Update on the impact of the coronavirus crisis on fixed income and equity markets in Asia
by Fabrice Jacob, CEO of JK Capital Management Ltd., based in Hong Kong
Asian bonds suffered severe price falls last week as a wave of de-risking swept across global markets. As cases and fatality rates of the COVID-19 virus began to accelerate across the world and the majority of western developed economies began to implement aggressive lockdowns of their populations, the stark reality of the economic impact of disease began to take root. The Asian USD bond asset class which had managed to trade through the initial China outbreak with a degree of relative stability and even outperformance in February and early March, began to see a significant pick up in volatility last week following the sharp asset price devaluations in US and Europe. Concerns over the potential unwinding of leveraged hedge funds positions exacerbated the situation, particularly in the US where large ETF exposure to the US bond market resulted in a significant increase in indiscriminate selling of both high yield and investment grade bonds. Meanwhile the ability of sell side institutions to provide market liquidity buffers has been severely limited on the account of Dodd Frank rules, imposed in the wake of the 2008 financial crisis. Unsurprisingly, in such an environment, fixed income assets have begun to see their prices meaningfully diverge from fundamentals and despite signs of a stabilization of the virus outbreak in China, any outperforming sectors in Asia have unfortunately provided little relief from a global bearish sentiment and liquidity driven sell off.
However, it should be noted that, however tragic the news flow appears now, markets will ultimately find their floor when the virus inevitably stabilizes, particularly given the massive levels of monetary and fiscal stimulus at virtually every major financial hub in the world. In one encouraging sign in the Asian high yield market, we have started to see announcements of corporate bond buy backs and while these bids have so far come at significant discounted valuations, this trend proved to be one of the key catalysts of driving eventual market stabilization during the similar market crash of 2008. With poor liquidity dominating through global credit markets, as evidenced by extremely wide bid/offer spreads, maintaining a strict focus on corporate fundamentals and maintaining dispassionate stance asset price valuation will ultimately prove to be a key determinant in navigating these extremely challenging times.
The situation is slightly better on the equity front as the main equity markets across the Asia region have remained highly liquid. The A share market of China (Shanghai and Shenzhen) is outstanding in this regard, outperforming very significantly the rest of the world so far this year. It is worth remembering that the A share market is largely domestic-driven (foreign participation remains in the single digits), and that China is ahead of the world in fighting the coronavirus. The Chinese government managed to re-open approximately 80% of its economy after more than two months of lock-down and is focused now on economic stimulation. As Bloomberg put it in an article on 23rd March, “China is swimming in cash with cheapest funding since 2006”, which is in sharp contrast with the situation in the US where the yield gap between US commercial paper and risk-free rates is at its highest since the 2008 global financial crisis.
Hong Kong, Taiwan and Korea have also remained very liquid as local investors in these markets (both retail and institutional) tend to be very cash rich. They are attracted by what they might perceive as being a once-in-a-decade buying opportunity. In other words, any foreign investor who wants to sell any of these markets will probably find a local buyer. The stability of the Chinese RMB and of the Taiwanese dollar are other reasons why these two markets are relative safe haven.
It is in South East Asia (India, Indonesia, Thailand, Malaysia, Philippines) that the situation is more complicated as the currencies of these countries have suffered strong bouts of depreciation over the past few days, triggering intense selling pressure from overseas investors without much of a local bid. A number of companies in these markets went limit-down day after day, and saw their trading suspended as a result, even though an oil price at $22 a barrel should be a reason for them to celebrate. These markets could be described as being totally dislocated, valuations being meaningless. This explains why China funds are typically outperforming Asia funds these days.
The critical question on everyone’s mind is whether we are going to see a second wave of outbreak in China. Unfortunately, the situation in Korea, Singapore and Hong Kong has deteriorated over the past few days as nationals of these countries came back home from Europe, brought back the disease and disregarded quarantine discipline.
However, the situation in China seems to be under control, and that is the most important news for the rest of the world that is watching closely as it stands on the edge of a precipice.
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