Investors keep wary eye on recession risks and China’s confidence woes

I was recently on a business trip to Australia and Asia, meeting with investors across the region. In general, they shared many of the same views in their outlook. There is a concern that developed economies face a moderate recession risk following a year of monetary tightening. This is reflected in their investment stance. Most people do not have an overweight position in equities. Fixed income is viewed more favourably with a peak in interest rates in sight. Also, there is a common view that no major asset allocation decisions are likely when cash offers a reasonable return and credit and equity markets are not seen as particularly cheap. The performance of equity markets was widely discussed. Most investors seem surprised at how strong returns have been, particularly when the default macro view is that a recession might be on the horizon. There is an understanding that the performance of the US market has largely been driven by technology stocks and the frenzy around artificial intelligence. On that, investors seem open-minded. Non-technology experts understandably do not see all the potential benefits and risks from AI, but they seem sympathetic to the view that it has the potential to provide non-linear growth for those businesses directly in the AI supply chain and those that are able to use AI to boost productivity and profitability. At the same time, few investors want to chase the AI frenzy when all other macro indicators are negative for short-term equity returns. My trip started in Australia. The Reserve Bank of Australia (RBA) has been raising interest rates since May 2022, taking rates from close to zero to a current target for the cash rate at 4.1 per cent. Market expectations are for the RBA to take rates to around 4.5 per cent. ‘It’s never been this bad’: what’s behind Australia’s looming mortgage crunch? Headline consumer price inflation reached 8.4 per cent in December 2022 and has since fallen to 5.6 per cent in May. Forecasts have it falling towards 3 per cent in 2024, in line with expectations for the United States and Europe. This is good for Aussie bonds – the current benchmark 10-year bond trades with a yield of more than 4 per cent, just shy of the highs it reached in 2022. These are decade-high yields at a time when inflation is falling and thus are attractive for local pension and insurance funds. Another big discussion is what happens to the housing market. Australia has a similar mortgage market to the UK, with loans tending to be on fixed rates for two to three years. Just like the UK, there is a wave of refinancing of mortgage loans ahead at much higher rates. This will hit household cash flow and the housing market. There is clearly a risk of declines as housing finance conditions tighten. Is that enough to cause a recession? The forecast for GDP growth in 2024 is around 1 per cent, so a modest recession is very much on the cards, especially as commodity prices have also fallen this year, hitting revenues to the mining sector. China was the last stop on the trip. The most common questions asked in Beijing and Shanghai were around whether foreign investors would be willing to increase their exposure to Chinese assets and whether geopolitical concerns were the main constraint. China’s post-Covid economic health check My view is one of the reasons at the crux of the lack of enthusiasm for Chinese equities is that the post-pandemic recovery has been disappointing so far and this is reflected in the performance of Chinese stocks. Investors in the West got the recovery trade wrong. Lockdowns might have left long and deep scars on confidence in China. In contrast to the situation in Western economies, lockdowns lasted longer and were not accompanied by the same level of financial generosity from the government. Consequently, households and businesses have emerged with stresses on cash flow and balance sheets. The property sector remains troubled. Many are looking to the government to help the recovery, but so far this has been limited to some modest easing on the monetary side. There are structural challenges as well, around demographics, debt levels and job creation. None of this is likely to change the stance of foreign investors in the immediate future. In the longer term, there are interesting things happening in terms of the green transition in China and around the country’s need to respond to the controls put on its technology exports. These will provide potential opportunities in Chinese equities, but the near-term macro outlook and the uncertain geopolitical outlook will provide major hurdles to inflows. Chris Iggo is chair of AXA Investment Managers Investment Institute and chief investment officer of AXA IM Core