Asia - Looking Through 2Q Risks

Vaccinations in Asia accelerated in March-April, particularly in Singapore, Hong Kong, and China. But infections have also rebounded sharply, particularly in India, Thailand, Philippines and Japan. These have caused divergences in financial markets – The latter four markets have seen underperformance in recent weeks. By contrast, the markets that are leading in terms of vaccinations have done better since late March. The recent bounce in infections have already pushed back the schedule for travel bubbles and reopening. But Citi analysts believe this delay could be temporary and advances in vaccinations could still bring about more travel freedom in the second half.

Asia’s sensitivities to US and Chinese policy

• Other key risks to look out for include rising US yields and tightening Chinese credit and Citi analysts look at how sensitive Asian equity markets and sectors are to these risks.

• Asian equities generally outperform during periods of rising US long term yields because they were periods of stronger growth. Within the region, it may benefit more cyclical markets and sectors. China had traditionally been the largest beneficiary given its dominant supply chain. But fraught trade relationship with the US may push US demand elsewhere. Australia, Indonesia and Singapore may see more of the benefits. Among sectors, cyclicals like Materials, Industrials, Consumer Discretionary and Energy could benefit.

• Meanwhile, aside from China’s own equity market, Korea and Taiwan are the most sensitive to China’s credit cycle. Japan is the third most sensitive, while US and Europe both have moderate correlation. On the other side, Australia and Southeast Asia tend to be negatively correlated. These are also likely to be beneficiaries of supply chain diversification from China and may be more resilient towards a tightening in China’s credit conditions.

• In both cases, Southeast Asia appear to be well positioned to benefit from US demand and being more resilient to Chinese credit conditions.

Implications for portfolios

• Citi analysts suspect that markets may be range bound in 2Q with some volatility from policy uncertainty, but this is a necessary process as investors get accustomed to a more normal policy backdrop. This is consistent with Citi’s asset allocation changes to re-allocate from markets that have enjoyed strong beta performance, to assets that may deliver growth without being too expensive.

• In summary, Citi’s analysis of sensitivities to rising US yields and to tightening Chinese credit conditions supports a neutral allocation in China, Korea and Taiwan equities, while remaining overweight in Southeast Asia.