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The Asian view

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A Q&A with Robert Rountree, Global Strategist at Eastspring Investments, on where he sees value in Asian equities in the post Brexit context.

To what extent are global concerns leading the performance of Asian equities?

The answer is, ‘An awful lot’. In fact, one could almost go so far as to say, ‘The overwhelming bulk’. Since last August, global factors have been firmly in the driver’s seat resulting in an almost perfect one-for-one correlation between movements in the global and Asian equity markets (in local currency terms that is). 

These global factors need no introduction: 

• The ‘to-ing and fro-ing’ surrounding US interest rate movements (let alone concerns over US growth and its impact on Asia); 

• The European move into negative interest rates and bond yields and its repercussions;

• Brexit and its impact on Asia.

And waiting in the wings are the growing concerns as to whether Japan will introduce ‘Helicopter’ money, and if so, when, and what then?

While investors are focusing on these issues, domestic Asian issues are being overlooked. Many Asian profit and (economic growth) forecasts, for example, have risen this year; a fact almost totally overlooked judging by the extremely low valuations.

Broadly speaking, Asia’s economic and fundamental picture is strong. By reacting to global fears and ignoring strong domestic fundamentals, Asian markets are exposing great value. This great value, however, could become ‘greater’ value as fears ebb and flow. Some great value is there, but the triggers for discounting this are not yet evident. 

What has been the effect and impact of Brexit?

The immediate interplay between the Brexit vote and the reaction of the Asian markets highlighted the opportunities that can appear as investors react to these external fears. 

As reason overcame the fears, the adverse impact on Asian equities was fleeting. It should be noted that it took a rally in UK shares to spark a corresponding rally in Asian shares!

Following the vote, the UK market fell over 5.5 per cent (collapsing around 16.25 per cent in US dollar terms). Asian equities fell over 2.5 per cent (circa 3.5 per cent in USD).

But even Asia’s relatively modest sell-off looked exaggerated given that Asia’s value-added exports to Europe account for only 2.6 per cent of GDP (14.3 per cent of total exports). Put another way, sales revenue of Asia’s listed companies that comes from Europe ranges from around 15 per cent (South Korea and Taiwan) to less than 5 per cent (China, Indonesia, Malaysia, the Philippines and Thailand).

One suspects that given the dynamics at play at the time, fear would have driven Asian markets lower, despite weak grounds for doing so. The UK’s rally saved Asia’s bacon, it seems.

What do Asian equities offer investors in these difficult times?

The difficult times relate to areas outside Asia. Asia has its issues, but it is difficult to not conclude that many of these issues have been exaggerated. Low valuations (some very low) suggest that most concerns have been discounted in large measure. 

Asia offers:

• Higher economic growth with many forecasts having risen in 2016.

• Stronger corporate profit growth forecasts. Some forecasts have been downgraded in the year-to-date but most remain significantly higher than US and Eurozone profit forecasts. In short, we have seen the forecast cuts and valuations still look good.

• Equity valuations mostly range from fair value to ultra-low. Even Singapore equities, with their just-above-zero profit growth forecast, have a valuation lower than that at the height of the 2008 financial crisis. Are things that bad? Really?

• Many Asian central banks have room to cut interest rates as inflation falls.

• Asian bond yields and equity dividends look very attractive, exceedingly attractive, in a world of negative interest rates.

In short, Asian equities and bonds offer a lot particularly as negative rates ‘bite’ in the developed economies.

What is the latest on Abenomics? Is it working?

As the ultimate aim of Abenomics was to stimulate economic growth and break the chains of deflation, one has to conclude that it has not worked! If it were working, there would unlikely be any talk of ‘Helicopter’ money, for example. 

The flaw in Abenomics seems to be that it is not pushing the money into the hands of those who would spend it – that is, the general public. The critical key to the success of Abenomics was always that the various monetary injections and limited reforms would force wages, and thus spending, higher and so allow the economy to break free from deflation’s shackles. 

This is happening to a limited extent, but is neither sufficiently strong nor fast enough to achieve the desired outcome.

Helicopter money or additional quantitative easing in some form seems inevitable; it is quite unclear what this will achieve. In response to this mere prospect, Japan’s government bonds have already soared this year. The 40-year benchmark bond has rallied over 50 per cent and now yields only 0.25 per cent; Japan’s pension funds will be forced to invest offshore if they want to meet their future commitments.

More of the same (i.e. throwing more money at the problem) will only accelerate the capital outflow, it seems.

BUT, and this is a big but, investing in Japan should not be on the basis of whether Abenomics works or not. Japan’s companies are in much better shape than the economy owing to some massive and ongoing corporate restructuring.

Be a buyer of Japan’s companies not Japan’s economy is our counsel.

What are the risks and rewards of investing in Asian equities at the moment?

The reward of investing in Asia today is that one can buy some exceptionally cheap assets with attractive yields. Many of Asia’s high dividend equity stocks, for example, are to be found in the cyclical growth related stocks, which have been driven down into bargain basement levels owing to the fears already discussed.

The risk is that the fears highlighted above could drive low valuations even lower. Buying good value and tucking away seems the order of the day.

Asian bonds deserve a special mention. Negative yields and compressing yield gaps in the developed bond markets are forcing investors in search of yield to (a) increase the duration of their funds, and (b) move further up the risk scale. 

Under these conditions, the higher yields associated with Asian bonds are looking increasingly attractive. But as with equities, that good value could be accompanied by high volatility. 

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