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Citi

Going Cyclical in Asia

Investors in Asia have flocked to COVID-19 defensive or growth sectors like technology this year. These companies have benefited from stronger demand due to social distancing and excess liquidity. While Citi analysts believe in their ability to generate solid long term growth, they also see valuations as more fully priced in. In contrast, COVID-19 cyclical or value sectors have lagged significantly. The MSCI Asia ex Japan index is up 6.8% in 2020 up to Aug 26. But among its nearly 900 member companies, 6 out of 10 remain negative YTD.

 

 

Citi analysts expect this relative performance to reverse, at least partially, as re-opening takes place and see 4 main factors supporting this trend

  • Recovery is likely to continue and broaden. Though infection trends still look worrying, there is a potential for effective vaccines in 4Q, with production and distribution in 1H 2021. This could enable broader reopening, more recovery in jobs, and a return of economic activity.
  • Policy remains supportive. Policymakers may still focus on recovery in the coming 12 months. The Fed is committed to maintaining low interest rates to meet their mandate of maximizing employment and stable inflation. Additional fiscal stimulus are still forthcoming.
  • Longer term interest rates are likely to rise and the yield curve is likely to steepen. As economic activity and inflation normalize, long term interest rates are likely to rise, with 10yr US treasury yield likely to exceed 1% within the coming year, while short term rates are anchored by the Fed and other major central banks.
  • USD is likely to remain on a weakening trend. Aside from short term volatility, the USD has likely embarked on a weakening cycle that is likely only halfway complete.
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Favor large caps in EM Asia

  • Unlike in the US, Asia’s small and mid cap (SMID) stocks actually outperformed the large caps by decent margin through the rally since the March low, while the YTD performance was similar to the overall index. This is partly due to different market structures in Asia, where COVID-19 defensives and cyclicals are much more balanced (around 50/50) in both SMID and large cap markets, whereas US tech giants hold dominant position in S&P 500.
  • The outperformance of SMIDs was even more evident in the Chinese market, as CSI SMID 700 surged 27% YTD, while large caps lagged with 15% (as of Aug 26). The CSI SMID 700 had a higher proportion of growth stocks – IT and healthcare – weighing 34.1%, versus 20.6% in the large cap index. Citi analysts suspect that the stellar outperformance is unlikely to repeat as a broader recovery unfolds.

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