Our views on China’s policy finetuning

We see China’s recent policy loosening as an important shift to a modestly more supportive stance for the near term, yet don’t expect the overall hawkish bias to change as it is crucial in China’s focus on quality growth in the medium term. This is supportive of our views on China: We are neutral on equities and overweight government bonds tactically, and positive on both on a strategic horizon.

China’s slowing growth

Actual and estimated China real GDP, 2019-2022

We debuted our standalone China asset views in our Midyear 2021 global outlook, as we believe it is time to treat it as an investment destination separate from emerging markets (EM) and developed markets (DM). China’s policymakers have held a hawkish stance since mid-2020; China’s economy returned to its pre-pandemic growth trend in late 2020, as shown in the chart. In recent months growth has shown signs of slowing, though last week’s data was largely positive, with better-than-expected June activity data and slower-than-expected second-quarter GDP growth. This may have given Beijing the incentive to frontload policy support in order to stave off a potentially more pronounced slowdown, especially as inflation pressures have eased, in our view. Earlier this month the People’s Bank of China cut the reserve requirement ratio for most banks, or the required amount of cash banks must hold as reserves. We see potential for more, broad-based loosening in the near term, including in fiscal and other policies. Yet we expect a measured approach from policymakers, and see their medium-term hawkish stance unchanged despite the near-term finetuning. A Chinese Communist Party’s politburo meeting later this month will be key to watch.

We see an overall hawkish policy stance as critical to China’s “quality revolution” – an effort to move away from an overriding effort on the quantity of growth toward a greater focus on the quality of growth. China aims to become a more productive economy with each unit of incremental GDP generating proportionately less pollution, inequality and financial risk (debt). This is key to our China asset views. We are tactically neutral on Chinese equities but strategically positive because we believe ongoing reforms in China could weigh on near-term growth but potentially improve its quality in the long run. We are overweight Chinese government bonds on both tactical and strategic basis as we believe China will continue to have relatively high nominal and real yields compared to global peers, thanks to its hawkish policy stance. The persistent inflows to China bond exchange-traded products (ETPs) have underlined the appeal. Year-to-date cumulative flows into global China bond ETPs stood at $14.1 billion as of July 12, vs. a record $16.2 billion in 2020, our data showed. 

Monetary and fiscal policy tightening is just one aspect of China’s overall hawkish policy stance, with the other two being  measures to stabilize property price increases and an anti-monopoly clampdown. Property market policies will unlikely change much, in our view. The anti-monopoly campaign has become a significant market driver, causing China’s tech sector to shed as much as $1 trillion in market capitalization since February. As a result, market positioning has become much less crowded in this space and market pricing now looks to be somewhat reflecting the clampdown. We expect this campaign to continue, but see potential for reduced intensity as the government’s near-term focus shifts to encouraging growth. This renewed focus on growth may also continue to keep credit defaults contained, after the effort to restructure China’s credit markets to nurture more productive companies and a healthier economy has driven an increase in corporate debt defaults this year, in our view.

The bottom line: China’s policymakers may be loosening up policy for the near term, but we still expect them to uphold the hawkish stance over the medium term to advance its quality revolution. Strategically we see a need for dedicated exposures to China as one of the two poles of global. We recognize implementation of our asset views will differ across investor types and geographies, depending on objectives, constraints and regulation.

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Assets in review
Selected asset performance, 2021 year-to-date and range

Market backdrop

U.S. consumer price index (CPI) gained 0.9% in June, the largest rise in 13 years, driven by the unusual supply and demand dynamics amid the powerful economic restart. We expect a higher inflation regime in the medium term – as a result of a more muted monetary policy response than in the past. In a noisy and unprecedented economic restart, volatility in data and market reaction is to some extent expected, in our view. China’s GDP increased 7.9% year on year in the second quarter, slightly slower than expectations.

Week ahead

July 13 – ECB policy meeting
July 15 – Flash purchasing managers’ index (PMI) for the U.S., euro area and UK

Investors will focus on the ECB’s first policy meeting after its strategic review was published. We expect an update of the central bank’s forward guidance on its monetary policy decisions to reflect its shift to a symmetric 2% inflation target, though we don’t expect updated growth or inflation forecast until September. Global PMI data will shed some light on the ongoing restart in activity as growth momentum shifts from the U.S. to Europe and Japan.

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Directional views

Strategic (long-term) and tactical (6-12 month) views on broad asset classes, April 2021

Asset	Strategic view	Tactical view
Equities
We are overweight equities on a strategic horizon. We see a better outlook for earnings amid moderate valuations. Incorporating climate change in our expected returns brightens the appeal of developed market equities given the large weights of sectors such as tech and healthcare in benchmark indexes. Tactically, we stay overweight equities as we expect the restart to re-accelerate and interest rates to stay low. We tilt toward cyclicality and maintain a bias for quality.

Credit
We are underweight credit on a strategic basis as valuations are rich and we prefer to take risk in equities. On a tactical horizon, credit, especially investment grade, has come under pressure from tightening spreads, but we still like high yield for income.

Govt Bonds
We are strategically underweight nominal government bonds as their ability to act as portfolio ballasts are diminished with yields near lower bounds and rising debt levels may eventually pose risks to the low-rate regime. This is part of why we underweight government debt strategically. We prefer inflation-linked bonds as we see risks of higher inflation in the medium term. We are underweight duration on a tactical basis as we anticipate gradual increases in nominal yields supported by the economic restart.

Cash
We use cash to fund overweight in equities. Holding some cash makes sense, in our view, as a buffer against supply shocks driving both stocks and bonds lower.

Private markets
We believe non-traditional return streams, including private credit, have the potential to add value and diversification. Our neutral view is based on a starting allocation that is much larger than what most qualified investors hold. Many institutional investors remain underinvested in private markets as they overestimate liquidity risks, in our view. Private markets are a complex asset class not suitable for all investors.

Notes: Views are from a U.S. dollar perspective, March 2021. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any particular funds, strategy or security.

Our granular views indicate how we think individual assets will perform against broad asset classes. We indicate different levels of conviction.

Tactical granular views

Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, March 2021

Equities

Asset		Tactical view
United States
We are overweight U.S. equities. We see the tech and healthcare sectors offering exposure to structural growth trends, and U.S. small caps geared to an expected cyclical upswing in 2021.

Europe
We are neutral European equities. We believe the broad economic restart later in the year will help narrow the performance gap between this market and the rest of the world.

Japan
We are underweight Japanese equities. Other Asian economies may be greater beneficiaries of a more predictable U.S. trade policy under a Biden administration. A stronger yen amid potential U.S. dollar weakness may weigh on Japanese exporters.

Emerging markets
We are overweight EM equities. We see them as principal beneficiaries of a vaccine-led global economic upswing in 2021. Other positives: our expectation of a flat to weaker U.S. dollar and more stable trade policy under a Biden administration.

Asia ex-Japan
We are overweight Asia ex-Japan equities. Many Asian countries have effectively contained the virus – and are further ahead in the economic restart. We see the region’s tech orientation allowing it to benefit from structural growth trends.

UK
We are overweight UK equities. The removal of uncertainty over a Brexit deal should see the risk premium on UK assets attached to that outcome erode. We also see UK large-caps as a relatively attractive play on the global cyclical recovery as it has lagged peers.

Momentum
We keep momentum at neutral. The factor has become more exposed to cyclicality, could face challenges in the near term as a resurgence in Covid-19 cases and a slow start to the vaccination efforts create potential for choppy markets.

Value
We are neutral on value despite recent underperformance. The factor could benefit from an accelerated restart, but we believe that many of the cheapest companies – across a range of sectors – face structural challenges.

Minimum volatility
We turn neutral min vol. Our regional and sectoral preferences warrant a higher exposure to the factor. Min vol’s underperformance has brought valuations to more reasonable levels in our view.

Quality
We are overweight quality. We like tech companies with structural tailwinds and see companies with strong balance sheets and cash flows as resilient against a range of outcomes in the pandemic and economy.

Size
We are overweight the U.S. size factor.  We see small- and mid-cap U.S. companies as a key place where exposure to cyclicality may be rewarded amid a vaccine-led recovery.

Fixed income

Asset		Tactical view
U.S. Treasuries
We are underweight U.S. Treasuries. The accelerated economic restart has sent yields surging, but we prefer to stay underweight as we expect short-term rates will stay anchored near zero.

Treasury Inflation-Protected Securities
We are neutral TIPS after the sharp rise in inflation expectations since late year. Further increases seem unlikely in the near-term. We still see inflation pressures building over the medium term due to structural reasons.

German bunds
We are neutral on bunds. We see the balance of risks shifting back in favor of more monetary policy easing from the European Central Bank as the regional economic rebound shows signs of flagging.

Euro area peripherals
We are neutral euro peripheral bond markets. Yields have rallied to near record lows and spreads have narrowed. The ECB supports the market but it is not price-agnostic - its purchases have eased as spreads have narrowed.

Global investment grade
We are underweight investment grade credit. We see little room for further yield spread compression and favor more cyclical exposures such as high yield and Asia fixed income.

Global high yield
We are moderately overweight global high yield. Spreads have narrowed significantly, but we believe the asset class remains an attractive source of income in a yield-starved world.

Emerging market - hard currency
We are neutral hard-currency EM debt. We expect it to gain support from the vaccine-led global restart and more predictable U.S. trade policies.

Emerging market - local currency
We are overweight EM local debt as its year-to-date underperformance has left valuations more appealing, particularly if U.S. Treasury yields and the U.S. dollar stabilize. We see limited contagion to broader EM from selected country-specific volatility.

Asia fixed income
We are overweight Asia fixed income. We see the asset class as attractively valued. Asian countries have done better in containing the virus and are further ahead in the economic restart.

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Note: Views are from a U.S. dollar perspective. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.

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