Pathway to Recovery
02 February 2021
Against a backdrop of low interest rates and continued policy easing, risk assets could see further upside in 2021 aided by the roll-out of vaccines that would put global economies on a path to recovery. 

“After an anomalous 2020 which saw both the sharpest recession as well as strongest recovery in the same year, the biggest question now is if the rally can now continue into 2021? 

“So far, the year has started on a strong note despite a resurgence of new COVID-19 cases as the market believes that the vaccine would bring about a normalisation in the economy,” Teng Chee Wai, Managing Director of Affin Hwang AM said in his opening remarks at the company’s recent online webinar on the 13 January 2021.
This is supported by accommodative monetary policy and a weakening USD trend which is a boon for Asia and emerging markets (EMs). While infection rates remain stubbornly high especially in developed markets such as US and Europe, Asia has fared better by gaining better control of the pandemic. 

East Asian markets especially Korea, Taiwan and China have managed to contain the spread of the coronavirus and even reboot parts of their economy. David Ng, Deputy Managing Director and Chief Investment Officer said this augurs well for its recovery as seen in the global manufacturing purchasing managers’ index (PMI) which has rebounded sharply. 

“We think there is still room for the recovery to run within the manufacturing sector. Inventory levels have been kept low as production levels dropped during COVID-19. There is also a lot of pent-up demand with news on shortages in semiconductor chips and auto parts which disrupted production. So, demand is picking-up,” said David.

The other driver for growth is also the services sector which suffered heavily during COVID-19 as spending on consumption, travel and experiences plunged. As confidence improves and the vaccine roll-out continues, David expects the services segment to rebound further and provide another boost to the global economic recovery. 

David expects a similar positive trajectory for earnings with a larger percentage of companies seeing upgrade revisions compared to downgrades. “The earnings revision ratio has also been on a strong uptrend which will be supportive of equity markets. However, we are conscious also about valuations which are expensive compared to long-term historical averages. Though, a low interest rate environment to a certain extent can support higher multiples especially in light of the recovery we are anticipating,” David states. 

From a technical perspective, David also believes with such abundant liquidity and cash on the side-lines, this could add further legs to the rally. “The result of central banks injecting so much liquidity as well as consumers being cautious and not spending has resulted in a lot of cash trapped in the financial system. In aggregate, the global savings rate is at very high levels. As the economy recovers and confidence returns, the ammunition for investors to deploy back into financial assets is certainly there,” David said.

Asian Bonds Stay Resilient
Similarly in the fixed income space, Asian bonds are expected to outperform their regional counterparts on the back of stronger credit metrics and fundamentals. “We like Asian bonds as it continues to offer real positive yields to investors. Asian bond yield levels remain more attractive especially from a global perspective where bond yields are in negative territory,” Esther Teo, Director of Fixed Income said. 

“More importantly, Asian economies are in a better position to weather the impact of COVID-19 with cases under control. We expect China to stage the strongest recovery and would pull the rest of Asia alongside it. With better fundamentals, default rates in Asia are expected to remain low at 3% in 2021,” Esther adds.

Whilst the COVID-19 pandemic has triggered concerns of credit risk, global default rates have still been manageable according to Esther. This is due to highly accommodative monetary policy by global central banks to shore up liquidity.

“Compared to the global financial crisis in 2008, where we saw global default rates rise between 15%-20%, the risk of defaults is relatively more manageable in this current pandemic-induced recession. At the peak of the crisis in May 2020, there were estimates by credit rating agencies that default rates would shoot up between 12-15%. But actual default rates came in lower than expected.

“In the US which has the largest corporate bond market, the US high yield bond segment posted default rate of about 9%. Even in Asia and EMs, default rates have been manageable. In the Asian credit space, default rates only came to about 3.8% for 2020,” Esther mentioned.

Global central banks embarked on a swathe of easing measures at the height of the pandemic to provide liquidity which supported the bond market. “The aggressive cutting of interest rates helped to lower the borrowing or funding cost for corporate bond issuers which really provided them a lifeline.”

“Secondly, corporates also had access and could easily tap into the debt market to refinance or raise funds during the pandemic. Many of the global central banks such as the US Federal Reserve, Bank of Japan and the European Central Bank (ECB) had stepped in with its bond-buying programme which provided confidence to the credit market.

“Many companies took advantage of this especially in a low interest rate environment. That really helped them to build a war chest to weather through the pandemic. That’s why we didn’t see default rates spike in 2020,”Esther said.

Moving to 2021, Esther expects the credit rating trend to improve globally as the economy recovers and corporates report better earnings and cashflow. Companies would then pare down debts they have raised which would help improve their credit profile especially HY issuers.

However, Esther adds that certain segments could still be at risk. Those sectors that are slowest to recover from the pandemic especially those tied to travel and services could see a delayed recovery given the resurgence of COVID-19 cases.

Tighter Liquidity a Risk to Markets
Whilst markets continue to notch higher gains, Teng is mindful of technical indicators reaching extreme bullish levels which could signal a pullback. “We are aware that there is currently a strong consensus view on markets right now with most analysts and strategists projecting a strong 2021 for the stock market. As such, we are constantly asking ourselves what could be the blindsides for markets,” Teng states.

David believes that one of the key headwinds that could derail risk assets are potential policy risks by central banks that could lead to tighter liquidity conditions.

“If central banks raise interest rates or withdraw liquidity too early before the economy has found a firmer 
footing, markets could see some pullback. However, based on pronouncements by major central banks, we think this is unlikely because policymakers are also conscious that the economy is still fragile.

“Another related risk is any inflation surprise. If inflation rises too sharply, this could lead to a disorderly selloff in bonds resulting in higher bond yields. This typically negatively impacts both the equity and bond market,” David said.

Whilst there has been great progress on the vaccine development and rollout programme, David does not rule out COVID-19 as a lingering headwind for markets in 2021. Concerns about the coronavirus mutating and the efficacy of vaccines were some of the top questions asked by audiences in the webinar.

However, based on latest findings it was found that the SARS-Cov-2 virus does mutate, but at a much slower rate relative to the common flu viruses that circulate every year. So far, even the most highly mutated variants of the virus that have been sequenced, have less than a 0.7% deviation in the spike protein (portion of the virus targeted by all vaccines) relative to the original strain detected 1 year ago in Wuhan.

Given this rate of mutation, vaccines are expected to be 90-100% effective at preventing hospitalisations for a few years at the very least. By that time vaccine developers would have had ample time to adjust their vaccines to any new dominant strain if necessary according to David and his team. 
"As more and more people are immunised, this will lead to confidence and support recovery. Based on guidance, the mortality rate is expected to have halved by April and by July herd immunity will be achieved in the US. This would put us on the path to further normalisation as more parts of the economy reopen,” David said. 
This article has been prepared by AHAM Asset Management Berhad (“AHAM Capital”) (formerly known as Affin Hwang Asset Management Berhad) specific for its use, a specific target audience, and for discussion purposes only. All information contained within this presentation belongs to AHAM Capital and may not be copied, distributed or otherwise disseminated in whole or in part without written consent of AHAM Capital.

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