Asian Equities Outlook - Catching a falling knife
Many people will view the prospect of investing in Asian equities right now as like catching a falling knife.
The perfect storm of a looming trade war, US dollar strength and rising interest rates have driven the MSCI Asia ex-Japan index down 16% this year to mid-November, by Bloomberg data, led by a 17.5% drop in China’s CSI300 Index.
Moreover, economic growth has started to slow across nations worldwide. This, together with the likelihood of more US rate hikes, threatens to peg Asian economies back further next year, especially those running deficits or dependent on oil imports.
Asian currencies are vulnerable to a strong dollar, with the Indian rupee, Indonesian Rupiah and Philippine peso most susceptible. Central banks in Jakarta and Manila have raised borrowing rates to defend their currencies – which promises to eat into companies’ profit margins.
US trade tariffs similarly threaten to undermine corporate earnings, particularly in China – which has become such a key driver of economic growth for countries across Asia Pacific.
With the impact of tariffs yet to be felt fully, fresh data point to a cooling of China’s economy, with fixed asset investment having sunk and indications that manufacturing activity is slowing.
All of this has sowed seeds of doubt in the minds of investors about the near-term prospects for Asian equities.
However, it’s not as though the People’s Bank of China has been sitting on its hands. The central bank has cut the reserve requirement ratio for liquid assets that banks need to hold as a buffer on their balance sheets by 2.5 percentage points this year.
It has also loosened policy to ensure sufficient credit is available in key areas of the economy, and has slashed tariffs on non-US imports to reduce costs for consumers and companies.
As an investor focused on value, when the herd moves in one direction, we tend to look the other way. We’re happy to go against the grain if the numbers tell us to.
The International Monetary Fund has forecast 6.6% growth for China this year, 7.3% for India and 5.3% for Asean. That’s comfortably more attractive than 3.7% for the world as a whole, 2.9% for the US and 2% for the Eurozone.When we scrutinise businesses’ prospects, we still find good growth potential across Asia. Consensus company earnings forecasts are 11% for this year and 10% for next year1 . Pre-tax earnings and cash-flow yields have been rising and many firms are cash-rich.
Balance sheet strength gives companies options. They can invest in their own growth; they can maintain or raise dividend payouts; and they can pour money into research in areas such as tech innovation to help futureproof their firm. It’s all potentially good news for investors.
In addition, market corrections this year have driven regional valuations below historic averages. Mean price-to-earnings and price-to-book ratios for stocks on the MSCI Asia Pacific ex-Japan Index are below peers on MSCI World, MSCI US and MSCI Europe (table 1). The sell-off this year has made Asian equities look even more like a buy now.
These numbers reinforce our long-held conviction on the region. We’re confident that growing populations and rising middle classes and wealth can power domestic consumption for years. That encourages us to search for strong consumer companies well positioned to benefit from this structural dividend.
China has been orienting its economy successfully towards domestic consumption and services in a drive to become more self-sufficient. Revenues and costs for domestically focused firms are renminbi-based, with their customers and supply chains based in China. This will help to insulate them from RMB depreciation or the fallout of a trade war.
In a similar vein, average real wages in India are forecast to quadruple between 2013 and 2030 and its middle class to more than double to 547 million by 2025-26, based on figures from New Delhi-based think-tank the National Council of Applied Economic Research. Indian consumers will witness a major transformation in the next decade.
All of which, we believe, bodes well for company earnings next year and beyond.
Seizing on opportunities
We are a fundamental stock-picker, not a thematic investor. Our sector allocations are a reflection of where we have found firms we like. That said, we do take an industry’s outlook into consideration when we think about a company’s growth prospects.
In China we anticipate tailwinds for companies in insurance, travel, internet technology and those that deal in product essentials. These are things that people demand as they get richer, or feel they simply can’t do without.
We have capitalised on the recent correction to build up positions in companies and initiate new names. We are positive on firms in line to benefit from growth in tourism and trends such as electrification and autonomous driving.
In India, share price performance has been mixed across sectors this year. Financial services have been hit hard after infrastructure lender IL&FS suffered a debt default, with quality Indian banks caught up in the sell-off.
We think the price correction was unwarranted and predict a rebound in financially strong franchises with high deposit funding and a proven record of asset-liability management.
We are positive on the outlook for banks in general as we look ahead to next year. Monetary tightening by the US Federal Reserve has driven the dollar and prompted rate hikes around Asia. This should boost banks’ net interest margins, while stabilising credit costs will support earnings.
We are also optimistic about the outlook for IT companies, particularly leading semi-conductor players able to use their balance sheet strength to invest in cutting-edge next-generation technologies.
Source: RIMES, MSCI, Morgan Stanley Research, 26 October 20181 Source: Factset, IBES, Goldman Sachs Global Investment Research, September 2018
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