In early June, PIMCO’s investment professionals from around the globe gathered by video to discuss our latest Cyclical Outlook. Our baseline continues to be a bumpy and uneven recovery with pre-crisis level of economic activity unlikely to be reached before 2022 in most Western economies. In this Q&A, Asia portfolio manager Stephen Chang shares our thoughts on the path to recovery in Asia and the implications for investors in Asia credit.
Q: While PIMCO believes a near-term mechanical bounce in global economic activity in response to the lifting or easing of lockdown measures looks likely, we expect the subsequent climb up to be long and arduous. How do we see the prospects for China?
A: Growth in China’s June high frequency and manufacturing activity data indicates that the economy continues to recover from the effects of the coronavirus pandemic, supported by strong housing and infrastructure investment and normalization of consumption. This points to positive growth in second-quarter GDP overall. The recovery in Q2 has been driven by easing of lockdown measures, catching up on lost production, a surge in demand for medical products and online work equipment, and significant stimulus measures.
On the macro policy front, the State Council, via the People’s Bank of China (PBOC) has cut the reserve requirement ratio (RRR), required banks to compress profits to help companies, promised to help small and medium banks raise capital, and pledged to lower lending rates and bond yields. China’s government has made it a clear priority to support lending to the real economy.
So while there is some uncertainty around the relationship with the U.S., the data so far in China has recovered on pace and the trajectory is looking more promising.
Q: Our latest Cyclical Outlook discusses how the key swing factor for the economic outlook lies outside economic or policy spheres. A rapidly evolving COVID-19 pandemic could easily push the global economy into better or worse trajectories than our baseline over our cyclical six- to 12-month horizon. What do the good and bad scenarios discussed in the cyclical outlook mean for APAC credit sectors?
A: The good scenario is we have a more rapid economic recovery. This would happen if a vaccine or other medical treatments are developed with scalable results, reducing the need for social distancing faster than expected. In a V-shaped recovery, we favor certain domestic consumption sectors, for example China internet and China property, as well as companies that have a strong liquidity profile but which have underperformed year-to-date from sectors such as autos, ports and leasing. In this scenario, we would be less positive on sectors with limited upside in earnings and the potential for more significant spread tightening, such as banks and utilities.
A bad economic scenario of a much slower recovery or even a double-dip recession would most likely result from strong and widespread second waves of COVID-19 infections that lead to renewed interruptions of economic activity. In an L-shaped recovery, some domestic consumption sectors would again benefit (particularly China internet & China property) given their strong market share and funding access. In addition, we would favor defensive sectors with high regulatory support and decent sponsors (banks, utilities, renewables and telecoms).
Q: Can you explain further why the China internet and China property sectors could outperform in both scenarios?
A: China internet is a secular story and this sector will continue to be a beneficiary of the consumer adjustment to the impact of COVID-19, particularly in terms of working from home and online shopping. Apart from their business growth momentum, the financials remain solid for these internet companies and their equity share prices have stayed buoyant. This allows them to tap various funding channels as they expand and their relative valuations, compared with global internet peers, still look attractive.
China property is a more domestically driven sector and hence less sensitive to global growth. Chinese policymakers would prefer to keep this important economic driver steady, so we expect monetary policy to help support this segment until the economy fully recovers. In an L-shaped recovery, we expect them to relax property policies to boost the sector. Alternatively, in a V-shaped recovery, consumers will have more purchasing power and we do not think that policymakers will start tightening policy prematurely, even if the market quickly reverts to a more normalized level.
Q: What is our outlook for Asia fixed income markets in the cyclical six- to 12-month horizon?
A: We expect central banks in Asia to maintain an easy monetary policy stance and enact a range of measures from rate reductions, reserve requirement cuts, quantitative easing and other liquidity tools to foster a conducive environment for growth and recovery. However, performance in Asian fixed income is likely to be uneven, with credit differentiation becoming increasingly large as fundamentals diverge. Overall, sectors that rely on domestic consumption are more likely to outperform in most economic recovery scenarios.
In our view, it is important to be an active investor in this environment and to be selective and judicial in deploying capital, while maintaining flexibility since markets are likely to remain volatile for a while ahead.
Stephen Chang is a portfolio manager based in PIMCO’s Hong Kong office.
This material was originally published by Citywire. Date of original publication
6 August, 2020.