In our latest Cyclical Outlook, we discuss why what we are currently experiencing is different from a normal recession. This is the first-ever government imposed global recession, where a temporary and partial shutdown of the economy was deemed necessary to suppress the spread of the coronavirus. Given the origin of this recession is unique, its depth and duration is also likely to be very different. We expect the global economy and financial markets to transition from intense near-term pain to gradual healing over the next six to 12 months, although it is difficult to find a comparable playbook from history.
China’s economy likely to see a muted recovery
In China, which was the first to experience the impact of the coronavirus, the economic loss is severe and arguably unprecedented. The first quarter of 2020 will mark the recession trough in China, in our view, with GDP having declined 9.8% quarter-on-quarter.
While manufacturing PMI1 data for China in March and April has come in above the 50 mark that separates growth from contraction, new orders have declined as exports continue to slow with the spread of the virus globally. Some of the key higher frequency indicators, such as consumption, property sales, power utilisation and factory activity are running at between 50% and 90% of normal activity. It is also worth pointing out that private debt levels have risen rapidly over the last decade in China, with credit used as a key instrument for economic expansion. While we may see a temporary pickup in credit growth again, the government will be closely monitoring financial risk and we are unlikely to see the same magnitude of increase as happened after the global financial crisis (GFC) in 2008.
Despite easing of confinement measures, along with the Chinese government’s large and swift monetary and fiscal policy response, the economy may not recover to fourth quarter 2019 production levels until perhaps the first quarter of 2021.
Broader Asian market recovery dependent on access to dollar funding and oil prices
In mid-March, the Fed introduced a number of different measures to help arrest market illiquidity, and we have seen some improvement in Asian markets since then. In addition to underlying economic activity, two factors will have an important impact on the speed of recovery in the region. Firstly, in an effort to lower borrowing costs, the Fed, together with many central banks around the world, established swap and repo lines to allow better access to dollar liquidity. We are monitoring whether this can avoid dollar funding needs becoming acute and creating the risk of a sudden depreciation in local currencies.
Secondly, even though the OPEC+ members have come to an agreement on a reduction in the oil supply, the market does not seem convinced that this will make up for the drastic reduction in demand. As most Asian economies are net oil importers, the collapse in the oil price is likely to continue to benefit the region on a comparative basis.
Investment implications: lower rates, further tech adoption and easier policy for China property
Central banks in Asia are likely to adopt an easy monetary policy stance over coming months. We expect them to enact a range of measures including interest rate reductions, reserve requirement cuts, quantitative easing and other liquidity tools to foster a conducive environment for recovery in growth. In this context, interest rate sensitive sectors, utilities and other sectors that are eligible to directly benefit from those central bank programs may see stronger performance.
We remain positive on the technology sector in Asia. Tech should continue to enjoy a secular growth trend even as other parts of the economy experience disruptions. Social distancing measures will further increase the speed of digitalisation in certain areas of the economy. Businesses from hardware to e-commerce, online entertainment to cloud-based services should reap the benefits.
The Chinese property sector is another area that may offer an interesting dynamic for issuer selection. The Chinese government adopted tight policy measures for the sector over the past few years, but we believe these measures could be relaxed in an attempt to support domestic growth. With the overall impact of COVID-19 on the sector being negative due to reduced income growth and increased unemployment, we expect the government will shift toward a neutral stance on the sector overall, with relaxation measures decided on a city-by-city basis. Onshore debt financing may also be made more easily available to developers given that we have seen official approval for and successful issuance by a few bellwether companies over the past month.
We believe this is a good time for active management and to be selective regarding investment opportunities. Performance in Asia fixed income is likely to be uneven and with credit differentiation, or the dispersion of returns, becoming increasingly large as fundamentals diverge. In our view, it is important to be judicial in deploying capital and to maintain flexibility since markets are likely to remain volatile for a while ahead.
Read PIMCO’s latest Cyclical Outlook, “Looking Beyond the Many Recessions,” for detailed insights into the 2020 outlook for China, the U.S. and other key global markets.
Stephen Chang is a portfolio manager based in PIMCO’s Hong Kong office.