With the US election most likely converging towards a Joe Biden victory, combined with a freshly-inked regional trade deal and positive vaccine news, Asia received a series of positive developments over the past week that should provide a strong tailwind for the region’s equity and fixed income assets. We believe the momentum will continue to drive returns higher in the near and longer term; investors should be overweight the whole zone.
A normalization of US foreign policy
Following the likely victory of Joe Biden in the US presidential election, emerging markets should benefit from a political environment that is set to become more benign and less uncertain. Under President Trump, Washington had adopted a punitive and unpredictable approach with regards to China: the US administration had placed tariffs on hundreds of billions of dollars of products, imposed sanctions on Chinese companies and restricted Chinese businesses from buying US technology. As a result, the region has been crippled by weak sentiment and global demand.
Under President Biden, the stance on China will probably remain firm as recent remarks from Biden suggest that he would continue to take action against Beijing. However, we expect a significant change in tone and style that should lead to a normalization of the US-China relationship and give more stability to the region. The US will likely adopt a more conventional foreign policy, working smoothly with traditional regional allies in order to contain Chinese ambitions. In recent years, the Trump administration was regarded as unreliable for Asian countries. The new administration will probably focus on working with democratic allies instead of bullying the whole region through impulsive and unforeseeable tweets.
The world’s largest regional free-trade agreement: Regional Comprehensive Economic Partnership
After nearly a decade of negotiations, fifteen Asian nations finally came together to sign the Regional Comprehensive Economic Partnership (RCEP). It is the world’s largest regional free-trade agreement, accounting for nearly a third of the world’s population and over USD 12tn in trade flow. RCEP includes all 10 members of Asean, along with Australia, China, Japan, New Zealand and South Korea. The RCEP is the first free trade agreement between China, Japan, and South Korea and is the first multilateral free trade agreement to include China.
The agreement covers trade in goods, investment and e-commerce, intellectual property, and government procurement. The goal is to reduce tariffs and red tape among its members in order to facilitate international supply chains and trade within the region. While the agreement will not lead to large cuts in tariffs, it would unify rates, taking the region closer to a trading zone like the EU or North America. RCEP noticeably excludes India, which dropped out of the discussions. India’s key concerns were that competition from China would affect its domestic industries. India, though, will be allowed to rejoin the trade pact at a later stage if it is willing to.
An effective control of the pandemic
We remain also supportive of Asian markets, as the region's control of the pandemic has thus far been more effective than in other parts of the world where strict lockdowns are returning. We believe that the arrival of a vaccine will not fundamentally change the situation in the short term.
The US is declaring around 150,000 daily new cases, while China, Japan, South Korea and South East Asian countries have all largely controlled the pandemic. This can partly be credited to policymakers’ swift action: the closure of borders, contact tracing and mandatory quarantining. The region’s mild Covid-19 outbreak also owes to a unique mix of other factors. Stay-at-home and social distancing orders were strictly obeyed as a patriotic duty. That is clearly apparent in the universal adoption of masks since very early in the crisis. The successful containment could also be in part due to culture: most of Asians traditionally greet without touching, while hugging and kissing in public is rare throughout the region.
Attractive yields differentials
A US presidency led by Joe Biden with a republican senate is probably the best possible scenario for emerging market assets. A democratic government is likely to keep interest rates low for a long time and increase government debt, thereby weakening the dollar to the benefit of developing countries’ currencies. The central bank message is that monetary policy will remain as accommodative as possible and we should expect further easing over the winter.
In this prolonged low yield environment, investors should consider increasing their allocation to Asia in order to take advantage of the high rate differential with the US and Europe. Many central banks have cut interest rates, but there is still room for further rate cuts and nominal and real yields are high compared to the rest of the world.
We are particularly favorable towards Russian, Chinese and Indonesian local currency debts where nominal and real rates are high and currencies are expected to be stable over the next year.
Emerging markets had found themselves in a tough spot over the last year. Trade war, weak global demand and a pandemic have caused severe economic contractions and weak sentiment. However, it seems that now the wind has turned and many short term and long term catalysts are aligned to provide a strong tailwind for the region. We therefore encourage our investors to be overweight Asian debt and equity assets.
This article has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The article cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact Probus Group to discuss these matters in the context of your particular circumstance. Probus Group, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this article or for any decision based on it.