The fourth quarter has begun with a broad-based selloff in global markets for equities, bonds and currencies. During the latest client call, Claire Teng, Equity Strategist for Asia, J. P. Morgan Private Bank, and Jackey Chan, Head of Investments for China, J. P. Morgan Private Bank, discussed the recent and future market developments, and explored potential investment opportunities and strategies given the current market conditions.
We believe the recent retreat in US stock markets is more of a technical correction induced by: 1) the surging 10-year US Treasury yield and looming inflation fears; 2) concerns about the possible release of negative guidance in the upcoming earnings season; 3) a need for profit-taking and technical correction after substantial gains this year; and 4) the inherent pressure for the US stock market to narrow its divergence with the rest of the world.
Looking ahead, we believe the latest technical correction could persist for a while. However, fundamentals remain healthy in the US stock market: 1) S&P 500 earnings growth is still very strong. With the help of tax cuts, we expect the growth to exceed 20% in 2018 and reach 8%–9% in 2019; 2) Inflation and interest rates are both rising at a steady and measurable pace. Markets could pull back temporarily to digest the trend, but an unexpected collapse seems unlikely; and 3) While interest rates are an important factor to watch, we do not see any major risks or concerns in global markets and the US economy that would lead to a stock market crash.
Therefore, we expect US equities to regain strength after a short-lived selloff. However, markets are likely to see increased volatility and limited upside in the later stages of the current economic cycle. Investors should keep a close watch on opportunities that may arise from a potential sector rotation or oversold rebound in 2019 and at the same time avoid overreaching for risk.
Both onshore and offshore Chinese stocks are already pricing in a possible 25% tariff hike for all goods imported from China to the US. Still, we see a risk of further deterioration in the current trade tensions from two aspects: 1) the US has already reached a new trade agreement with Mexico and Canada and may seek to work out similar arrangements with Japan and the EU, leaving China more isolated on trade negotiations; and 2) The recent tough speech by US Vice President Mike Pence is seen by many as a de facto declaration of a cold war with China, fuelling concerns that the Sino-US relationship could continue to worsen. However, we cannot rule out the possibility that the harsh comments could merely be a mid-term election strategy.
Nonetheless, we believe Chinese stocks may stage an oversold rally after a sustained period of weakness, based on the following considerations: 1) after the mid-term election, the US and China may return to the negotiating table and reach some kind of consensus on resolving their trade disputes; 2) a possible meeting between China and US leaders at the upcoming G20 summit may ease the current strains in the relationship between the two nations; and 3) Historically, there has been no lack of technical rebounds in Asian stock markets, even in the most challenging years like 2000 and 2001. That said, trade tensions could take a toll on China’s economic data and corporate earnings in mid-2019, triggering another selloff in Chinese stocks.
First, we believe the rise in the 10-year US Treasury yield above 3% should be a reflection of the healthy economic fundamentals, such as an improving labour market, rather than a sign of an imminent recession. Second, following the Fed’s clear guidance, markets are already pricing in three or four interest rate hikes in 2019. We believe this should help mitigate the potential market impact of future rate hikes. Third, we think the recent spike in long-end yields was mainly driven by short-term technical factors. The recent selloff in stock markets could trigger a "flight to safety" into Treasury markets, bringing down Treasury yields. We believe 3.1%–3.2% might be considered as an acceptable level of yield for 10-year US Treasuries. If the yield rises to 3.4%–3.5%, we are likely to see some collateral damage to risk assets.
We expect the renminbi to depreciate slowly against the US dollar to partially offset the impact from an escalating trade dispute. The USD/RMB exchange rate is unlikely to breach the 7 mark until 2019. We believe the depreciation of the Chinese currency is not the decision of the People’s Bank of China, but an inevitable result of the current economic situation. The depreciation pressures not only come from a narrowing interest rate gap between China and the US on the back of policy divergence, but also from a fad among multinational companies to move businesses and money out of China as trade tensions threaten to disrupt global supply chains.
Tech stocks ended 2017 with stellar performance and rich valuations, which have given rise to an overly bullish view of the sector. The recent selloff has brought their valuations down to more reasonable levels. Apart from excessive optimism, other catalysts for the selloff include: 1) worries about Chinese economic conditions and trade tensions; 2) regulatory pressure from the halt of new games’ approvals and the new e-commerce law; and 3) the margin drag from tech companies’ new investments to seek more growth drivers.
In the medium/long term, however, we remain upbeat on the growth prospects of the tech sector. Historical data shows that the sector has been consistently delivering attractive returns during the market's ups and downs. We remain positive on leading tech companies for their strong industry positions, sustainable earnings power and growth potential from new investments. We believe the recent pullback presents a good opportunity to buy shares in these companies, but it is important for investors to control their exposures and seize the right timing to buy.
(1) Keep emotions in check
First, it is important for investors to avoid blindly following others when it comes to making investment decisions and throw in a bit of contrarian thinking during periods of higher market volatility. In order to make the right judgment and decision, investors need to stay calm and rational while others panic, look through all the noise and remain focused on their personal goals.
(2) Avoid overreaching for risk
Second, considering higher market volatility in a late-cycle environment and greater risks facing Asia than the US, we advise investors not to employ too much leverage in their portfolios so as to avoid severe short-term losses.
In addition, investors may use hedging strategies and set a hedging budget in their portfolios to protect returns from downside risks. For now, investors can still pay an acceptable cost of hedging in exchange for more stable returns in their portfolios.
(3) Diversification is key
Third, we continue to highlight the importance of diversification in mitigating the volatility of investment portfolios. To successfully navigate the growing trade tensions, Chinese investors may consider diversifying away from RMB-denominated assets and into those denominated in USD or other non-RMB currencies. In the meantime, investors may consider allocating to short-duration bonds that are less exposed to the risk of rising interest rates, alternative investments that are capable of delivering consistent, absolute returns in volatile markets, such as hedge funds and private equity funds, or other products that can protect portfolios against downside risks.
This material is for information purposes only. The views, opinions, estimates and strategies expressed herein constitutes the judgements of Jackey Chan and Claire Teng based on current market conditions and are subject to change without notice, and may differ from those expressed by other areas of J.P. Morgan. This information in no way constitutes J.P. Morgan Research and should not be treated as such.
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