Focusing on Asia, below we examine three market trends we believe are likely to shape markets and direct investor flows in 2023.
China’s re-emergence
All eyes will be on China in 2023, and despite the myriad of challenges it is facing, there are reasons for optimism. The world’s second-largest economy may prove to be countercyclical to the global growth slowdown; its ongoing easing of monetary policy and mild inflation offer room to support its growth recovery from an expected 3 per cent in 2022 — versus 5.5 per cent in wider Asia — to potentially 5 per cent in 2023.
The implications of China successfully re-starting its economy stretch well beyond its borders, into wider Asia and around the world — Europe in particular. The potential uplift the economy could enjoy from a reinvigorated export market, domestic services and consumption could be very powerful, and global markets should help alleviate some of the supply chain issues, in turn easing inflationary pressures. Chinese equities have room to rally too, given the market has been derated to historic lows, with the Shanghai Composite down some 27 per cent over 2022.
Recent optimism has seen stocks move higher, but any rebound is unlikely to happen in a straight line, as questions remain over how smooth China’s growth journey will be from here. Investor concerns about the housing market downturn, deglobalisation, technology restrictions, private-sector policy and an ageing population will keep China’s potential growth in focus beyond excitement about the long-awaited reopening, which is itself creating concerns over the impact of a new surge in COVID-19 cases.
Harnessing bond yields
Hedging costs are increasingly directing investor flows globally, notably in Asia. Given the global backdrop of tightening monetary policy, with the exception of Japan and China, in 2022 we witnessed a shift in Japanese investor preference away from US dollar-based assets increasingly into euro-based assets and Japanese government bonds (JGBs). With the Federal Reserve hiking interest rates faster than other central banks, the US dollar was a major outperformer in 2022; the dollar index posted its biggest annual advance since 2015, and the dollar itself strengthened against every G10 currency. This has made US dollar assets hedged into local currency less attractive.
However, the European Central Bank initiated its monetary tightening cycle well after the US, making euro assets more attractive on a hedged basis, due to the narrower interest-rate differential. Therefore, as US dollar interest rates are higher than those in Europe, the cost for Japanese investors to hedge their dollar holdings are higher than that for euro holdings.
Simply put, investors get less yield in Japanese yen from US dollar bonds than from euro bonds. Hence, we have observed an increasing preference for euro bonds in 2022, which we expect to continue in 2023, as the policy gap between the US and Eurozone is not expected to close. Tellingly, in November, Japanese institutional investors offloaded a net 1.9 trillion yen ($14.1 billion) of overseas debt, marking an all-time high, as JGB’s assets are becoming more attractive. We expect this trend away from particularly US dollar assets to accelerate if the BoJ were to completely end its yield curve control. Japanese money would be more inclined to stay at home, which could put pressure on US dollar bond yields.
ESG momentum
Few asset classes emerged unscathed from 2022 and portfolios targeting environmental, social and governance (ESG) factors were no exception. As we enter 2023, we think ESG themes are likely to benefit from the aftermath of the pandemic and the Ukraine war, as the focus hardens on energy transition and food security, as well as reshoring trends provoked by geopolitics. We also expect social themes to gain more attention, as the deteriorating labour market and the impact of inflation bring potentially harmful consequences. Companies want to do more in this area for their consumers — and their investors — while asset managers are developing more sustainable investment products to meet the ever-growing demand from clients of all types.
In Asia, the landscape is evolving, with companies, investors, regulators, and other stakeholders working together to put frameworks in place that allow for transparent and accurate ESG information flow to drive change. We see this as an exciting journey to be part of, and an opportunity to make a real impact. Asia as a region is economically and culturally diverse, and it is expected that the transition risks and impacts of climate change will not be distributed equally among the nations.
The pathways for transition will be unique to each country. Participation and ESG disclosures by corporates in Asia are improving rapidly — for example, when we look at the Task Force on Climate-Related Financial Disclosures (TCFD), which helps guide corporate ESG reporting, out of 3,400 pledged TCFD supporters worldwide, nearly 25 per cent of the companies are in Japan, with around 10 per cent from across Australia, Singapore, India, Hong Kong and Mainland China.
At the same time, investors are finding a growing universe of ESG-integrated and green assets in which to invest, and this is only going to grow in Asia and worldwide. Globally, the green bond market hit a US$2 trillion milestone at the end of the third quarter, and some estimates see issuance reaching US$5 trillion per year by 2025.
Ecaterina Bigos, CIO of Asia (ex Japan), AXA Investment Managers
