OCBC OneWealth App– Looking beyond Asian shores

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ASIA AND BEYOND

Looking beyond Asian shores

31 July 2017

Asian equities have done well since the U.S. elections last year

Record high stock markets show that investors were, and still are, clearly in the mood for risk after President Trump’s surprising success at the polls last November. Yet correlation need not imply causation. While Trump’s pro-growth agenda could have gone some way to inspire investor confidence, it was not nearly the only factor pushing markets higher. The stronger global growth environment as evidenced by healthy global manufacturing and services PMIs, the rebound in global industrial production and trade activity as well as still accommodative monetary policies should be given some, if not most, of the credit.

Asia ex-Japan and European stocks were among the key outperformers following the U.S. elections. On Asia ex-Japan, robust export numbers and better-than-expected GDP growth figures went a long way to reinvigorate interest in the region. Equity flows into Asia increased as investors sought yield and value.

Asia ex-Japan: Benign outlook, but higher downside risks after period of outperformance

To be sure, the near-term outlook for Asia remains relatively benign, even while economic momentum appears to be moderating.

Taking reference from the Asia Pacific Citi Economic Surprise index, we find the index retreating progressively from the highs observed during the first quarter. The recent slate of economic data have mostly met or slightly disappointed expectations, a far cry from months before when economic indicators consistently surprised significantly on the upside. Nevertheless, moderation does not mean recession. It just means the pace of economic activity could slow down after a fairly robust 1H2017.

Focussing on the risks

Other developments on the horizon suggest that it might not be completely smooth sailing for Asia in the 2H2017 much unlike the way it was in 1H.

Foremost among these risks is tighter financial market conditions precipitated by major central banks including the Federal Reserve and European Central Bank, both of which seeking to tighten the liquidity spigots. Leading the charge on this front is the Federal Reserve. The U.S. central bank has increased interest rates four times since 2015 and Fed officials have begun preparing the market for the eventuality of quantitative tightening, a passive process designed to shrink its crisis-era balance sheet by ending reinvestments of principal from maturing fixed income assets be it treasury bonds or mortgage backed securities. The most recent policy statement suggests that the Fed could move to pare back its bloated balance sheet as early as September. As it stands, financial market conditions remain fairly loose despite the shift in policy rhetoric. However, we would caution against becoming too complacent with current conditions and prepare for the eventuality of higher volatility and tighter liquidity conditions as central banks prepare to head for the exits.
The economic rebalancing in China is yet a further concern that may continue to be a key focus this year. Current expectations are for Chinese government officials to continue to adjust the delicate mix of policy stimulus and tightening to keep growth on an even keel amid expectant significant political changes this year. Admittedly, balancing on this policy tight rope is not an alien concept to Chinese policymakers as they’ve done it multiple times before. However, we’ve also witness the consequences of policy mistakes in China. When the China sneezes, the world, especially Asia, flinches. Indeed, a bumpier-than-expected transition against a backdrop of an ever expanding credit bubble could introduce fresh volatility in the region. As it currently stands, China remains relatively quiet, but, as with many things in this prevailing market environment, we should watch against complacency.
The last concern is the lurking threat of protectionism. This will continue to remain a key risk during Trump’s presidential term. The Trump administration has been rather quiet on this front but may use such threats as leverage in trade negotiations and potentially as a source of distraction should President Trump continue to face trouble in pushing his pro-growth agenda through Congress.

On balance, prepare for a bumpy road ahead

As such, even as the outlook for Asia remains fairly benign, downside risks have increased following a period of outperformance. The road ahead may be bumpier than what we’ve been accustomed to in 2017, but this is not unusual. It is entirely possible for the recent period of low volatility and loose financial market conditions to extend into the foreseeable future. However, this does not seem sustainable with major monetary policy shifts likely on the horizon and other geo-political risks coming to the fore. Whatever the case, we would not want to be caught on the wrong side of a trade when (or if) the tide finally turns.

Mitigate risks and improve portfolio resilience amid potential bumps ahead

As such, in the face of potential turbulence ahead, investors should seek to increase the resilience of their investment portfolio through diversification. A portfolio comprised of a single fund forces investors take on unnecessarily concentrated risks and increase vulnerability to potential ructions in the market.

Consider an investor who was purely invested in Asian securities. In good times, the rewards could be fantastic to be sure. But let’s assume there was a change in the investment climate that, in one way or another, favoured developed markets over Asia. As a general consequence, investors would expect funds to flow out of Asia into other more advantageous territories. This is bad news for Asian-only investors who would inevitably have to stomach the loss from such regional outflows almost entirely, whereas a more diversified investor who may have added exposure to developed markets could see returns in those regions increase, potentially offsetting the loss from Asian outflows. In essence, investors with concentrated regional exposures will likely face the full brunt of negative regional flows and other idiosyncratic regional risks. There is no buffer in place to mitigate or reduce potential downside pressure.

In this case, a better investment strategy would be to construct a portfolio with a number of different funds that offer investors access to various investment strategies and a myriad of other potentially less-correlated securities. In this manner, investors should be able to lower correlations and volatility of their overall portfolio.

It’s like having a meal at MacDonalds or any other fast food joint for that matter. A hearty burger can be fulfilling all on its own. But a full meal, complete with fries and a drink, ensures you are neither thirsty nor hungry. Yet, whether one is fully satisfied with the meal will largely depend on how well it was prepared and put together to begin with. In this case, building a portfolio comprising of a number of high-performing funds with varied investment strategies could be an ideal solution.

For this purpose investors may consider the following funds with fairly differentiated investment strategies that might be complimentary to their own portfolios:

The information below solely constitutes the views of OCBC Bank and does not consider the specific investment objectives, financial situation or needs of anyone. The Bank is therefore not responsible for any loss or damage arising from this information. Investment involves risks. If you wish to make an investment, you should first speak to your OCBC Relationship Manager or a Personal Financial Consultant.

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