This article first appeared in Personal Wealth, The Edge Malaysia Weekly on July 15, 2019 - July 21, 2019

The turbulent geopolitical climate continues to dominate the headlines, sparking fears of an impending global recession among investors. While investment experts believe the risk of recession remains contained, they say trade tensions are expected to impact the growth of regions such as Asia and the US.

Yuejue Jin, senior investment specialist for multi-asset solutions at JP Morgan Asset Management in Hong Kong, says her base case economic view is one of slightly sub-trend growth, moderate inflation and easy monetary policy. “The tail risks around this view have increased and the balance of risks is tilted negatively. However, we do not expect a recession over the next 12 months, even though the recent inversion of the yield curve is one of many leading indicators contributing to a moderate increase in recession risk.

“However, with geopolitics and trade issues in particular increasingly driving the macro outlook, we must concede that there are currently elevated levels of risk in our macroeconomic projections.”

Building an optimal portfolio against this backdrop presents a challenge as the outlook for returns is constrained by low rates and modest earnings growth, says Jin. “Moreover, given that the global economic outlook is heavily influenced by geopolitics, the environment is not necessarily supportive of taking meaningful relative value risk. As a result, paying close attention to the volatility and correlation across asset classes is essential to maintaining risk-adjusted returns and appropriately sized portfolio risk.”

While the risk of recession is higher now than at the beginning of the year, strong economic data suggest that the risk of one occurring in the near term is relatively contained, she adds.

Jonathan M Liang, senior investment strategist for fixed income at AllianceBernstein Holding LP in Hong Kong, says populist sentiment around the world continue to fuel geopolitical tensions, with the current trade dispute between the US and China being just one symptom of that trend. The consequences are a slowdown in global growth, as businesses scale back on capital spending in response to policy uncertainty, and potential disruption to global supply chains, he adds.

Asia is expected to bear the brunt of the circumstances as a result of the region’s greater sensitivity to global trade, says Liang. “Conversely, the US may not be as affected due to the relatively low contribution exports provide to the economy. However, if tariffs do rise, there may be a short-term increase in the price of US consumer goods.

“We expect the US economy will likely see a slowdown in growth, primarily driven by a decrease in business spending in response to policy uncertainty. Already, the latest manufacturing surveys in the US are showing a marked slowdown in activity.”

Emerging markets beyond Asia are less likely to be directly impacted by the ongoing trade negotiations between the US and China, but they will be indirectly affected by the slowdown in Chinese economic growth, says Liang. “However, China has already taken steps to loosen both monetary and fiscal policy. So, we are not expecting a ‘hard landing’ in China but rather, a gradual slowdown of growth to about 6% this year.”

Value Partners Ltd’s senior fund manager Philip Li says slower growth in China will inevitably affect regional economic activities. The escalated trade tensions have also added negative pressures within the region.

Globally, however, developed economies are expected to adopt more accommodative monetary policies following a year of quantitative tightening as a prolonged low interest rate era will continue to cushion slower growth, says Li. “In Asia, we expect that an interest rate cut is a possible measure in countries like Indonesia, while countries such as China will remain flexible on monetary and fiscal easing. Having said that, we believe a recession is an unlikely event.”

On the massive selloff of Asian equities in May, Li says the broad-based selloff in stock markets that are reliant on the Chinese economy was not unexpected following the uncertainties arising from the US-China trade tiff. “It also offered a good excuse for the market to take profit after a solid equity market performance in the first few months [of this year].”

The pause in interest rate hikes has worked to suppress the already low-volatility foreign exchange market to levels not seen in the last five years.

Manish Jaradi, senior investment strategist at Standard Chartered Bank in Singapore, says it is difficult to expect volatility to continue trending lower from its current levels. “We see the US dollar as key to this outlook. After years of being supported by rising US interest rates, a pause or temporary turn in the cycle could lead to a weaker dollar. We see this as most beneficial to the euro and many emerging-market currencies. But this may come with somewhat higher volatility than what we have been used to recently.”

Silver lining

Despite the risks, it is not all doom and gloom. For one, emerging markets are expected to benefit from potential US Federal Reserve rate cuts this year, says Liang. “That would likely preclude the US dollar from strengthening further, which in turn may allow certain emerging markets to also cut interest rates.

“From a fixed-income perspective, investors may want to deploy capital to areas least affected by the ongoing trade tensions from a credit perspective, and also capture opportunities from potential interest rate cuts by central banks in response to the slowdown in global growth.”

He adds that certain US credit sectors may provide a respite from the current trade tensions as the economy is relatively less dependent on trade. Asian credit markets, which may be caught in the cross hairs of the ongoing trade tensions, could also benefit from fiscal and monetary policy loosening in China.

Value Partners’ Li says the US stock market selloff in May pulled back some quality and non-trade-related sectors to more attractive valuation levels. He sees great bottom-up stock-picking opportunities after the recent correction.

More specifically, Li says the firm favours high-quality companies — fundamentally strong leaders of their industries that are able to weather uncertainties. This includes players in the education and healthcare sectors.

With no indication of interest rate hikes occurring in the near future, StanChart’s Jaradi says the US dollar is expected to weaken. “However, falling bond yields and the likelihood of at least limited Fed rate cuts mean this source of support is likely to erode.

“We expect the euro to be the main beneficiary of this change in trend, even if there are few changes in the eurozone from a yield or policy perspective, though the yen is likely to see limited strength as well. Emerging-market currencies — particularly those like the rupee, which offers high yields and an improving external balance — are likely to be significant beneficiaries as long as the yuan remains stable.

“We are also bullish on the pound sterling, with the main driver likely to be an avoidance of a hard-Brexit outcome later this year.”

These issues and strategies will be discussed at The Edge-Standard Chartered Market Outlook Forum 2019, titled “Navigating the New Normal”, on July 20 at the JW Marriott Hotel Kuala Lumpur.

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