Q&A with Teresa Kong
In this short Q&A, Teresa Kong, Portfolio Manager, provides her insights on the economic impact of the coronavirus and where she sees risks and opportunities, and why the current prices could represent a once in a decade opportunity to buy Asia high yield.
Q: From your perspective, what has been the impact of the coronavirus to the markets?
A: The coronavirus is the black swan of this decade. I would characterize the unfolding of the market crisis in five stages:
- China crisis—January to February
- Global crisis—February to March
- Dash for cash—March 9-19; margin calls and correlations converged to 1, catalyzed by the oil price breakdown
- Crisis Policy > response—March 19-April 3
- Policy response > Crisis—So far in April
Until a vaccine or a treatment is commercially available, I see market vacillating between stages 4 and 5. Risky assets will rise as the policy response is deemed to be sufficient to offset the income caused by the sudden stop of global economic activity and analogously, sell off, when policy response is deemed to be insufficient. Because we experienced such a sudden regime shift from expansion to contraction, most economic indicators are not providing a timely and accurate picture of the current state of the economy. As such, I expect we will stay in a period of high volatility for the next several quarters.
Q: Which asset class do you see as most risky?
A: We are most concerned about currencies as they are the most difficult to determine intrinsic value. Most emerging Asian currencies have not depreciated to the trough levels of the Global Financial Crisis (GFC), although the velocity of the depreciation has exceeded that experienced during the GFC. While the dash for cash has subsided, we still expect more capital outflows to be greater than inflows, leaving especially emerging Asian currencies still vulnerable.
Q: Where do you see the best opportunities?
A: Credit. With the U.S. Fed's announcement last week to include sub-investment grade bonds in its buying program, it provides a floor to U.S. credit, but also to Asia credit through relative value. Within Asia credit, we find the best relative value in the “fallen angels.” These are now companies that were rated investment grade, but have been downgraded to junk by one or more of the rating agencies. The Fed's announcement to specifically target these fallen angels was bold and has already led to healthy bound and narrowing of bid-offer spreads for these bonds.
Q: What about defaults?
A: Yes, we expect defaults to rise. But with Asia high yield spread hovering at 900 basis points (9.0%), it is already impounding a historically high default rate. Assuming historical recoveries of 45 cents on the dollar, current spreads are impounding in about mid-teen percentage probability of default. During the GFC, Asia high yield experienced a 14% default rate, so high yield has already priced a GFC scenario. Another way to mitigate default risk is to consider active managers who can maximize the alpha potential versus just getting broad market exposure through a passive vehicle.
Q: So what do you recommend investors do?
A: We believe that current prices could represent a once in a decade opportunity to buy Asia high yield. We are within 100 basis points (1.0%) of the wides experienced during the GFC.
We believe that that current prices are more than compensating active investors who can avoid defaults. The forced selling of these bonds due to margin calls have also subsided as price moves are no longer as violent as during the “dash for cash” we saw in mid-March. With the epicenter of the crisis having moved from China to the rest of the world, we expect Chinese credits, especially of issuers in domestically driven sectors like property to be amongst the first to recover as they trade at a substantial discount to intrinsic value.
Q: What is the upside potential?
Empirically, if you bought Asia high yield whenever spreads reached current levels, there was not a single instance when you would have lost money over the last two decades (since the inception of the J.P. Morgan Asia Credit Index in 1999). Returns were indeed attractive—10 percent annualized, with at least a one-year holding period.
The JP Morgan Asia Credit Index (JACI) tracks the total return performance of the Asia fixed-rate dollar bond market. JACI is a market cap-weighted index comprising sovereign, quasi-sovereign and corporate bonds and is partitioned by country, sector and credit rating. JACI includes bonds from the following countries: China, Hong Kong, India, Indonesia, Korea, Malaysia, Philippines, Thailand and Singapore.