SCB CIO warns of rising concern on economic recession

The risk of a recession can be mitigated by raising a portfolio's allocation to government bonds. From the perspective of recovering rents and occupancy rates, investing in Singapore and Thai REITs is an attractive alternative among risky assets, while the outlook for stocks remains neutral.  

The stock markets in China and Thailand represent safe options for investors because of their promising futures and current low prices.

Kampon Adireksombat, First Senior Vice President and Team Head of the SCB Chief Investment Office at Siam Commercial Bank revealed that banks in the United States and Europe are tightening their already stringent lending standards in response to the current financial sector stress, which will likely have a chilling effect on the forthcoming economic and commercial rebound.

The IMF has recently estimated that the decreasing lending trend, coupled with the strong impact of interest rates, is expected to hurt the economic growth of both regions, resulting in a decline in GDP of about 0.4% per country.  Meanwhile, the SCB CIO anticipates an increase in concerns regarding a potential recession, particularly in the US, throughout the remainder of 2023.

While the Chinese economy remains the primary driving force behind the global economic recovery, the first quarter's GDP growth of 4.5% compared to the same period last year indicates an uneven recovery. Domestic consumption is steadily recovering, but the investment sector is experiencing a slower rebound.

Additionally, the export sector may still face pressure due to the risk of a severe global economic slowdown recovery from its lowest point. Nevertheless, the retail sector has shown a steady recovery with a growth of 10.6% YOY in March, up from 3.5% YOY between January and February.

Investment in fixed assets is also gradually recovering. Although China's March export figures increased by 14.9% YOY after five consecutive months of contraction, the impact of the US and European economic slowdown on the global and Chinese economy is still a matter of concern.

According to Kampon, the SCB CIO continues to believe that the US Federal Reserve (Fed), the European Central Bank (ECB), and the Bank of Thailand (BOT) will likely all halt rate hikes in 2Q23 but are unlikely to cut rates this year.

Although inflation has slowed down, it is still above the target level, so the Federal Reserve is expected to raise interest rates by only 0.25% at their May 2-3 meeting and keep them there between 5.00 and 5.25% until the end of the year. As a result of rising financial sector tensions, the European Central Bank (ECB) is expected to raise interest rates by 0.25% once or twice.  

The benchmark rate in Thailand is expected to remain at 2% through the end of 2023, when the BOT raises it by 0.25% at its meeting on May 31. Domestic demand will continue to improve, resulting from the revival of the tourism and service industries, although inflation is expected to return to the 1-3% target range in 2Q23. However, the threat of a worldwide economic recession is more than anticipated, and this is what will ultimately weigh on Thailand's export sector.

The SCB CIO suggests that investors should consider hedging their risks in the face of mounting recession concerns by increasing their allocation to government bonds within their portfolios. Based on the SCB CIO's analysis, it has been observed that during periods of heightened recession risk - characterized by a steadily declining PMI below 50 and high inflation – three assets commonly utilized as hedges against economic downturns are US government bonds,  US investment grade bonds, and gold.

When taking into account the risk-adjusted return, however, US treasuries were shown to be the best hedge against the possibility of a recession, so we have upgraded our outlook on US government bonds to positive and revised our view on high-grade bonds to slightly positive. The difference in yields between high-yield bonds and government bonds tends to accelerate in the next phase after lending standards have tightened, thus, we keep our recommendation on high-yield bonds at slightly negative. 

Due to worries regarding commercial real estate (CRE) issues in the office sector and a slowdown in housing prices in developed markets, we have also revised our outlook on DM REITs, or real estate investment trusts in developed countries, as slightly negative.

Higher financial costs and relatively substantial debt maturities in the next one to two years are the key constraints on the office sector, while hybrid working methods are delaying income recovery following the city reopening.  Housing prices have also begun to slow down due to higher interest pressures, which will likely impact the recovery of rents in the next 12-18 months. However, we maintain our slightly positive view on REITs in Singapore and Thailand, as they are still likely to benefit from a recovery in rental rates. 

The outlook for stock investment remains neutral, and it is important to keep a close eye on the listed companies’ earnings from the first quarter of 2023, particularly regarding the risk of earning downgrades. While central banks may pause interest rate hikes, it is worth noting that interest rates are still high. Furthermore, financial stress within the US and European financial sectors may put pressure on economic growth rates and profits of listed companies, leading to possible downward revisions for the remainder of the year.

For those looking to invest, we recommend considering China A-shares, which have a positive outlook, as well as Chinese H-shares and Thai stocks, which are slightly positive due to their attractive valuations and potential for profit recovery in the future.