A monthly review and outlook of the Asian Quality Bond market.
Market Review - as at April 2019
April was a very eventful month during which we had election in Indonesia, International Monetary Fund downgrading global growth and Chinese local currency bonds entering the Bloomberg Barclays Global Aggregate Index. However, none of these events have a material impact on the broad market trend which was one of gradually tighter credit spreads and higher US treasury yields. Risk sentiments were generally positive throughout the month even though the euphoria sweeping the market during the first quarter seem to be fading. JACI spreads ended the month 7 bps tighter at 251bps while 10 year US Treasury yield moved 10bps higher to 2.5%. This allowed the JACI to eke out a modest 0.35% gain for the month bringing year to date return at an impressive 5.25%. By country, spread returns was largely positive with the exception of some weaknesses witnessed in Mongolia and Sri Lanka.
Indonesia held their presidential elections and quick count results suggest a Jokowi win with 54-56% of the vote vs Prabowo’s 44-46%. This means Jokowi has likely secured a second term as president with a winning margin of around 8-12%, which is wider than the 6% in 2014. This victory bodes well for further structural improvement in the economy as Jokowi’s pre-election campaign suggests that he is likely to continue focusing on industrialisation through developing special economic zones and accelerating infrastructure developments.
During the month we saw some signs of stabilisation in China’s economic slowdown. Q1 real GDP came in at 6.4%, which was unchanged from the rate in Q4 2018 even though it has moderated from the 6.6% full year growth in 2018. What is more encouraging is that we witnessed broad based recovery in industrial production, fixed asset investments as well as retail sales in the month of March. Meanwhile over in South Korea, the Bank of Korea (BoK) lowered 2019 growth and inflation forecast as economic activity disappointed in the first quarter. Despite the weak data, BoK kept policy rate unchanged at 1.75% and reiterated that rate cut are not being considered despite the weakness in the economy. Bank Indonesia also met and kept its 7 day reverse repo rate unchanged at 6%. They maintained their 2019 GDP growth forecast at 5.0-5.4%.
New issuance market remained active with a total issuance of USD 31.4b. This brought year to date supply to USD 103b, which is a 17% increase year over year. The most notable deal was Tencent USD 6b multi tranche deal that was 4.5x oversubscribed. Tencent sold $2 billion in fixed and floating rate 5 year notes, $500 million in 7 year notes, $3 billion in 10 year notes and $500 million in 30 year notes. Meanwhile China Evergrande Group priced a USD 2bn multi-tranche issue, making the Chinese real estate developer the largest high yield issuer this year with a total issuance of USD 5.6bn.
The First State Asian Quality Bond Fund returned 0.23% for the month of April on a net of fees basis.
The positive return was largely attributed to the continuation of credit spread tightening and income return which more than offset the rise in US treasury yield.
On a relative basis, the fund has outperformed the index as our overweight in credit along with security selection both added value since the start of the year. Our overweight in US interest rate duration also contributed positively to our excess return.
Asset Allocation (%) 1
Top 10 Issuers (%) 1
1 Source: Lipper & First State Investments, Nav-Nav (USD total return) as at 30 April 2019. Allocation percentage is rounded to the nearest one decimal place and the total allocation percentage may not add up to 100%. Fund inception date: 14 July 2003. Performance is based on First State Asian Quality Bond Fund Class I (USD - Acc) is the non-dividend distributing class of the Fund. *The benchmark displayed is the JP Morgan Asia Credit Investment Grade Index.
We reduced our credit exposures during the month and is now neutral to the benchmark in terms of credit spread duration contribution. We also maintained our limit long duration in US interest rate duration on attractive valuations and expectations that the rate hike cycle by the Fed has ended.
By country, we remained underweight in Philippines sovereign on tight valuations. We are also underweight in Indonesia as we believe all the good news have been priced in following the spectacular year to date performance in Indonesian spreads. Within China, we are overweight Investment grade property, Banks’ leasing companies and Asset Management companies while underweighting core SOEs, banks and LGFVs (Local government financing vehicles). We do not like India banks and corporates as valuation does not reflect the fast weakening fundamentals.
While growth concerns especially in the developed markets are likely to persist, the technical backdrop for risky assets including Asian credit has improved significantly in the near term following dovish rhetoric from both the Fed and the ECB. The Fed has all but ended their rate hike cycle, while the sharp downward revision by the ECB on both the growth and inflation outlook means that rate hike now looks like a distant possibility. What this means is the chase for yield is likely to continue though we would exercise caution given how sharply the market has rallied. We would also question the effectiveness of developed markets’ ultra- easy monetary policies following a decade long of reckless money printing and what else could these central bankers do should we get another severe crisis.
Much focus by the market recently has been on the inverted yield curve in the US and the possibility of a recession. Recession or not, what is clear to us is that growth in the US has peaked around Q3 2018. In the absence of new fiscal stimulus; which will be especially hard to get approved just one year prior to the next election, it will be difficult for the US growth to surprise on the upside in the year ahead. While economic data could see a rebound following the end of the US government shutdown coupled with the possibility of a positive development around trade discussion between China and the US, effects from the previous rate hikes and monetary tightening cannot be discounted as that has been a drag on growth. Voicing concerns around the growth outlook, the Fed has effectively ended the hiking cycle and put an explicit end date to quantitative tapering. While market cheered this move and is likely to welcome another round of quantitative easing by the Fed, we are skeptical on the effectiveness of these measures ten years on. We are also of the view that the Fed took too long to start normalising interest rates and that balance sheet has also grown too large to the point that they now have limited ammunition in their war chest should we get another crisis. Against this backdrop of no more rate hike, slowing growth and a potential flight to quality should the next crisis hit, we turned more bullish on US treasuries. We maintain that the treasury curve will fully flatten to an even lower level of around 2.25-2.5%.
The situation in Europe is even more dismal. The above trend growth for a large part of 2018 proved to be short-lived with the ECB now slashing both growth and inflation for this year aggressively to around 1%. At the same time, rate hikes is now pushed back to beyond 2019 even though we were skeptical right from the start whether they can even deliver any hike at all. The toolkit that the ECB has to tackle the next crisis now look even lighter than that of the Fed. Four key leadership jobs including the President of the European Parliament, European Council, European Commission and ECB are set to change hands in 2019. These could hopefully bring about some positive changes but at this juncture we are not holding our breath.
Despite being at the receiving end of Donald Trump’s provocation, China’s nimbleness in diversifying its export markets away from the US has allowed them to cope better than the US in this trade war. More importantly, commitment from the government to maintain stability is strong ahead of the 70th anniversary of the founding of the People’s Republic of China on the 1 October, which means we are likely to hear more positive development coming out of China in the near term. This has been evident so far this year as the government aggressively cut tax while the People’s bank of China launched a bill swap program to help improve liquidity of perpetual bonds issued by banks. As a result, confidence has improved and credit growth has picked up.
The slowdown we were anticipating for the rest of Asia since the start of the year did materialised. The region’s exports tumbled amid a maturing global trade cycle, ongoing trade war between US and China and lower commodity prices. While exports could stabilise should we get a positive outcome around the discussion between the US and China, we need to see a meaningful turnaround in semiconductor sales before we can declare a bottom in the current export downturn. The tightening cycle amongst Asian central banks is now officially behind us as data continues to disappoint in the past few months. In fact market is now expecting rate cuts in countries including India, Indonesia and Malaysia. Inflation is almost non-existent in Asia thereby providing central banks the ability to cut rates aggressively if they need to. While India, Indonesia and Philippines are still running current account deficits, the levels look manageable and are far from those crisis levels during the 2013 taper tantrums. Upcoming election in Indonesia and India may bring about some volatility should we get an upset, though our base case remains that they will be non-event and post-election, we could see some fiscal measures being roll out should the weak growth persists. Thus while challenges remain, Asia looks to be in a relatively good shape to deal with further slowdown especially when compared to the developed nations.
Asian credit has rebounded strongly during the 1st quarter with JACI IG spreads rallying almost 30bps from the peak of the sell-off. Coupled with the even stronger move in US treasury yields the Asian credit as an asset class has delivered exceptional returns for investors. Valuation is now looking less attractive with JACI IG spreads at around 190bps. However, technical backdrop still look very strong and with spreads at 40bps off recent tights, we would not rule out further tightening should credit fundamentals remain stable. The next round of earnings in the coming months should provide further clues as to whether that trend will continue. Our bullish outlook on US treasuries means they should further enhance returns for investors or at least provide a buffer for spread widening should the market retrace. In this quarter, our key focus would be to continue to explore opportunities via the new issue market and further increasing portfolio diversification through high quality names in Hong Kong and Singapore and South Korea. Credit selection and relative value analysis will likely continue be key drivers of excess returns.
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