Resilience amid volatility: Asia holds its breath

Emerging markets hang tough amid market disruptions

While many market observers are convinced volatility is here to stay, some sellside analysts see this as hints of a shortening economic cycle – a cyclical adjustment that may end early next year

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2 Oct 2018

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Global market disruptions in the face of rising interest rates, massive deleveraging and the US-China trade war have brought an end to investor complacency. The waves of emerging market sell-offs have added to the bearish sentiment for credit investors and their sellside advisors. For a select few, the past many months have been an opportunity to showcase their skill and acuity.

Although heavily impacted by fiscal and monetary policy shocks in the US, Asian emerging markets performed better than those in Latin America, Europe, Africa and the Middle East, sellside individuals say in a survey led by Asset Benchmark Research.

Some of the sellside individuals suggest that the long-term potential for capital growth from Asia’s large population and fast-growing companies continue to offer compelling arguments to retain exposure in the region, despite market volatility and challenges that routinely impact its markets. 

“We expected Asia to outperform other emerging markets like Latin America and they have done so,” says Nitin Pahwa, a trader at Goldman Sachs. 

One of the most damaging trends witnessed in the past few months was the non-discriminatory flight of global investors’ capital from the emerging markets. Global investors’ “undifferentiating eye” on Asian countries was, to some extent, unfair given that each market bears its peculiar risks. 

“People have looked at all emerging markets through the same lens, delineating very little between countries with and without real issues. Asia is a combination of emerging markets and developed markets and a blanket approach doesn’t work here,” says a trader at BNP Paribas. 

“If the international investors had differentiated the Asian countries properly, some markets should not have been penalized as much,” says Ding Shuang, chief economist focused on Greater China and North Asia at Standard Chartered Bank.

The capital flight has resulted in thinner liquidity for Asian emerging markets. “Trades tend to be one-way with many clients flipping new issues. Liquidity has been poor and often can’t move off-the-run. My impression is both buyside and sellsides are either flat or down,” says Judy Zhu, a sales executive at Jefferies.

“Thinner liquidity in Asia credit also results in volatile markets, often extending the spillover effect to the rest of the market space, which then moves in sympathy. Definitely not a poised and easy market to trade in this year,” says Audrey Wu, a sales executive at Morgan Stanley.

With the indiscriminate sell-off and thin liquidity in Asia, especially in the high yield space, Asian credit investors are piling into short duration high-quality papers to ride out the storm. 

“Given the flat yield curve, investors have stayed defensive in short duration buckets and also in higher rated bonds,” a trader in Mizuho Securities notes.

New issues, meanwhile, receive frosty receptions in some pockets of the market, as Meggy Losaria, a salesperson at ING, points out: “Investors are definitely more selective now with new issues, especially Chinese new issues. The short-dated high grade paper remains a boring, but in-demand sector.”

Sell-off pressures that sprouted out of Turkey to infect Asian bond markets caught some investors off guard. Carry trades have been a popular, albeit complacent way to lock in sizeable gains for years. As a result, investors tended to neglect fundamental analysis, so that now only papers that are perceived as safe are deemed fair play.

“Credit investors will be more demanding and selective going forward as risks become more apparent. Credit selection based on fundamentals will be increasingly important as investors will look carefully at each issuer on a case-by-case basis and their ability to repay or refinance. The expectation of relying on liquidity as a backstop for the market will no longer be enough,” says Vince Littke, a trader with Bank of America Merrill Lynch.

Meanwhile, the China bid’s diminishing impact on high yield bonds has not gone unnoticed.

“Investment grade credit has held its ground as well as could be expected given its overall rating and strong local ownership. High yield has come under higher pressure due to stretch valuations that had been distorted before by China onshore bids. With lower demand from China onshore investors and still heavy supply, high-yield valuations have corrected to a more reasonable level,” observes Soo Chong Lim, analyst at J.P. Morgan.

The key to cpoe with market volatility is diversification, many sellside individuals say. Without a critical mass of investors taking a contrarian view to the market, secondary trading volume will remain thin for many papers and concentrated on a few blue-chip securities. A more diverse view means trades can be done at preferable prices while providing liquidity during a rout.

“Given the general lack of liquidity in secondary trading, investors that can take a contrarian view would be able to get trades done at preferred prices (while acting as a liquidity provider). I think Asia needs more contrarian investors,” an analyst at Barclays notes.

Many market observers are convinced that volatility is here to stay. But some analysts referred to this process as the shortening of the economic cycle, predicting that the ongoing cyclical adjustment will end this year or early 2019. Asian markets will recover eventually and the potential upturn could last by 2020 before descending into another period of downward adjustment in 2021. 

The current volatility, thus is a good opportunity to gain further exposure in Asia.

“Asia has seen a much-needed correction in the high-yield complex, which has created some opportunities and made valuations look attractive again. Comparatively, the US high yield market has had a stellar year and things are looking toppish. The fundamental story in Asia remains intact. Earnings continue to be good. Overall, China deleveraging has helped sentiment. We have seen more credit differentiation, but that is healthy for the market,” says Megha Goyal, a sales executive in Morgan Stanley.

Given that each country has its distinctive market dynamic, the tough business landscape implies that Asian sellside individuals should more than ever develop and offer unique trade ideas.

For Asian investors the message is to focus once more on fundamental research and diversify holdings.

Date

2 Oct 2018

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