Asia credit market outlook
From a total return perspective Asia credit appears to be supported by attractive carry and alpha opportunities. We share our perspectives on the macro backdrop and broader market direction.
Stable macro environment
Stable macro environment
Inflation has remained subdued in most of Asia in the recent past – unlike the US and Europe, which make up the bulk of developed markets (Figure 1). As a result, most countries in Asia has avoided an inflation spike, bypassing a tighter monetary policy regime.
On the other hand, economic growth remains healthy in Asia, which should continue to drive the world economy.
Figure 2: Real GDP growth and forecast
Figure 2: Real GDP growth and forecast
Location/Year | Location/Year | 2021 | 2021 | 2022 | 2022 | 2023 Forecast | 2023 Forecast | 2024 Forecast | 2024 Forecast |
|---|---|---|---|---|---|---|---|---|---|
Location/Year | US | 2021 | 5.8 | 2022 | 1.9 | 2023 Forecast | 2.4 | 2024 Forecast | 1.2 |
Location/Year | Eurozone | 2021 | 5.9 | 2022 | 3.4 | 2023 Forecast | 0.5 | 2024 Forecast | 0.6 |
Location/Year | World* | 2021 | 6.6 | 2022 | 3.4 | 2023 Forecast | 3.1 | 2024 Forecast | 2.6 |
Location/Year | Asia** | 2021 | 7.6 | 2022 | 4.2 | 2023 Forecast | 5.0 | 2024 Forecast | 4.6 |
Solid credit fundamentals and technicals
Solid credit fundamentals and technicals
We continue to see strong underlying credit fundamentals in Asia ex-China corporate bonds and broadly expect them to remain stable given solid economic growth and stable political backdrop. The overall fundamental profile of Asian investment grade credit is strong, which is underpinned by government ownership of many of these companies.
Net leverage for Asian investment grade companies has increased from 1.4 in 2012 to 2.0 at year-end 2022. On the other hand, net leverage at US investment grade has increased 71% over the same period ending at 2.4.
Demand for Asian corporate bonds remains strong given the higher yield levels. There is additional demand from local buyers in USD denominated debt because of the compression in yield differentials to local bond markets.
The supply backdrop is also supportive given USD funding levels are high versus local currency markets compared to recent history. Hence companies have shifted to raising capital in local currencies rather than via the hard-currency market. We expect this trend of scarce bond supply to continue into 2024.
In addition, corporates across the region have been able to refinance in local currency markets (both domestic capital markets and bank funding), which alleviates the need to refinance in the USD market. This provides an additional anchor for favorable demand-supply dynamics.
Wide valuations
Wide valuations
Yields in Asian investment grade are close to their highest levels since 2010. This has increased demand from institutional asset allocators and local buyers.
For Asian high yield (HY), weak sentiment from recent years has resulted in average credit spreads of around 900 basis points (bps). This is at the higher end of the spectrum, with the historical average ranging from 300 bps to 600 bps.
Even if we exclude the China property sector, the rest of Asia HY trades at roughly 11% yield in USD and 630 bps spread (Source: J.P. Morgan. Data as at end November 2023), which provides strong carry for Asia HY to perform in 2024.
The tide is turning for China
The tide is turning for China
Since late August 2023, we have had positive indications that China could be on the path to further stabilization as policy makers announced more stimulus to boost growth and support the property market and private enterprises. These actions could finally improve the trajectory of Greater China credits into 2024.
Investor sentiment on Chinese assets is already on the weaker side and the valuations remain at historically low levels. The upside case from here could arise from a normalization in consumption, in conjunction with an assertive stance of policymakers. On the other hand, the bearishness of investor sentiment and existing valuations provide a reasonable margin of safety against any downside scenario from here.
Is China property distress in the rearview mirror?
Is China property distress in the rearview mirror?
The default cycle in China real estate has largely played out with most of the Chinese privately owned real estate issuers in restructuring. Select credits provide attractive potential upside given distressed valuations and more policy support to come for the sector.
After the restructuring of China real estate credits, the weight and significance of the sector in the index has been greatly reduced. The Asian credit universe now is more diversified and balanced in terms of sector and country exposures.
As of end November 2023, the China real estate sector only accounts for 1.9% of the overall Asia credit market and 7.0% of Asia high yield. (Source: J.P. Morgan. Data as at end November 2023)
For 2024 our default rate forecast for HY corporates within the JP Morgan Asia Credit Index is 11% driven by the real-estate sector in China. Ex-China real-estate sector our default expectations stand at 2.2%.
For the broader JP Morgan Asia Credit Index which includes investment grade and high-yield segments, the forecasted default rate is 1.8%.
Figure 6: J.P. Morgan Asia Credit Index (JACI) sector breakdown
(Top 5 and China real estate)
Figure 7: J.P. Morgan Asia Credit Index Non-investment Grade (JACING) sector breakdown
(Top 5 and China real estate)
As a result, the impact from any further weakness in the sector should be less of an impact than before. Furthermore, the current distressed valuation levels also provide good upside optionality through a potential positive return scenario which could be driven by either policy stimulus or cheap valuations.
Although policy implementation in recent years has weighed heavily on Asian credit, we believe these policies are beneficial to the country in the long run with an associated reduction of moral hazard. Decreased leverage in the real estate sector as well as improvement in transparency help reduce financial risk for the future. In addition, social risk goes down since the expectation that housing prices will always go up has been dispelled.
Further, demand for housing benefits from the long-term trend of migration to the cities and from cultural home ownership norms. As evidenced in global housing down-cycles, we anticipate that the market will find balance in the medium term.
Given attractive all-in yields and alpha opportunities, we hold a favorable outlook for Asia credit in 2024 from a total return perspective.
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