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Manulife InvestChoice – 2022 Q2 Asset Class Outlook

April 2022

Quarterly Asset Allocation Views1

Equities

We still like equities and remain overweight, albeit less so than the previous quarter. Also, we have adjusted our allocations within the asset class. The Russia-Ukraine conflict (and its repercussions) amount to a stagflationary economic shock, impacting a global economy at the time already suffering from painful inflation and signs of a looming growth slowdown. We have increased conviction to our existing call that the first half of 2022 – particularly the second quarter – could be mired in stagflationary dynamics (lower growth and higher inflation), as well as persistent volatility, and more frequent bouts of risk aversion.

Furthermore, we lower our conviction that the second half of 2022 will see an easy return to a “Goldilocks” scenario (stable growth and lower inflation). Energy, metals, natural resources as well as relatively more defensive equities have stood out. We are relatively more positive towards US equities (less growth impact from Russia sanctions versus other regions) and select Asian equities and agriculture (commodity-exporting markets, such as Indonesia, Thailand, and the Philippines).

  • Valuations across emerging markets have rapidly adjusted to price-in levels of geopolitical risk not seen in decades, plus the potential impact of higher energy prices on growth via inflation. Although geopolitical crises tend to be short-lived in terms of their overall impact on markets, the nature and scope of further sanctions and potential for a protracted military campaign mean the effect on Russian and Eastern European share prices is likely to be prolonged.
  • Russia is a significant exporter of oil, gas, aluminum, platinum, and nickel. Ukraine, once known as the breadbasket of the world, is a major exporter of grain. The immediate increase in commodity prices and potential for sanctions-related supply disruption will impact inflation, consumer spending, and ultimately growth and financial conditions globally. Much of Asia (notably India) is dependent on imported oil, and Europe is vulnerable given its dependence on Russian energy supplies, closer links with the Russian financial system, and euro weakness. With their loan books and exposure to Russia, European banks and financial-service companies should be monitored in the face of a Russian default. Current levels of uncertainty would suggest that ongoing heightened volatility lies ahead.
  • Within developed markets, US equities are favoured over their European counterparts. We believe the US will be minimally impacted by sanctions against Russia, although signs of a financial deleveraging in the face of liquidity withdrawal by the US Fed still need to be watched carefully. Within the US, the energy and defence industry should see higher substitute export demand. For example, the US will play a more important role given the ban on Russian oil exports, as it can provide shale gas in lieu of natural gas from Russia.
  • Given weaker economic growth momentum, coupled with ongoing geopolitical uncertainty, we expect equity markets to experience heightened volatility. However, markets with significant exposure to energy and materials (as inflation hedges) and consumer staples (as a defensive play) may find some insulation thanks to higher commodity prices.·      
  • Within emerging markets, we are relatively more positive towards select Asian equities commodity/food-exporting markets, such as Indonesia, Thailand, and the Philippines. 

Fixed Income and Alternatives

Given the weak return profile of government bonds, coupled with the fact that the balance of risks is slightly to the upside (for yields), we maintain a modest underweight in this space, underweight duration but less so than in previous quarters. In the longer run, we believe that yields will continue to move modestly higher as the US Fed continues to tighten its monetary policy, further warranting an underweight in the asset class. Credits still remain a preference with spread opportunities in Asia as well as still attractive yields within US fixed income given a resilient US economy.

  • The prospect of aggressive rate hikes is now lower, and the US Fed is expected to raise interest rates by only 25 basis points in March (50 basis points had been anticipated). Also, we think that bonds look more favourable, and our overall allocation has been revised to less of an underweight.
  • We assume current geopolitical events and stagflation do not lead to a severe recession, at this point. However, a rapid deterioration of the conflict and more severe sanctions against Russia may significantly weaken the global economy (subject to the scale of the conflict and its duration).
  • We believe the US high-yield market has the potential to deliver relatively better performance versus risk assets like equities, as it is better compensated under rising inflation. Also, US high yield has a lower default potential, as these bonds have a greater exposure to oil and gas sectors, as well as a relatively stronger US economy.
  • Meanwhile, floating-rate bonds (beneficiaries of a rising rate environment), China renminbi government bonds (a stable exchange rate and higher coupon rates), and preferred securities (a fixed income-like product with higher coupon rates) are also expected to be more resilient than risk assets.·       
  • Other income-generating asset classes, such as REITs, will be supported, as rate differentials (REIT yields minus government bond yields) should narrow at a slower pace than before.
  • We view commodities from two perspectives, both as hedges and diversification tools. We expect commodity prices, such as oil and agriculture products, to remain elevated on the back of supply disruptions and geopolitical tensions. Commodities with inflation-hedge properties, like precious metals (gold and silver), oil, and farm products will perform better.
  • At the time of writing, the macro-outlook and geopolitical events are still highly fluid. The odds of slower growth and higher inflation are increasing, and investors should seek active management and diversification to reshape their portfolios for an evolving investment landscape.

Cash

We believe the low short-term rates make cash a relatively unattractive asset class.

Quarterly Fund Managers’ Views

Below market views are provided by the respective fund house.

Equity



The Fed raised interest rate by 25bps in policy meeting in March as expected. As we have long communicated, higher inflation and an increase in rates driven by economic growth is a net positive for physical assets, which in turn could support the fundamentals of REITs. Historically, REITs have also acted as hedge to inflation as their dividends could grow alongside the economy.

During the last US rate hike cycle from December 2015 to December 2018, Asia REITs as measured by FTSE EPRA/NAREIT Asia ex Japan Index registered a 43% total return1, outperforming the 29% of Asia equities1 as measured by MSCI Asia ex Japan Index over the same period.

That being said, concerns on higher energy and food inflation driven by recent geopolitical conflicts could have an impact on the rate response by central banks, which is something that we will monitor closely. The investment case for Asia REITs remains with the recovery in real estate operating metrics and increased visibility and improvement of the income as borders reopen progressively over the course of 2022.  

Within major REIT market in Asia Pacific, we continue to favour the Singapore on its relative valuation and the reopening recovery theme. The Singapore economy continued to bode well with Q4 2021 GDP growing by 6.1%2 yoy, the highest among major Asia Pacific REIT markets. The Singapore government is also expected to make bolder steps on loosening social and travel restrictions once the current Omicron outbreak peaks and subsides, which should be supportive to the REIT market.

Hong Kong REITS market saw broad weakness as the local Omicron situation worsened. However, we believe the upcoming government consumption vouchers could provide a relief for retail landlords as they are expected to provide rental concessions following the tightened social-distancing measures introduced. The Hong Kong government has announced a fresh round of HK$10,000 vouchers for 2022, of which HK$5,000 will be distributed in April and the remainder mid-2022.

Against this backdrop, we believe neighbourhood malls in Hong Kong are deemed to be more resilient and defensive as they are not dependent on discretionary spend or tourism.

1 Bloomberg, as of 16 March 2022. Asia REITs measured by FTSE EPRA Nareit Asia ex Japan index (capped); Asia Equities measured by MSCI Asia ex Japan Total Return Index. Based on monthly data.
2 Bloomberg, as of 16 March 2022.

The Russia-Ukraine conflict and the start of the US interest rate hike cycle have led to choppy trading in Asia’s stock markets. Still, Asian dividend stocks have remained relatively resilient, supported by economic and corporate earnings growth.

The ongoing conflict in Ukraine and other nations’ response to Russia are exacerbating the global supply shortage of oil, gas and other commodities, adding pressure to inflation in a number of markets and dampening the outlook for Europe. Geopolitical uncertainty will likely persist in the near future, but we believe Asia’s economies will continue to reopen, supporting corporate earnings growth alongside attractive valuation, boding well for Asian equity dividend.

We see opportunities in three types of Asian dividend-paying stocks:

1.      Value: financial stocks such as banking and insurance currently present value as they stand to benefit from a rising interest rate environment. Meanwhile, return-on-equity is generally a key focus, supporting potential dividend payout over the longer term.

2.      Quality-at-reasonable-yield (QARY): These companies generally present robust earnings growth momentum and a sound dividend record, driven by good corporate governance, effective cost management and the ability to adjust prices based on demand. For example, digitalisation and the deployment of 5G are driving robust chip demand for smartphones and the Internet of Things, benefiting the semiconductor sector.

3.      Defensives, or bond proxies: Asian real estate investment trusts with sound fundamentals generally have lower volatility while presenting more yield opportunities than US Treasury.

Diversification remains key in the Strategy and we can harness multiple dividend opportunities in Asia Pacific, while navigating different market conditions. From a theme perspective, we are currently more exposed to dividend-paying stocks with value to capture opportunities amid rising rates. Geographically, we continue to remain overweight in Hong Kong, Singapore and Australia as these markets generally present relatively more income opportunities.

The information contained in this document does not constitute investment advice, or an offer to sell, or a solicitation of an offer to buy any security, investment product or service. Informational sources are considered reliable but you should conduct your own verification of information contained herein. Forecasts, projections and other forward looking statements are based upon current beliefs and expectations. They are for illustrative purposes only and serve as an indication of what may occur. Given the inherent uncertainties and risks associated with forecast, projections or other forward statements, actual events, results or performance may differ materially from those reflected or contemplated. The Strategy is actively managed; holdings, sector weights, allocations and leverage, as applicable are subject to change at the discretion of the Investment Manager without notice.

Investment involves risk. Past performance is not indicative of future performance. Please refer to the offering document(s) for details, including the risk factors before investing. This document has not been reviewed by the SFC. Issued by JPMorgan Funds (Asia) Limited.

Fixed Income



The Fed raised interest rate by 25bps in policy meeting in March as expected but surprised the market by the six more hikes signaled for 2022 which effectively locked in a 25bps hike at every remaining meeting this year.

Historically, preferred securities are less sensitive to interest rates. During rate hike cycles in June 2004 to May 2006, and Dec 2015 to Dec 2018, preferred securities were up 10% and 10.4% respectively1. There are three reasons for preferred securities to perform well in rate hike cycles.

1.      The relatively higher coupons provide extra carry, compensating for the reduction in bond price when rates rise. 

2.      Preferred securities with fixed-to-floating coupons offer coupon protection from rising rates and lower the overall duration.  

3.      The preferred market is dominated by financial issuers, which benefit during rate hike cycle.

While the rising rate environment may provide tailwind for preferred securities, economic uncertainty has also increased as the geopolitical conflict in Ukraine has tempered investor expectations. Having said that, recent volatility creates buying opportunities for high quality names. We believe constructing a high-quality portfolio with compelling yield is vital in the face of headwinds and could lay a good foundation for pickup when volatility wanes.

We remain positive to the overall market as preferred securities are usually issued by high-quality companies that have strong balance sheets, and we expect the strong investor demand together with fewer supply this year should eventually stablise the market. We also remain constructive on corporate fundamentals overall which continue to be supported by accommodative central bank policies and strong investor demand.

Preferred securities offer a combination of attractive yield characteristics, interest rate risk mitigation, inflation-hedging potential, and portfolio diversification. With investors willing to look beyond the traditional areas of fixed income, preferred securities have become an attractive alternative. 

1 Bloomberg, as of 16 March 2022.

High yield markets posted negative returns in the first 2 months of 2022 as investors remained anxious about inflationary persistence and the growing probability of stagflation. Russia’s invasion of Ukraine added to market volatility. However, comparing to its European counterpart, the US high yield market reacted to the Ukraine crisis relatively calmly.

The US high yield market is underpinned by 3 drivers. The first is credit fundamentals are strong: net leverage remains at historically low levels, interest-coverage ratios are at record highs and cash balances are comfortable. The second factor is that the Ukraine crisis is not heavily impacting the US high yield market. The businesses of many mid-cap and smaller issuers are domestic in nature and less exposed to global events. The third driver pertains to the solid fundamentals and outperformance of the energy sector, which is providing material support to the broader high yield market. Energy accounts for over 13 per cent of the US High Yield Index1.

In addition, the supply-demand picture for US high yield is supported by technical factors. Over the year to date, the supply of new high yield bonds is down by over 60 per cent. This comes in the wake of strong market conditions in 2021 that allowed companies to refinance. As a result, many issuers choose to sit out the current market volatility. On top of that, several rising stars will be departing the high yield universe and heading to the investment grade space.

However, investors still need to be cautious. Amid the heightened geopolitical uncertainty, inflationary dynamics, the Fed’s policy stance and how it impacts the yield curve, we believe that liquidity is key. Also, the interplay between inflation and credit fundamentals is crucial, and we are keeping a close eye on margins and sector performance. In conclusion, careful credit selection remains vital.

1 Source: Fidelity International, 9 March 2022

Multi-Asset



The U.S. Fed raised their policy rate by 25 basis points at the March meeting, as had been widely expected. The new dot plot shows a median projection for the benchmark Fed funds rate to end 2022 at about 1.9%, and rising further to about 2.8% in 2023. In our view, the Fed is signaling a much faster pace of tightening in the face of significantly higher than previously anticipated inflation of 4.3% this year1.

We’re still of the view that policymakers’ concerns over high inflation will ultimately give way to worries about slower growth or other stagflation dynamics (lower growth, higher inflation). We believe that geopolitical events and a stagflation outlook will not lead to a global economic recession at this point. However, a rapid deterioration of the conflict, and more severe sanctions against Russia may significantly weaken the global economy (subject to the scale and duration of the conflict).

Global yields are now higher, credit spreads are wider, and equities are lower, which opens a great opportunity for an income investor to consider a multi asset income solution. The portfolio will continue to be flexible, investing across the capital spectrum and different geographies to achieve the distribution yield2.

Fixed income: High Yield credits, which, by their natural makeup are less sensitive to higher rates, lower duration vs higher quality bonds. Credit risk (defaults) remains the key risk amongst the cohort, and as such hasn’t been impacted as much by the drive to raise rates by the Fed given high(er) inflation prints.

Equity: The equity exposure in developed markets across global sectors which will help weather through broad market volatility expected over the year.  In addition, the blend of growth and value stocks tends to be somewhat defensive.

Option writing: The tactical use of option writing, writing call options on top of the equity basket, or writing puts on a cash basket allowing for harvesting option premium opportunities.

Assuming current geopolitical events and stagflation do not lead to a severe recession, we believe the US high-yield market has the potential to deliver relatively better performance versus risk assets like equities, as it is better compensated under rising inflation. Also, US high yield has a lower default potential, as these bonds have a greater exposure to oil and gas sectors, as well as a relatively stronger US economy. Although signs of financial deleveraging in the face of liquidity withdrawal by the US Fed still needs to be watched carefully.

1 Source: Bloomberg, as of 18 March 2022.

2 Source: Manulife Investment Management, as of 28 February 2022. Information about the asset allocation and portfolio holdings is historical and is not indication of the future composition. Due to rounding, the total may not be equal to 100%. Diversification or asset allocation does not guarantee a profit nor protect against loss in any market.

1 Source: Multi-Asset Solutions Team (MAST) in Asia, Manulife Investment Management, as of March 2022. Projections or other forward-looking statements regarding future events, targets, management discipline or other expectations are only current as of the date indicated. There is no assurance that such events will occur, and if they were to occur, the result may be significantly different than that shown here. 

Disclaimer – Quarterly Asset Allocation Views

Manulife Investment Management is the global wealth and asset management segment of Manulife Financial Corporation. The information and/or analysis contained in this material have been compiled or arrived at from sources believed to be reliable but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness or completeness and does not accept liability for any loss arising from the use hereof or the information and/or analysis contained herein. Neither Manulife Investment Management or its affiliates, nor any of their directors, officers or employees shall assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained herein.

This material was prepared solely for educational and informational purposes and does not constitute a recommendation, professional advice, an offer, solicitation or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security. Nothing in this material constitutes investment, legal, accounting or tax advice, or a representation that any investment or strategy is suitable or appropriate to your individual circumstances, or otherwise constitutes a personal recommendation to you. The economic trend analysis expressed in this material does not indicate any future investment performance result.   This material was produced by and the opinions expressed are those of Manulife Investment Management as of the date of this publication, and are subject to change based on market and other conditions. Past performance is not an indication of future results. Investment involves risk, including the loss of principal. In considering any investment, if you are in doubt on the action to be taken, you should consult professional advisers.

Proprietary Information – Please note that this material must not be wholly or partially reproduced, distributed, circulated, disseminated, published or disclosed, in any form and for any purpose, to any third party without prior approval from Manulife Investment Management.

This material is issued by Manulife Investment Management (Hong Kong) Limited. This material has not been reviewed by the Securities and Futures Commission (SFC).

Disclaimer and Important Notice - Quarterly Fund managers’ Views

The relevant information is prepared by relevant fund house(s) for information purposes only. The contents are based on information generally available to the public from sources reasonably believed to be reliable and are provided on an "as is" basis but have not been independently verified. Any projections and opinions expressed therein are expressed solely as general market commentary and do not constitute solicitation, recommendation, investment advice, or guaranteed return. Such projections and opinions are subject to change without notice and should not be construed as a recommendation of any investment product or market sector.

The opinions as expressed in the relevant articles do not represent those of Manulife Investment Management.

Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness or completeness and does not accept liability for any loss arising from the use hereof or the information and/or analysis contained herein.

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