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Can Asia’s recovery survive the risks?
Asia in 2017 is in a much different, and stronger, position than it was in 2016. Above all, the region is finally reflating after years of disinflation and even deflation. Higher energy prices, rising inflation expectations in the United States as well as accommodative monetary policies in the region are all helping to reflate Asia. Meanwhile, corporate profits in most markets are poised for a strong year and trade is broadly percolating.
In most years, investors would be risk-on and quite bullish about the year ahead, given the robust fundamentals and positive trends. But this isn’t most years: Mr Donald Trump, European disintegration and geopolitical tensions have fused to create unease even among the most optimistic investors.
So could these risks derail the mounting momentum in the region? Possibly, if tail risks and worst-case scenarios materialise. Therefore, it’s essential that investors are aware of potential risks and how to effectively protect their portfolios in the event that these events intensify.
THE ELEPHANT IN THE ROOM: TRUMP AND TRADE
Trade has traditionally driven Asia’s business cycle. The good news is that US and EU import demand has stabilised and started to increase, driving faster export growth across most markets in Asia; current export trends should result in a modest 10 per cent nominal export growth in 2017, according to our forecasts.
The bad news is that Mr Trump’s protectionist trade positions could undermine the windfall from the anticipated uptick in commerce this year. The US President intends to rebalance the country’s trade by unwinding or renegotiating deals like Nafta and penalising countries he believes are manipulating their currencies or unfairly propping up domestic industries at the expense of American jobs. Mr Trump and his administration have reportedly considered imposing import tariffs of 5 per cent to 20 per cent across the board.
China is at risk of being a target for punitive trade measures, given its sizeable surplus with the US. If the US uses access to tax subsidies and preferential loans to foreign firms as a basis for imposing trade restrictions, China’s industrials, materials, and some household sectors would be candidates for tariffs. The US may also focus on industrial sectors with a very large trade imbalance or export footprint for action, such as machinery, electrical and electronic communications, transportation and data-processing equipment.
Should Chinese exports become the main focus of US trade measures, then associated supply chains in Taiwan, South Korea and Japan would be hit the hardest in the region as they have the highest share of exports to China that pass through to the US. Conversely, beneficiaries of trade migration away from China and its associated hollowing-out would include parts of Asean and India which have a more diversified export footprint.
GEOPOLITICAL TENSIONS AND EUROPE’S FRAGILE UNION
Meanwhile, geopolitical tensions are rising around the world and a wave of populism is sweeping across Europe, with the potential to upend global financial markets.
Mr Trump’s approach to foreign diplomacy could lead to political tensions between China and the US; frictions between the two are expected to escalate in the year(s) ahead. In the meantime, conflicts in the Middle East are always at risk of escalating. Other potential risks which could catch investors by surprise and drive up political risk premia include terrorism, cyber attacks, Russia’s expansionary foreign policy and the South China Sea dispute.
Any such developments would likely weigh on risky assets, at least in the near term; however, the market impact depends on intensity, duration, location and the parties involved, and could therefore be short-lived. In times of heightened geopolitical tensions, oil prices rise and investors flock to safe-haven assets like gold, government bonds and the yen.
The European Union will face rising challenges this year, with elections due in the Netherlands, France and Germany, as well as possibly Italy – all potentially taking place amid a refugee crisis. While elections alone are unlikely to alter Europe’s economic outlook as a whole or affect corporate profitability in 2017, they do have the potential to change the political landscape or even call the entire EU project into question.
While for the time being this seems a low-probability scenario, its occurrence could ultimately increase risk premia on European assets, with financial equities suffering the most while export-oriented sectors benefit from the weaker euro.
Against these geopolitical and protectionist trade risks, small, open and trade-dependent economies like Singapore could have the most to lose.
FEAR NOT, REFLATION IS HERE
Despite the looming uncertainties, which investors must monitor closely, our base case is that the Asian reflation story will likely remain in place, assuming the selective imposition of higher US trade tariffs. Asia’s governments would likely step up their own policy easing to offset losses from the contagion of risks, in particular those related to trade. So how should investors invest in a rising inflation environment?
First, equities are better positioned than other assets to generate returns in periods of inflation accompanied by growth. We are overweight global and US equities in our global tactical asset allocation. Sector beneficiaries of rising inflation could include US and euro-zone energy stocks, US financials, healthcare and technology stocks.
Second, US Treasury Inflation Protected Securities, whose par value climbs along with inflation, stand to benefit as US inflation expectations rise, and can prove an attractive portfolio diversifier. US senior loans should also deliver attractive returns as US interest rates gradually rise.
Third, precious metals have historically benefited from falling real yields, and stand to benefit again today as central banks seem likely to raise rates more slowly than inflation rises. Palladium and platinum should be additionally supported by greater economic growth and industrial demand.
Source: http://www.straitstimes.com/business/can-asias-recovery-survive-the-risks