Over the past several years Latin America fixed income securities have outperformed their Asian counterparts. As China goes so goes the Asian Credit complex, and the underperformance in 2018 was led by China (down 3.7%) which suffered from a combination of concerns surrounding the burgeoning U.S.-Chinese Trade War, diminished on-shore liquidity and poor technicals as supply moved into the off-shore market in response to policy efforts to de-leverage the domestic economy.
We are now becoming more positive on Asian High Yield Credit, with the main catalyst being a more constructive view on Chinese High Yield Property. Our heightened confidence level is based on the following factors:
Valuation—After underperforming the past several years (and in particular in 2018), Chinese High Yield is attractive vis-à-vis both Latin America and EEMEA High Yield.
Fundamentals---Company balance sheets in Asia are improving. Furthermore, the Chinese government has enacted a number of “tweaks” to stem the GDP decline and the forward looking market anticipates further stimulus and macro-policy easing should the need arise.
Technicals—Net supply overall in 2019 should be below 2018 in particular for Asian High Yield.
Global Economic Backdrop--Perception of a more dovish U.S. Fed and diminished headwinds from U.S. $ strength. Within the Credit space the higher beta sectors should be primary beneficiaries of an enhanced investor appetite for risk. Given our more optimistic view, we are upgrading a number of recommendations in the Chinese High Yield Property space.
Valuations More Attractive in Asian High Yield driven by Chinese Property
As the chart below shows, Asian High Yield has underperformed Latin America since 2016. There were several factors at play. In 2015 the “commodity bust” adversely impacted many (primarily) Brazilian companies, which resulted in dramatic Latin American underperformance in that year. As the commodity cycle turned and the overall Brazilian Credit space improved, this led to spread tightening and outperformance in 2016 and 2017 (Brazil is by far the largest component of Latin America Credit). This trend continued into 2018. China faced headwinds over concerns on the economic impact from the burgeoning U.S-Sino trade war coupled with diminished onshore liquidity and poor technical factors.
Valuations for Asian High Yield are now attractive and we believe conditions are in place for a reversal of recent underperformance.
Asia now trades at more than 230 basis point (bps) discount to both Latin America and EMEA, close to a two-year high.
China High Yield now trades at a spread of +814 basis points to U.S. Treasuries, the highest spread among any major country in Emerging Market High Yield and close to 100 basis points above the Emerging Market High Yield aggregate. In fact, the Barclays Bloomberg Chinese High Yield index now is a visually compelling 10.0% yield.
Performance in Asian Credit Driven by China
As the table below shows, Asia High Yield Credit is dominated by China; it constitutes almost 2/3 of the total JPM JACI index by market capitalization. Hence, the investment call on China will essentially determine overall success within Asian Credit.
Fundamentals Remain Broadly Supportive
Leverage has improved for Asian high Yield and default rates have also remained low in 2018, below 2.0% versus a historical average of EM High Yield of around 4.5%.