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China’s strong start to 2019

Targeted measures to control the impact of tighter credit conditions in China, combined with a delay to further US trade tariffs on Chinese imports, have markedly improved investor sentiment towards Asian markets. Both China equities and high-yield bonds have had a strong start to the year as a result. But, while debt securities do not need more forceful tailwinds to continue their upward trend, a sustained stock market rally would require an additional boost in investor sentiment. For investors looking to add to risk, it’s the credit market that looks like the better option in the near term, with Asian high yield offering the most compelling opportunities.

While valuations of Asian equities, and in particular Chinese equities, are attractive, earnings expectations still remain relatively high, permeated with hope that recent credit easing measures will halt further declines. This leaves room for disappointment. In addition, it is unlikely that any significant coordinated stimulus will come until after the US-China trade negotiations. That said, a resurgence in northbound flows from Hong Kong to the mainland show signs of improving investor confidence. It may just take longer than expected for that value to be realised.

Protection by selection

Meanwhile, the decline in corporate credit fundamentals for Chinese bond issuers has been modest and manageable. But as always, high levels of selectivity are required. Defaults among issuers reliant on onshore funding access are likely to continue rising, while investing in offshore high-yield bonds benefits from a focus on issuers with generally better balance sheets and funding flexibility.

Investing more broadly across the region’s high-yield market also helps with diversification, and valuations still stack up better than equities. Spread per turn of leverage (a useful valuation metric that incorporates a basic measure of balance sheet risk) for the Asian high yield market remains very attractive, and well above historical averages. As a result, high-yield bonds currently offer a compelling proposition for investors seeking a prudent balance of income and growth.

George Efstathopoulos

George Efstathopoulos

Portfolio Manager