.
The P/E ratios of Chinese and Hong Kong markets are relatively low, which could be appealing to long-term investors. When China rolls out favourable policies to support the economy, and the conditions for border reopening are ready, market sentiment in Hong Kong and Macau could rebound. In view of closed borders, and until we see any reversal in strategies by Chinese authorities towards Macau's VIP gaming sector, we remained prudent towards Macau's gaming sector.
In conclusion, the fluctuating pandemic situation, global supply chain disruptions, and Russia-Ukraine war have fuelled the inflation pressure. These factors have all played a part in inducing market uncertainties which dampened sentiment. But the market is not without investment opportunities. If one looks closer, especially across Asian equities where valuations are trading at low levels, there remains room for long-term allocation in select sectors.
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