Merge by RHB | Hunting for yield in a low interest rate environment

It has been more than a week since the 2020 US presidential election has been called, and although the results have yet to be officially certified by the electoral college, it is fairly certain that Democrat candidate Joe Biden has successfully defeated incumbent President Donald Trump with 306 electoral votes at the time of writing. While the Trump campaign is currently preparing a litany of legal charges to contest the results, the likelihood of any impactful outcome is low.

For the House elections, the Democrats retained control of the House of Representatives, but saw the Republicans eat into their majority. As for the Senate elections, the Republicans are currently holding a slim lead of 50-48, but there is a chance that the Democrats can successfully flip control at the January runoff elections by winning the two seats for Georgia, as the newly elected Vice President Kamala Harris would have the ability to cast the tie-breaking vote.

Risk sentiments have improved under the likely government split of a Democratic president and House plus a Republican Senate. First, it suggests that most investors are looking through the risk of a serious legal challenge and the possibility of civil unrest. This may be premature but we tend to favour this position.

Also, a Republican Senate implies no major tax hikes — which is good for corporates — and RHB believes that Big Tech will be getting an added boost on the lower likelihood of regulatory constraints or even breakup. Although the odds of a massive fiscal package would be smaller under the current scenario than a blue sweep, this also means a lower supply of US Treasuries to support the fiscal deficit. Hence, we are likely to see a period of low rates (that is, low borrowing costs) and low taxes, which are beneficial to corporates.

“Given the intensifying economic, technological and geopolitical rivalry between the US and China, we believe that tensions between the two countries will continue regardless of the election outcome,” says Tan Jee Toon, chief investment officer for Asia-Pacific equities at RHB Asset Management in Singapore.

“While the strategy remains the same between the Republicans and Democrats, their tactics differ. In the initial months, Biden will have to continue playing internal politics so as not to appear ‘too soft’ against Beijing. Nonetheless, a Biden win would still be a more positive outcome for Asian countries, especially for China, as his approach towards US-China relations would be more diplomatic, predictable and rules-based.”

As the US elections get out of the way, investors’ focus will return to the recovery of the global economy, which is under threat again from resurging Covid-19 infections. Worldwide cases of the virus have just surpassed 50 million while the total number of cases in the US crossed the one million mark on Nov 9. Increasing Covid-19 cases have pushed European governments to once again start imposing national measures.

Until Dec 1, people in France will only be allowed to leave their homes to buy essential goods, for medical reasons and to exercise for an hour a day. Unlike the first lockdown, however, schools and nurseries will remain open. In Germany, Angela Merkel’s administration has imposed a partial lockdown since Nov 2, which will last for four weeks. Bars and pubs will close while restaurants will remain open for takeaways only.

Spain has imposed a national curfew (11pm to 6am) since Oct 25 while Italy has shut down several services and limited operating hours for bars and restaurants for a month since Oct 26. British Prime Minister Boris Johnson announced that the UK will enter a second lockdown on Nov 2, making the country the latest in Europe to impose new national restrictions.

Vaccines and cures remain the wildcards for a sustainable global economic recovery. Globally, 11 vaccines are now in Phase 3 clinical stage trials, according to WHO’s Nov 12 report. On Nov 9, Pfizer Inc and BioNTech SE announced that their Covid-19 vaccine was more than 90% effective based on trial data while Moderna announced that its trial vaccine was 95% effective in combating the virus. A subsequent announcement by Pfizer on Nov 18 said its vaccine had ended trials with 95% efficacy and the company would push for deliveries to start before Christmas. Although the numbers are highly promising and warrant some optimism, there are many hurdles — such as production, distribution, safety and effectiveness — which need to be cleared.

RHB Asset Management retains our view that global growth will be severely impacted due to the Covid-19 pandemic, with inflation to remain largely depressed throughout the rest of this year and 2021. Monetary policy is likely to remain accommodative across both developed-market and emerging-market economies in the near to medium term.

The International Monetary Fund expects global growth to fall 4.4% in 2020, 0.5 percentage points above its June projection as it is projecting a somewhat less severe, though still deep, recession in 2020. Global growth for 2021 has been cut by 0.2% to 5.2%. The focus for policymakers has shifted from targeted emergency support to broader demand-boosting stimulus. This could help the economy cope with pressures from a still-struggling private sector and limp domestic demand. How far domestic demand will fall, and for how long, is difficult to predict and will depend on the pandemic, as well as the timeliness and effectiveness of government actions.

The different stages of outbreak around the globe signals that external demand may remain a considerable drag until most countries are out of their respective lockdowns. Global markets continue to witness volatility with heightened geopolitical tensions while monitoring how reopening unfolds. Countries that have the most stringent policies also experienced the largest declines in their PMIs, pointing to the need to balance “lives” versus “livelihood” of individuals and businesses.

Given the context, RHB believes the broader focus will be more on income preservation in the light of lower interest rates for longer as economies begin the move towards sporadic and, hopefully, sustained recovery from the devastating effects of Covid-19.

Within developed markets, we continue to like the US as it has relatively more policy space versus other developed markets. We also like Asia ex-Japan on prospects of growth uptick and within which, we favour China.

The speed and effectiveness at which China was able to deal with the virus while avoiding wide-scale shutdowns mitigate the downside risks that concerned the market. China is in the early stages of restarting its economy and has more policy space to revive activity, but RHB will remain cautious due to the possibility of renewed US-China tensions, even as a new president takes the reins.

RHB remains constructive on the outlook for Asia bond markets going into 2021, both on a fundamental and a relative valuation basis. In general, given its stronger fundamental profile, many Asian countries are holding up better than many other emerging markets in this crisis. Ample global liquidity as evidenced by the US$14 trillion worth of negative yield bonds and investors’ hunt for yield in a depressed yield environment would be supportive of Asia bonds.

Asia USD credits stand out in terms of both credit spreads and relative value basis versus other major bond markets. Asia USD investment-grade bonds offer an extra 40 basis points in credit spread versus their counterparts in the US. The absolute yield of 8.25% from Asia USD high-yield bonds (Bloomberg Barclays Asia USD High Yield Index) is also more attractive than the 5.78% yield offered by the US Corp High Yield (Bloomberg Barclays US Corporate High Yield Index) as at Oct 30.

Although RHB is currently overweight investment-grade Asian bonds versus high yield, we are increasing our exposure to the high-yield sector on a selective basis as we believe the worst is over.

In China, we prefer both the bonds issued by core central state-owned enterprises (SOEs) and the high-yield bonds issued by select Chinese developers. The SOEs we favour are of strategic importance to the country.

Despite the less-than-certain outlook, we are very constructive on the outlook for the Chinese property sector. The Chinese property developers in our portfolio have stronger branding, land bank (mostly in tier 1 and tier 2 cities as well as selected strong tier 3 cities in fast-growing regions), sales execution and funding access compared with their smaller and weaker peers. Thus, they are expected to continue outperforming the broader market and gain market share as weaker developers are forced out of the market.

With higher nominal and real yields, in addition to potential stronger currency versus the USD, RHB is also constructive on some of the Asian domestic bond markets such as the MYR and CNY local currency bonds. With the US Federal Reserve pledging to keep its policy rate unchanged at current levels until at least 2022, we will see increasing investor interest in emerging-market yields, which are still decent compared with those of developed markets.

MYR bonds are attractive from a real- yield perspective, given the benign outlook on growth and moderate inflation. Yield-hunting strategies by global investors could potentially see foreign inflows into the MYR bond market.

Accessibility to the onshore Chinese CNY bond market is improving and the market is starting to garner the attention of many international fund managers. CNY internationalisation is an important part of the 14th Five Year Plan and given its economic prospects, we expect the CNY currency to strengthen and this will enhance the attractiveness of CNY bonds.

On a cautious note, the negative impact of Covid-19 is far from over, and a number of weaker Asian countries are still adversely affected by the economic and fiscal fallout from the pandemic crisis. Their situation is exacerbated by the limited access to funding. We would stay underweight on countries such as Sri Lanka.

To tackle the adverse impact of the virus on domestic economies, a number of Asian countries have started experimenting with quantitative easing. Although a significant one-time increase in fiscal measures, funded by the central bank, is understandable in the current extreme situation, such policies may open a Pandora’s box. RHB will be monitoring these countries closely for their fiscal and monetary discipline.

In conclusion, given these political uncertainties and a pandemic that is far from over, bonds remain relevant and will continue to have a role in any investment decision. Based on an individual’s risk appetite, RHB offers a variety of bond fund strategies — funds that invest in Malaysian bonds, sukuk, emerging market bonds, China bonds, US bonds, Asian high-yield and US highyield offer different returns and risk characteristics.

Investors need to take into consideration the investment horizon, risk and geographical location to select funds that would suit them in view of the fact that interest rates, including fixed deposit rates, will continue to be low for a longer period of time.

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