Asian equities did well in the nine months to 30 September 2017, returning more than 30% in US dollar terms. After such a strong run, there may be some moderation into the year-end. We believe the ‘cushioning factor’ is that the gains in the first half of 2017 were driven mainly by upward earnings revisions and currency appreciation rather than higher valuations.
Our Asia Pacific Equities team believes the acceleration of the earnings cycle over the next few years can support an extension of this strong performance, which means that any pullback in Asian equities would represent a buying opportunity for long-term investors.
Time for a breather for Asian equities
Asian equities have outperformed larger emerging markets and developed markets so far this year, with China offshore, South Korea and India the top performers.
A combination of: earnings upgrades, stronger regional currencies and increases in price-to-earnings multiples from a low base was the main reason behind this regional rally.
A number of key factors supporting this uptrend have remained in place: a weaker USD, China’s improved growth outlook and improving results from supply-side discipline among Chinese companies.
Exhibit 1: Earnings growth – the main driver of Asia’s market performance (year-to-date 2017)
After this year’s great rebound in Asian economic activity, we expect momentum to taper off in the fourth quarter/early in 2018, given the weaker commodity prices and the base effect of strong growth.
The cycle of earnings upgrades in the two sectors (information technology and materials) that saw most of the increased forecasts appears to be softening.
Watch out for an attractive entry point
Despite the pullback by Asian equities, we remain bullish for the longer term, given our optimism that Asia will benefit from continued improving regional growth, stable macroeconomic conditions and undemanding valuations. We do not expect Asia to face any major crises any time soon.
- Improving economic activity – While GDP growth is expected to remain relatively stable year-on-year, Asia continues to deliver higher growth relative to other regions. We continue to see structural opportunities in India and the ASEAN countries over the longer term given the working-population growth, the lower penetration of products and rising disposable income. Strong trade tailwinds and the renewed product launch cycle in the tech sector should continue to benefit the export markets of South Korea and Taiwan.
- Earnings recovery – Asia is currently in the first year of an earnings recovery after six years of curbed profit growth. After strong earnings growth this year, we believe that it may soften in 2018, but remain at a healthy double-digit level.
- Stability in China – Increased rigour in risk mitigation ahead of top-leadership changes in the fourth quarter of 2017 is crucial for Beijing to preserve economic, social and political stability. Stability in China should allow for a stable year for Asian equity markets.
- Resilience against external shocks – Most Asian currencies have appreciated against the USD this year. A stable oil price supports ASEAN equities, alleviating pressure on fiscal deficits. Across Asia, foreign exchange reserves remain healthy and provide sufficient liquidity, limiting the impact of actions by leading central banks at a time when markets are concerned about another ‘taper tantrum’.
- Undemanding valuations – Asian equities are trading at a discount versus the US and Europe. The MSCI AC Asia ex-Japan index is at 14.1x P/E (FY 2018 Bloomberg estimates, as of 3 October 2017).
- Global investors remain underexposed to Asia ex-Japan – Global mutual funds, totalling more than USD 1 trillion in assets under management, are about 520bp underweight, representing large inflow potential for Asian equities.
As bottom-up stock pickers, our team believes that competitive long-term returns can be achieved by identifying high-quality companies that can benefit from structural supply and demand drivers and by holding these positions for the long term. It is a core belief that sound fundamentals drive stock prices over time.
In our view, any near-term correction in Asian markets should be viewed as a buying opportunity given that the current policies aim to support the medium and longer-term outlook in Asia.
Written on 16/10/2017