Investor sentiment has turned more positive on emerging markets (EM) in recent weeks, including those in the Asia region, with the MSCI AC Asia ex-Japan index rebounding by around 15% since its mid-January trough (as of 31 March). The surprising reversal in global commodity prices was a critical factor behind the recent rally in under-owned, resource-correlated emerging markets. The turnaround in Asian equities, on the other hand, has been driven more by the fact that the risks posed by some major market negatives are perceived to have receded.
The first negative factor to have shrunk is the change in the number of rate hikes expected from the Federal Reserve in 2016. In the wake of recent communications (see, for example, Janet Yellen's speech on 29/03/16) few economists are now projecting an aggressive US rate hike cycle in 2016.
Secondly, the bearish outlook involving an imminent hard-landing scenario for China’s economy has been diluted by clearer signs that China’s real estate market is stabilising – contrary to the key premise behind the pessimists’ hard-landing scenario. The stabilisation of the renminbi (RMB) has also eased investor worries of full-blown competitive currency devaluation across the region.
In our view, some investors may not be aware of the numerous reasons we see why the Asia region offers better risk-reward prospects within the EM equities asset class. Asian economies are better positioned relative to other EM economies/regions when dissected across various factors such as GDP growth, inflation outlook, fiscal health and political circumstances. China has ratcheted down its fixed asset investment over the past five years and this, coupled with an expected muted outlook on global demand, means the GDP growth prospects for EM commodity-dependent economies are likely to remain under pressure. And it is doubtful that the recent commodities rally has much further to go, given what we see as mediocre fundamentals for the medium-term, supply-demand picture.
It is also worth highlighting that, despite fears of slower growth in China and across Asia, the region’s GDP growth rate looks set to continue to significantly outpace that of many economies worldwide. Many Asian corporates still have plenty of cash on their balance sheets. And certainly, we recognise that there are some sectors within certain economies with high debt levels. However, in general, the gearing is not broad-based. In China for example, the highly levered companies are mostly concentrated in the utilities, property, capital goods and resources sectors. Yet even within these sectors, selective opportunities can still be found.
Four under-the-radar facts about Asia which we think may surprise investors:
1. Asian equity valuations are approaching price-to-book levels not seen since the 2008 Global Financial Crisis. For us, this clearly implies that most recent bad news has been baked into stock prices. This in our view opens the door for potential upside surprises if China’s economic recovery accelerates and/or if the pace of economic growth in the US or Europe beats expectations (see exhibit 1 below).Exhibit 1: Price-to-book levels for the MSCI AC Asia ex-Japan are now close to levels not seen since the 2008 Global Financial Crisis.
2. Regional Asian equity funds offer a degree of diversification. The correlation between selected Asian market pairs has been surprisingly low in recent years. As exhibit 2 below illustrates, North Asian and South Asian markets in general have a low correlation to one another.
Exhibit 2: Graph showing the degree of correlation, over three years, between the performance of single Asian country MSCI stock indices (for example, the correlation between Hong Kong (HK) and China (CN) is, as might be expected high at 0.81% whereas the correlation between Indonesian stocks and Japanese stocks is low at 0.21%).
(CN= China, HK= Hong Kong, TW= Taiwan, IN= India, KR= South Korea, JP= Japan, AU= Australia, SG= Singapore, MY= Malaysia, ID= Indonesia, TH= Thailand, PH= Philippines)
3. Stock-to-stock correlation in the Asia Pacific region is much lower compared with that in major developed equity markets. This means Asia offers more ‘alpha’ opportunities for active managers to provide added value.
4. At 3%, dividend yields on Asian equities exceed most major global government bond yields. In a world where around one-third of global bond yields are negative and more than half of global bond yields are below 1%, a yield of 3% on Asian equities is really the icing on the cake!