Last year was the year of the dog and that certainly turned out to be the case for Asian markets.
Following a dismal 2018 in Asian equities where the MSCI AC Asia Ex Japan– a benchmark representing Asia without Japan — dropped roughly 15%, many investors are questioning whether last year’s correction offers a buying opportunity or perhaps even more losses in 2019. With the index up during the first two weeks of trading this year, market bulls are feeling confident, while bears are still warning of dangers ahead. Who will be right in 2019?
Let’s begin with the bears.
And These Bears Say…
Market bears argue that world economic growth will fall short of its full potential as the US-China trade war continues in 2019, softening global demand. Policy uncertainty creates anemic confidence for both the private and public sectors, thus delaying meaningful investment and forfeiting any future productivity gains.
Bears note that Asia’s trade data is beginning to look disappointing. The slowdown will force Beijing to implement another stimulus package, but such a move is unlikely to yield meaningful results, given that taxes were already cut last summer.
The US economy, the key global driver in 2018, will decelerate in the year ahead, according to the bears, as the impact of the 2017 tax cuts fades. Tightening labor dynamics and rising import prices will place upward pressure on inflation, supporting the case for higher interest rates. The Federal Reserve views the US economy as healthy and may continue to raise borrowing costs in tandem with reducing the central bank’s balance sheet. Slower growth in the US and higher short-term rates might create downward pressure for the yield curve, a traditional signal for an impending recession.
The bears argue further that geopolitical risk such as Brexit increases demand for safe-haven assets such as US dollars or treasuries. This will keep financial conditions tight and discourages investors from buying market dips. The American political situation will continue to be a source of uncertainty.
…But What Does a Bull Say?
Bulls understand some of these concerns, but argue that most negative variables are generally known and likely priced into valuations. This should limit the downside to current levels.
The US-China trade war is mostly political theater and may not have a big economic impact. Since Asia’s rising intra-regional and domestic demand growth is gradually offsetting non-Asian exports, this will also allow Asia to decouple from developed economies. Policy will likely remain loose in China, with Beijing giving the green light to pro-growth policies since a weak economy undermines party credibility. Most importantly, bulls argue, a hard landing in China will be avoided, because Beijing says so.
The bulls also believe the Federal Reserve will pause its tightening schedule, while still shrinking its balance sheet during this period. This rather positive development would give some relief to non-USD assets, which should benefit emerging markets. Possible OPEC cuts might stabilize oil prices, softening inflation pressure and allowing Asia’s central bank policies to remain accommodative, making Asian equities an attractive investment.
In future articles, we’ll critique both of the bull and the bear arguments in further detail.
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