Market PowerBar: March 2023

Topic 1: Maintaining our case for Asia ex-Japan

Markets rallied in January, especially with developed markets reporting stronger-than-expected growth data, and this has eased fears about a deep recession. However, markets turned cautious in February following strong labour market and inflation data. We continue to believe that the risk of a short and shallow recession in developed markets remains high. As such, we favour Asia ex-Japan, as the region stands to benefit from China’s ongoing reopening.

Key takeaways

1. The rally across developed markets in January has been driven by economically sensitive sectors. Some of the triggers that point to a sustainable market recovery are already in play: Inflation is easing, expectations of a Federal Reserve pivot are rising and the US dollar (USD) looks like it has peaked. However, sentiment has changed following stronger-than-expected labour market and inflation data in the US.
2. We remain cautious about an economic slowdown and impending recession. Earnings expectations tend to be overly optimistic at the start of a new year (Figure 1A). Stubbornly high inflation and a strong labour market in the US could result in further policy tightening. If that goes too far, central bank policy mistakes could derail any economic recovery.
3. Meanwhile, Asia ex-Japan markets have been driven by China’s recovery. This is ongoing and more sustainable in our view than continued improvement across developed markets. Asia ex-Japan markets could rally further as investors have yet to fully factor in the Chinese economy returning to normal. China’s valuations are still slightly below average even after the recent rally (Figure 1B).

In summary

The US has not avoided a recession yet. We still expect further deceleration in growth as companies are slowing investments and households appear to be saving less and borrowing more.

The end of lockdowns in China and possible end to the Fed rate hike cycle favour Asia ex-Japan and Chinese markets over developed markets for now.

Topic 2: Unintended spillover effects of China’s reopening

China is reopening faster than expected, which is a positive development for both the global economy as well as stock markets. The most obvious benefit to the world is the return of Chinese demand for goods and services, in addition to the easing of supply chain bottlenecks. However, we should be aware that not all these spillover effects are positive.

Key takeaways

1. China’s reopening presents several benefits to the global economy. If growth continues to slow down in developed markets, China’s revival can help to cushion against the downturn. As China normalises, supply chain bottlenecks in manufacturing and shipping activities should also dissipate, which will help push global inflation down (Figure 2A).
2. However, there could be unintended negative consequences as well. Should Chinese demand for commodities pick up, this could worsen supply issues and push prices higher. Figure 2B shows China’s top imported goods, representing categories where we might see some price pressure. This is hardly good news at a time when inflation is still a major concern. However, these inflationary forces could be partially offset by a decline in demand from the US and Europe.

In summary

Despite the recent rally in Chinese stocks, we remain positive on China on the back of its recovery and supportive policies.

Spillover effects like rising commodity prices might push global inflation higher and continue to weigh on global economic growth. Investors with the appropriate risk appetite can benefit from adding Chinese stocks to their portfolios, given that the A-share market is less correlated with global indices and may not be affected as much by a slowdown in developed markets.

Topic 3: ASEAN markets could continue to perform in 2023

While global stocks fell 18 per cent in 2022, ASEAN stocks were a relatively bright spot, outperforming global markets by close to 12 per cent. This was due to resilient exports to the West and the reopening of borders supporting overall economic recovery. With developed markets poised for a slowdown, can ASEAN stocks continue to perform in 2023?

Key takeaways

1. Export growth has been adversely affected in ASEAN (Figure 3A) as demand has started to slow in the West given the impact of tight monetary policy. As China continues its accelerated reopening in 2023, the weakness in export demand from the developed West could be offset to a certain degree by the Chinese recovery.
2. It is crucial to understand which countries have a larger exposure to Chinese final demand, especially since the Organisation for Economic Co-Operation and Development (OECD) estimates that around 26 per cent of China’s imports are intermediate goods and services not consumed within China.
3. Singapore, Thailand and Vietnam are more exposed to China’s final demand than to final demand from the US and European Union combined. These three ASEAN countries therefore stand to benefit more from an uplift in Chinese economic activity.

In summary

Just as importantly, the tourism recovery in ASEAN has some way to go. The region’s tourism arrivals last year only improved to about 60 per cent of pre-COVID levels (Figure 3B). The continued recovery in tourism will go a long way in lifting domestic employment, especially in the services sector, and that in turn will help to support consumption and overall sentiment.

Taken together, we believe that China’s recovery this year can be sustained, and will have a positive impact on ASEAN from both trade and tourism perspectives.

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UOB Investment Insights: Market PowerBar is a monthly series produced in collaboration with J.P. Morgan Asset Management, covering market developments, macroeconomic news, and investment trends. This report was first published here. For more investment insights, visit the Wealth Insights page.