3rd September 2015
The world is currently focused on the slowdown in Chinese growth which can be mainly attributed to falling manufacturing production though some of the impact is mitigated by expansion in the services sector writes Luca Paolini, Pictet Asset Management…
Our overall view on China is that while the structural trend is clearly pointing lower for the economy and we expect gross domestic product to stay below potential for some time, the rate at which it is deteriorating is slower.
Industrial production has turned moderately stronger since the first quarter of 2015 and house prices and sales have also improved so we think the Chinese economy is through the worst.
There are significant risks to consider, however, given widespread questions about the quality of official data from Beijing and the fact that the economy is very uneven, with some sectors and regions booming while others slump, rendering headline growth figures relatively meaningless.
With the world focused on the turmoil emanating from China and the impact this is having on other emerging markets, we have decided to scale back exposure to emerging market local debt, downgrading it to a single underweight.
The move is accompanied by an upgrade for the second consecutive month of European high yield bonds to a single overweight. We retain our overweight position in emerging hard currency debt as we still think this asset class offers good value relative to developed market bonds without the FX risk associated with local currency debt.
The big issue facing bond markets this month has been the impact of Beijing’s policy responses to Chinese financial market turmoil and slowing economic growth. Few in the markets expected the recent devaluation of the currency and it appears to indicate high level panic about the ineffectiveness of previous interventions.
We consider it likely that a further devaluation will follow. A near 5% adjustment of its daily fixing point is unlikely to be sufficient to turn around an economy as big as China’s and this led us to alter the composition of emerging market currencies in which we take short positions. Where we were previously short commodity producers, we have now taken negative stances on manufacturing exporters such as Korea that compete with China and will find the going tougher when faced with a devalued yuan.
We see more value in European high yield where spreads are looking more attractive at around 460 basis points. High yield was an early mover in the selloff and we believe it could be one of the first asset classes to rebound. The creditworthiness outlook for European high yield issuers is more benign than their peers in the US given the smaller weight of energy companies and continued support from European Central Bank actions.