2017 was a blockbuster year for Asian equities, underpinned by solid global growth and Chinese demand. A repeat performance looks unlikely in 2018. However, we do expect sustained returns, driven by a potent cocktail of robust fundamentals, resurgent company earnings and further multiple expansion.
Although we cannot ignore market concerns over risks such as a sharp China slowdown and further rises in US interest rates, we believe these drivers, coupled with Asia’s generally high economic growth and attractive equity valuations, should result in further upside for long-term investors.
Will Asian equities continue to deliver?
Healthy earnings growth
The robust tailwinds from the synchronised global economic recovery add to our confidence that Asia’s earnings momentum will continue in 2018, potentially achieving 12.9% earnings per share (EPS) growth.
What was comforting about the rally in Asian equities in 2017 was the quality of total returns: 80% of price gains were led by earnings expansion rather than multiple expansion. This should leave room for further multiple expansion and stock price upside this year.
Three key drivers
Asia’s sweet spot – its own ‘Goldilocks’ combination of stable growth, resilient exports and subdued inflation – has persisted early in 2018, propped up by:
- A sustained global tech upcycle, driving exports. We believe this cycle could last longer than previous cycles, given that chip demand is swiftly developing beyond smartphones. Manufacturing activity saw a general recovery in Asia with nearly all countries’ manufacturing purchasing managers’ indices (PMIs) expanding in December.
- Strong capital inflows in Asia expected to continue. The combination of continued developed market bond-buying by the Bank of Japan and increasing currency intervention by emerging market central banks should offset the effect of US monetary policy tightening, which should keep developed market bond yields low, thus prolonging the search for higher yields in Asia.
- Still-accommodative macroeconomic policies in Asia, supporting domestic demand. Soft inflation is allowing Asian central banks to maintain loose monetary policies, with policy rates at low levels. Fiscal policy in Asia is also stimulative.
Improving macroeconomic conditions
We remain optimistic for the longer term as Asia should benefit from improving regional growth, stable macroeconomic conditions and undemanding valuations. While GDP growth is expected to remain relatively constant year-on-year, Asia should continue to deliver higher growth than other regions.
- China – With 2017 GDP growth of 6.9%, thus beating consensus expectations of 6.8%, we expect momentum to slow in 2018. This reflects Beijing’s ‘new normal’ growth policy that prioritises quality growth through structural reforms over chasing growth quantity. This should offset some of the headwinds from the property market slowdown and state-owned enterprise (SOE) re-structuring. We believe the environmental agenda will remain pivotal to industrial, urbanisation and regional development policies. The manufacturing recovery has benefited from the swifter pace of industrial upgrading and better prospects of external demand.
- India – After demonetisation and the introduction of the Goods and Services Tax knocked growth off track, demand is now gradually recovering. The government has strengthened its efforts to tackle the problem of non-performing assets in the banking sector.
- North Asia – The global industrial cycle has lifted South Korea’s economy. Its semiconductor industry is showing soaring profits and its outlook remains robust given that China continues to invest heavily in the industries of the future. Taiwan’s economy is riding the tech boom, even though local demand seems shakier. Rising equity and property prices in Hong Kong are helping to prop up consumer spending.
- ASEAN - We continue to see structural opportunities in the ASEAN countries over the longer term given the growing working population, the lower penetration of products and rising disposable income. For Indonesia, we expect GDP growth to accelerate to 5.2% in 2018, led by investment spending growth. In Malaysia, the central bank may increase its key rates in 2018 now that the headwind of the general election has faded. GDP growth remains strong in Malaysia, as well as in Thailand and the Philippines. Strong external demand has boosted Singapore’s economy, where the housing market is showing signs of strengthening.
What are the risks?
A number of tail risks remain for Asian equities, however, including cooling construction activity in China, a sharp rise in US interest rates and the likely accompanying rise in the value of the US dollar, which could squeeze borrowers.
A sharp slowdown in China remains a risk, although the outcome of the 19th National Congress indicates that the Chinese government will not be aggressively pursuing deleveraging.
Given the low level of inflation and despite oil price increase, price pressures are likely to remain contained in Asia, allowing central banks to leave monetary policy relatively loose.
Asia has shown strong resilience against external shocks. Most Asian currencies rose against the US dollar in 2017 as well as in the early weeks of 2018. Across Asia, foreign exchange reserves remain healthy and should provide sufficient liquidity, limiting the impact of action by leading central banks.
In our view, Asian equities are attractive, trading at a discount against the US and Europe. The MSCI AC Asia ex-Japan is at 13.6x P/E (FY 2018 Bloomberg estimates, as of 04/01/2018).
 Thomson Reuters consensus estimates, as of 12 January 2018
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