Investment Strategies

"Great Divergence" Ahead As China Loosens Policy, Fed Tightens

Tom Burroughes Group Editor 20 January 2022

Different paths of monetary policy in the world's largest and second-biggest economies will be a dominant theme weighing on asset allocators and wealth advisors this year. Indosuez Wealth Management explores the forces at work.

North American and Chinese markets will diverge this year as the US Federal Reserve begins to tighten monetary policy while Beijing opens the taps to revive growth. South Asian countries are likely to be more sensitive to US rate hikes than is the case with North Asian countries due to different economic exposure, investment figures at Indosuez Wealth Management said yesterday.

This week, China’s central bank cut its key interest rate for the first time in almost two years, bolstering an economy that is losing steam. The People’s Bank of China made a 10 basis-point cut, coming before gross domestic product data showing a rise of 4 per cent in the final quarter of 2021 from a year earlier, higher than the 3.3 per cent rise projected by economists but slower than in the previous three months. Meanwhile, hot inflation figures in the US have prompted the Fed to bring forward the wind-down or “tapering” of its quantitative easing programme, with rate hikes in the offing.

“We have a huge amount of divergence,” Davis Hall, head of capital markets, Asia at Indosuez Wealth Management, said in a webinar presentation on his firm’s investment and market outlook. “The world seems very much out of sync.”

With nominal interest rates so low, real rates – allowing for inflation – are deeply negative in countries such as the US, creating bubble conditions in a number of markets, Hall said. He predicts at least three rate hikes in the US this year.

Geopolitics and the lingering impact of COVID-19 could affect the euro-dollar rate. A possible loss of Democrat Party control in the House of Representatives and Senate this November could see a less fiscally expansionary policy in the US. On the other hand, countries such as Germany, now in left-liberal hands, could become more expansionary, Hall said. The dollar-euro rate has the capability to move up to €1.16 from about €1.13 where it is now, he said. Elsewhere, he said, the price of gold could ease in the short-term if US official interest rates rise, but longer term the prospects for the yellow metal are supportive, given the sheer amount of dollars the Fed has printed in recent years.

Asia play
Asia should be able to outperform US growth in 2022 and China is boosting growth after the regulatory clampdowns on certain sectors, such as IT, gaming and finance, last year, Winnie Chiu, senior equity advisor at Indosuez WM, told the same webinar. The firm is neutral on Asian and Chinese equities overall. She said that the regulatory moves from Beijing, which rattled international investors last year, appear to have peaked. Beijing policymakers could announce fresh stimulatory measures when they gather in March, she said.

The firm is attracted to US firms which are able to post upward earnings revisions, since they tend to fare well in a rising rate environment, as past data shows. In particular, Chiu said that Indosuez likes sectors such as financials – banks’ margins improve when rates rise – and technology hardware. Other, more long-term secular growth themes remain compelling, such as cleantech and “Green” energy, she said. 

Asked whether rising US interest rates will hurt Asia – as has happened in the past – Chiu said that Asian countries today have far healthier current account balances than was the case 20 or 30 years ago. And, within the region, North Asian countries such as South Korea and Japan have had less interest rate sensitivity than southeast Asian nations.

Inflation and technology
While rising inflation is a concern, Ryan Landolt, senior equity advisor, warmed to the theme of history pointing to how adopting transformative technologies can be deflationary, reducing costs as new efficiencies kick in. 

This year, value stocks should beat growth stocks as economic conditions prove more challenging; there are opportunities to be found in Europe in particular, Landolt said.

Hall added that rising oil prices could be a bigger headache for investors than is currently appreciated. A range of factors, such as tensions in the Middle East (Saudi/Yemen) and Ukraine, could see oil prices going higher, with OPEC producers having a limited ability or desire to offset this with higher production.

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