We believe a favourable combination of external and domestic factors, coupled with relative attractive valuations, have put Asian equities in a “sweet spot”.
With the Standard & Poor's 500 and Nasdaq indices breaching all-time high levels pushing P/E multiples for the MSCI United States index to above the 5-year historic average, some investors are likely to re-think their portfolio in search of more attractively valued investments. Given the low growth expectations and concern over unresolved debt issues in some eurozone states, nor may Europe be considered a screaming “buy” by all investors at this juncture. Especially after the strong rally since the start of 2015. Meanwhile, the LATAM, middle-east, Eastern Europe, and Africa regions -- the darlings in the eyes of many investors in the not-so- distant past – are now plagued by a myriad of obstacles weighing on investors’ appetites.
While economies in Asia also confront a number of challenges, we believe relatively attractive valuations for the region coupled with internal domestic drivers put a floor under the market and position the region in a “sweet spot”. Additionally, a number of external factors provide a strong tailwind for Asian equities including: weak energy/commodity prices, an accommodative European Central Bank (ECB) ready to inject abundant liquidity into the financial system, and an expected sustained, albeit moderate US recovery propping up exports for Asia.
It is undeniable that many Asian economies also face a growth soft patch as they undergo rebalancing to the “new normal” slower global growth trend. However, we believe much progress has been made in recent years, with key notable positive developments in 2014. What is most encouraging is the determination demonstrated by many Asian governments to drive reform across all facets of the economy, including what were once highly sensitive government-dominated areas. We see this trend as being especially evident in China, India, and Indonesia where new “reform-minded” political leaders have taken office. The leaders in Japan and Korea can also be commended for championing much-needed reform agendas.
We should be mindful of the fact that despite the growth soft patch across many Asian economies, Asia ex-Japan countries continue to top the charts for global GDP growth. The International Monetary Fund (IMF) and consensus real GDP growth forecast for the Asia ex-Japan region averages around 5 to 6% -- much stronger than the 2 to 3% growth estimate for the US, and the 1% for the Eurozone.
Also worth mentioning is the fact that Asian corporates are cash rich. Cash on the balance sheets of Asian companies is approaching US$1 trillion, leaving the door open to possible dividend increases, share buy-backs, and opportunities to increase shareholder value through accretive acquisitions – all positives for shareholders.
A sustained cycle in the US economic recovery should help boost exports for many Asian economies, especially for Japan, Korea, Taiwan, China, Hong Kong and Singapore. Additionally, quantitative easing by the ECB should inject abundant liquidity into the financial system. This, in our view, bodes well for global equities. We believe Emerging Asian markets will be key beneficiaries of the new flood of liquidity given the region’s inherent higher-beta market structure.
As a net importer of commodities and energy products, Asia significantly benefits positively from the recent weakness in commodity prices. Given the structural demand-supply forces in the global commodity market coupled with the “new normal” softer global growth trend, we expect commodity prices to remain suppressed for some time. Weak commodity price has been a significant positive for Asia in a number of ways. For one thing, lower input costs for Asian corporates has recently and will continue to boost margins.
The steep decline in commodity prices has been a powerful disinflationary force globally. The low inflation environment has paved the way for many economies (e.g. Indonesia, India, China) to push through price reforms for energy and resource-based utilities. As a result of recent energy price reform implemented in India and Indonesia, both economies are now benefiting from a much-improved fiscal position, making them less vulnerable to a future normalisation of US interest rates.
Furthermore, disinflationary pressure has enabled many Asian central banks to trim benchmark rates to support growth. In fact, with inflation easing significantly across the region, many Asian economies now have an easing-bias (Japan, China, India, Korea, Thailand, Indonesia, Singapore, and Australia). And while the central banks in Taiwan, Malaysia, and the Philippines have not yet moved to an easing stance, their monetary policies are not positioned to hike anytime soon. On the contrary, if disinflationary pressures persist (we expect they will), these economies could very likely adopt a more dovish policy.
Our outlook on Asian equities remains very constructive. In fact, there may be a high probability, in our opinion, that Asia equities will outperform many global equity markets in 2015. Within Asia, we highlight the following opportunities:
Japan remains one of our preferred markets. Given the Bank of Japan’s easing monetary policy, the weak yen should continue to benefit Japanese exporters. We see many technology-related opportunities, especially in the healthcare equipment and industrial automation and robotics area. We are also encouraged by the early signs of corporate restructuring plans. It will be a slow process to change decades of ingrained cultural behavior and norms, but the early signposts are encouraging with Prime Minister Shinzo Abe at the helm.
India is also a preferred market and we expect a re-rating over the medium-term. The two recent rate cuts by the Reserve Bank of India are a huge positive to help boost growth. The long-term consumption growth story remains very much intact, and we believe increased household wealth will drive consumption for many low-penetrated areas across the economy. Meanwhile, the Modi government continues to accelerate structural reforms and improve the policy environment.
China offers the benefit of being one of the cheapest markets in Asia-Pacific. The urbanisation and increasing wealth trend in this country provide good support for consumption over the medium term. With the People’s Bank of China clearly signaling an easing posture, equities should be supported despite the weak growth trend. Excessive government debt and a weak property market, however, continue to be areas of concern.
Australia continues to face headwinds from weak commodity prices, but the economy is healthier than some may expect. We favor the consumption-related areas such as transportation (airport/toll road), healthcare, telecommunications and utilities. Risk remains high in energy and materials except for large diversified miners who continue to generate strong cash flows despite weak commodity prices. We also like a number of the banks as they offer very attractive yields, and operate in an oligopoly structure, which allows them to command strong pricing power.
Within ASEAN, our outlook for Indonesian equities remains very positive. Ongoing reform to mend the country’s balance sheet is very positive for the country over the long term. We favor banks due to the country’s low credit penetration and the oligopoly structure of the sector. The acceleration of infrastructure projects is seen as the next most important challenge for President Joko Widodo to overcome. If he succeeds, we expect Indonesian equities will see another strong year. We also have a positive outlook on the Philippines. With inflation risks in the rear-view mirror and growth picking up, this market is expected to continue to delivery, albeit the current market valuation is less compelling versus other regional peers.
We are more cautious on the outlook for South Korea, and the non-technology sectors in Taiwan. For South Korea, the weak Japanese yen will continue to pose headwinds for Korean exporters. Domestic consumption also remains weak. The government seems committed to pushing forward reform measures, and South Korea’s discounted valuation should provide support for the equity market. In Taiwan, domestic growth continues to be muted as well, but inflation is no longer a concern. We don’t see many positive catalysts for this market in general and prefer to remain invested in selected technology leaders.
Valuations remain attractive for the region. Despite the recent multi-year strong market performance for many of the Asian countries, with a number of markets breaching all-time high levels, valuations remain reasonable with both the MSCI Asia ex-Japan index and the MSCI Asia Pacific index still trading near its 5-year historic average P/E multiple (based on 12-months forward consensus estimates). Not to mention, Asian corporates offer one of the more attractive yields. Investors seem to be agreeing that Asia may be in a “sweet spot” if recent market performance is any indication.