The market correction over 1H2022 has improved the valuation proposition of equities, says Tai Hui, chief Asia market strategist, JP Morgan Asset Management.
Fixed income assets, too, are looking more appealing, adds Tai in a July 7 note.
“The key going forward is for companies to better manage their profit margins,” writes Tai in a 3Q2022 market outlook. “Value and quality should remain in favor until there is a clear peak in interest rates.”
Tai remains “constructive” on Chinese and Asian equities. “China’s economic rebound, additional stimulus and regulatory environment shifting from framework setting to enforcement could facilitate a valuation re-rating in both onshore and offshore Chinese equities,” he says.
For the rest of Asia, Tai believes the reopening theme is starting to provide fresh earnings growth momentum. This is despite concerns from higher food and energy inflation.
“If the US dollar starts to stabilise, this could help attract additional international capital flows,” he adds.
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US recession risk is rising
As we are moving toward the late part of the economic cycle, the risk of recession has risen with the aggressive monetary tightening by the Fed, says Tai. “Having said that, consumption data is still pointing toward steady growth entering 2H2022. An exceptionally low unemployment rate should support personal spending despite the rising costs, even as fiscal support from the government dissipates.”
According to him, there are several potential economic soft spots to watch out for. The housing market, for example, is starting to cool in reaction to rising mortgage rates, writes Tai, while corporate spending is sensitive toward borrowing costs and earnings growth.
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In addition, inflation is on the decline, says Tai, albeit slowly.
“Overall inflation in the US should start to decline, but only slowly,” he writes. “Some transitory forces, such as rising energy prices, higher auto prices and the government’s fiscal boost to household spending, should fade in 2H2022.”
That said, some inflation components could take longer to come down, such as housing costs. Says Tai: “Companies are also passing the higher labor and raw material costs to their customers, especially in the services sector where demand is strong.”
He adds: “Core consumption deflator inflation is expected to fade to 4% by 4Q2022, but will still be above the Fed’s target of 2%.”
‘Appealing’ fixed income assets
The appeal of fixed income assets has improved in 1H2022. “Corporate credit spreads have returned to close to their long-term averages, even though default rates remain low. At this point, investment-grade corporate bonds could be a good balance of income generation while remaining resilient amid weaker economic growth,” adds Tai.
Asian and emerging market (EM) fixed income should also benefit from a more stable US dollar, he writes, even though their central banks are on track to raise interest rates. EM fixed income return could also be boosted by spread tightening as investors continue to seek income.
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Asia could experience some demand-pull inflation as its domestic economy and tourism sector reopen, but given that fiscal stimulus has been more moderate compared with the US, Tai believes overall inflation pressure “should be less challenging”.
Tai writes: “We are constructive of both equities and fixed income and believe the markets should recover some lost ground after a disappointing 1H2022. After all, valuations of both equities and corporate credit have become less demanding, while earnings and credit quality are still relatively decent.”
Investors could consider a more balanced approach in equities and fixed income, says Tai, “given that we could be moving from the mid to late growth cycle in the US”.
Uncertainty from inflation, policy tightening and uneven growth across the world imply a greater emphasis on quality, he adds. “Income is also expected to play a more prominent role in contributing to total return.”
Room for optimism in China
Finally, there are reasons to be cautiously optimistic about China in 2H2022, says Tai. “The [Chinese] government is stepping up fiscal stimulus to revive economic growth, and the central bank policy should also be more supportive of growth, in contrast with other major economies’ central banks' tightening bias.”
For this recovery to be sustainable, however, consumer and business confidence need to stay buoyant, he adds. “One critical factor will be how the authorities handle the next round of outbreak. We do not expect China to abandon its current pandemic policy for now, but there is room to adjust the execution of quarantine measures to reduce the economic impact.”
