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Asia assets still firmly on strategists' radar - with caveats

While Asia valuations are yet to peak, trade tensions cast a pall

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ASIAN equity and fixed-income assets are firmly on the radars of investment strategists in 2018. But the gathering storm, precipitated by impending tariffs on US$60 billion worth of Chinese goods approved by the US President Donald Trump, has cast a marked pall over the outlook.

As at mid-March, China has indicated that it would retaliate. Hot on the heels of the US decision, it announced a relatively modest US$3 billion list of US goods in response. It also appeared to be open to negotiations.

This year, Asia stocks have weathered a rocky ride, going from a stellar start in January to a steep correction in February, and a more even keel in recent weeks. The escalating trade skirmish, however, may well wipe out year-to-date returns.

As at March 22, the MSCI All Country Asia ex-Japan index showed a year-to-date return of 2.79 per cent. The MSCI AC Asia Pacific Index is up 1.62 per cent in the same period.

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OCBC's global fund flows update up to the first week of March found that equity inflows into Asia ex-Japan remained strong, attracting US$1.2 billion in fresh funds. It remains to be seen if flows will reverse substantially. China, in particular, benefited with a share of US$479 million worth of inflows, although this was significantly smaller than the previous month's inflow of US$1.7 billion.

Economists note that the US plan to impose 25 per cent tariffs on US$50-60 billion in annual imports from China is likely to have a "relatively moderate" impact on China, as a Morgan Stanley commentary says. The firm's China economist Robin Xing estimates that the tariffs could weigh down export growth by 0.7-0.9 percentage points, which translates into a drag of 0.12-0.14 percentage points on GDP growth. "We believe the response from China will likely remain pragmatic."

Still, a column by State Street Global Advisors head of policy and research Elliot Hentov and portfolio manager Esther Baroudy is far from sanguine. They wrote that the imposition of tariffs on aluminium and steel imports and the latest action against China "marks a new phase of the trade dispute" between the two nations.

"We believe that unlike previous periods of trade tensions, this time is qualitatively different and could have significant and lasting implications for companies in China, certain sectors in the US and global investor portfolios."

In any case, investor sentiment - until recently bullish over Asia - is likely to suffer a blow. Strategists are advising investors to be diversified and consider portfolio insurance such as put options.

UBS global chief investment officer Mark Haefele said investors had actually expected tariff announcements of between US$30 billion and US$60 billion, with tariffs potentially higher than the 25 per cent indicated by the Trump administration. He said much of the market weakness following the announcement may be momentum based.

"We think it's important not to overstate the direct impact of these tariffs on the global economy or equity markets at this stage... The global economy is entering this period of increased trade tensions from a position of strong growth. 2018 is still expected to be the strongest year for the global economy since 2011."

He said the tariff announcement is not definitive. "Thus we view this as the beginning of a long process towards an eventual resolution. At this time investors should also ensure portfolios are well diversified and could consider equity put options to reduce portfolio volatility."

Patrick Ho, HSBC Private Banking Asia investment strategist, says Asia ex-Japan remains the bank's geographic pick within global equities for the year. He expects global government policies to continue to drive synchronised growth.

"This is clearly true in Asia ex-Japan where the governments of China and India continue to spend on infrastructure, both digital and logistical ... Asia ex-Japan has compelling valuations of 13 times of consensus estimate earnings for 2018, attractive especially to investors who are concerned about valuations of developed markets."

Mr Ho sees four key investment themes for the region. First is the rise of the Asian middle class. Emerging Asia, he said, will contribute 50 per cent of long term global growth, but account for 90 per cent of the global middle class by 2023. There is also the theme of innovation in China; China reforms which include reform of state-owned enterprises and deleveraging; and Belt and Road opportunities.

Credit Suisse APAC chief investment officer John Woods said China is likely to seek to actively negotiate with the US to avoid damaging valuable trade flows. In the longer term, "we should expect trade disputes to increase in frequency and severity". "A potent trifecta of populism, population aging and technology - all feeding on each other - suggests we're at the start of a period of heightened volatility.

The good news, he added, is that process of economic rebalancing is likely to accelerate in China and Asia, "leading both to become less reliant on and less susceptible to the volatility of global trade. Asia as a whole could end up in the healthier state of being more focused on supporting the growth and development of a services based, consumption driven economy."

James Cheo, Bank of Singapore senior investment strategist, notes that markets are bad at pricing geopolitics and trade tensions. "There is a need to manage risk from an investment strategy perspective. Investors should be nimble to adjust their positions should the situation deteriorate. At this stage, investors should stay engaged."

On a portfolio context, holding more cash will help to tide over the period of uncertainty. "On equity exposure, invsetors can manage risk by rotating out of companies with high exposure to US-China trade, that are vulnerable to trade risk." W

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