Searching for bright spots in the Asian economic picture
23 August 2017 | Markets and Economy
Commentary by Qian Wang, PhD, Vanguard Chief Economist, Asia-Pacific.
Each year, Vanguard issues a report outlining our views on the global economic and market outlook. Our 2017 paper forecast a fairly placid environment compared to the upheaval and anxiety of the recent past.
Recently, my US-based colleague Andrew Patterson gave a mid-year assessment, stating that the global economy 'looks a little less fragile' than it did at the beginning of the year, and seeing 'a relatively bright picture' in most major markets – particularly in the United States, where memories of the Great Recession are receding, and Europe, where a measure of optimism is finally evident after a decade of economic and political crisis.
In the Asia-Pacific region, the picture is somewhat less positive, though as always there are hopeful signs here and there, if you know where to look.
China: Slowdown, but no 'hard landing'
In China, economic growth likely peaked earlier this year, so Vanguard expects a gradual deceleration in the near term. We attribute this primarily to cooling investment growth in real estate and infrastructure.
While some market participants are increasingly concerned that the recent wave of tightening financial regulation may compromise economic growth, Vanguard still does not anticipate a 'hard landing' in the PRC for 2017–18. As long as the government maintains capital control, the central bank continues to inject liquidity when needed, and banks keep supporting debt rollover of the state-owned enterprises (SOEs), a tipping point is unlikely to come any time soon.
Looking ahead, maintaining stability on all economic fronts (especially financial, growth and capital flows) will be the most important policy objective heading into China's 19th National Party Congress, to be held in Beijing this autumn.
However, we believe focusing too much on near-term growth stability will eventually lead to further slowdown in productivity growth for China in the long run. Important market reforms are needed to correct distortions in resource allocation. Our recent Global Macro Matters analysis takes a close look at another key to improved economic productivity for China: Reform of SOEs, in which declining efficiencies and diminishing returns to credit continue to drag down growth.
Japan: Tailwinds and headwinds
Japan has benefited from a combination of fiscal stimulus, firming global demand, a weaker yen and other factors so far this year. Nonetheless, Vanguard believes these tailwinds are unlikely to be sustained. Structural headwinds remain strong, including a declining and ageing population, weakening productivity, low return on capital and high debt levels.
Unless there is a real breakthrough in efforts to reform structural economic policy – something that seems unlikely, given recent shakiness in the government of Prime Minister ShinzÅ Abe – Vanguard doesn't expect a significant improvement to Japan's medium-term growth outlook.
The continued fragility of the Japanese economy means the Bank of Japan (BoJ) is unlikely to join in the global return to normal monetary policy in 2017–18, and is likely instead to continue its 'Quantitative and Qualitative Easing (QQE) with yield control policy framework in an effort to boost growth and inflation.
Nevertheless, the BoJ might still consider reducing guidance on government bond purchasing and hiking bond yield targets in 2018–19 as global yields rise and the scarcity issue becomes more prominent.
Emerging markets: Watching China and the Fed
We continue to see strength and resilience in emerging markets. We expect that much of the sector, particularly Asia (ex-China) and Latin America, will experience decent GDP growth, modest inflation and weaker fiscal metrics between now and year-end.
Asia is likely to be the fastest growing region among emerging markets, followed by central Europe, the Middle East and Latin America. Africa will likely display weak growth. While government debt ratios in emerging-market Asia are deteriorating, they still remain lower than many of their developed-market peers. Current accounts are also improving in Asia, with a few countries posting surpluses in excess of 3% of GDP.
For the remainder of the year, Vanguard sees the biggest potential risks to the emerging-market Asian sector as:
- Diminished trade, increased protectionism, rising risk aversion and reduced international capital flows.
- The US Federal Reserve taking much more aggressive action on interest rates than expected.
- A sharper-than-expected deceleration in China.
- Continued diplomatic and military tension in Korea.
What should investors do?
The unevenness of growth in the world's leading economies – the US, China, Europe and Japan – is a testament to the importance of international diversification for investors. The markets, like national economies, rarely move up and down in synchronised lockstep. That's why Vanguard always advises investors to diversify their exposure to the risks (and opportunities) afforded by different global regions.
Periods of relative calm like this can be good opportunities for investors to take a careful look at their portfolio asset allocations. You may find, for example, that recent strong performance in the US equity market has caused your exposure to US-based shares to swell, leaving you more vulnerable to a downturn in the US. If you're overweighted in US assets, a modest pivot towards an underperforming region – Australia or Japan, perhaps – might be in order.
The idea is not to chase performance or respond to every news headline, of course. Rather, it's to make sure your portfolio reflects the diversity and breadth of today's globally interconnected marketplace, and that your exposure to potential risks and rewards reflects your own personal tolerance and expectations.
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