2022 was a difficult year as markets priced in a war in Ukraine, persistently high inflation, record interest rate hikes in the US and an economic slowdown in China. The macro backdrop in 2023 is much better as we are near the end of the interest rate hiking cycle in the US, and China is finally reopening. It is too early to turn positive on US equities as valuations are too high with significant risks to earnings. The theme that stands out in early 2023 is China’s reopening. We are positive on China equities which has improving fundamentals while still trading at attractive valuations.
SLOWER ECONOMIC GROWTH IN THE US
Figure 1: Rate of interest rate hike in US is one of the fastest ever
Source: Reuters 19 December 2022, Note: M – Months since rate hikes started
1. The US Federal Reserve (Fed) has aggressively raised rates (see figure 1) in 2022 to cool the economy and fight inflation. With recent softer inflation data, the Fed has guided for a slower pace of interest rate hike, and we could possibly see another couple of rate hikes till March before the Fed keeps interest rates stable for the rest of 2023.
Figure 2: Real Gross Domestic Production (GDP) growth in %
Source: Bloomberg November 2022, Note: F – Consensus Forecast
2. US economic growth is expected to slow significantly in 2023 (see figure 2) and several leading economic indicators, such as the consumer confidence index (see figure 3) and treasury yield curve, are suggesting that there is a real risk of a recession ahead.
Figure 3: US Consumer Confidence is at historical low
Source: Reuters 19 December 2022
3. US equities is not cheap (see figure 6), and earnings could be revised lower if the economy slides into a recession. Potential US dollar weakness in 2023, from peaking interest rate differentials, would also be negative for investments in the US. As such, we could see funds outflows as a drag on the US equities market.
CHINA’S ECONOMIC RECOVERY
Figure 4: MSCI China Net Returns
Source: Reuters 20 December 2022
4. The fundamental picture in China cannot be more different from that in the US and other developed markets (see figure 2). China’s GDP growth is expected to recover strongly from 2022 as i) China reopens from 3 years of Covid lockdowns and ii) China pivots its economic policies to support economic growth policies after the 20th National Party Congress in November 2022.
5. China has announced several rounds of relaxations to its Dynamic Zero-Covid policies since November 2022 with the latest policy being to scrap quarantine of overseas arrivals from 8 January 2023. Health experts in China has publicly forecasted that complete reopening is possible after March 2023. That said, the path to reopening may not be a straight line as localized lockdowns are still possible if hospitals become overwhelmed. In any case, a reopening would be a powerful boost to the economy, and we could start seeing positive economic data sometime in the second half of 2023 as consumption and industrial activities resume.
6. The risk of a property crisis in China has also abated with policy pivoting towards supporting the real estate sector. Key measures announced in November 2022 included stable financing to developers, financing for project completion, managing risks of financially distressed property companies, and protecting the rights of homebuyers. We see these measures as helpful in easing the credit crunch and promote a recovery in the property sector.
7. This positive development is only partially priced in the market. For example, the MSCI China Net Return Index has rallied 36% (as at 19 December 2022) from its 31 October 2022 lows but valuation (see figure 6) is still undemanding at 10.5 times 2023’s consensus earnings forecast. This is despite having one of the highest earning’s expectations compared to many key markets. This discount in valuation could close on catalysts such as i) the setting of a GDP growth target during the “Two Sessions” meeting in March 2023 or ii) recovering key economic indicators in the second half of 2023.
MIXED BAG FOR ASIAN EQUITIES
Figure 5: China reopening to boost tourists’ arrival numbers in Asia
Source: Reuters 20 December 2022
8. Most Asian economies (Australia, Thailand, India, Indonesia, Korea, Malaysia, and Taiwan) are likely to hike interest rates in 2023 due to inflation or foreign exchange considerations which would be a drag on the respective economies. The only exception being China and Japan, which are expected to maintain accommodative monetary policies in 2023. China’s reopening would jumpstart Asia’s growth engine though fundamentals could remain challenging if both the US and Europe goes into a recession. That said, the Singapore and Japan equities markets are being more resilient due to reasons specific to these markets.
9. We are moderately positive on Singapore equities due to attractive valuations. Hospitality and related sectors are likely to be well supported by an increase in tourists’ arrivals from China (see figure 5). We also expect the oil & gas sector to be supported as oil prices remain supported by increasing demand from China’s reopening. We are also positive on the financial sector as net interest margins continue to remain high while credit costs remain benign.
10. We are also moderately positive on Japan equities on attractive valuations and resilient earnings from a weak Yen. However, the conviction is much lower compared to a quarter ago as the Bank of Japan (BoJ) may turn more restrictive in April 2023 when BoJ Governor Kuroda’s term ends.
Figure 6: Valuation and consensus earnings forecast
Source: Thomson Reuters, 16 December 2022, Note: F – Consensus Forecast, x – excluding, P/E – Price to Earnings
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