After five years of uninspiring relative returns, will Asia ex Japan equities crow loudest in the Year of the Rooster? The Asian markets beat global equities comfortably during the 2000s but have lagged since late 2010. However, on a medium term view, this may be about to change.
Improving Economics. China is of course the biggest player in the region and changes in the Chinese economy help to explain strong equity returns in the 2000s and weaker ones since. The Chinese authorities have deliberately slowed the economy, seeking more sustainable growth led by consumer demand and services output. The markets doubted whether China would succeed but may be changing their minds.
The IMF said last month that it expects Asia’s emerging economies to grow by 6.4% this year. China will slow a little to 6.5% and India pick up to 7.2%. Private sector forecasters are pencilling in 6.4% and 7.4%. Despite large error bands around any economic forecast, Asian growth looks impressive.
Looking at more timely indicators, Asia’s purchasing managers’ indices are mainly above the key 50 level: South Korea is the key exception. More interestingly, Citi’s economic surprise index for Asia Pacific recently hit a six-year high. The markets did not anticipate the better figures.
At an industry level, DRAM prices are rising sharply. In fact, they have doubled over the past eight months. Meanwhile, the International Air Transport Association noted late last year that shipments of components for consumer electronics, a regional strength, are rising. It also reckons that total freight volumes rose 9.8% yoy in December.
Cheap Equity Markets. After a long period of weak equity returns, it is no surprise that valuations are attractive. As of 31st January, MSCI calculated a forward P/E ratio of 12.7x for Asia ex Japan equities versus 15.7x for MSCI World and a price-to-book ratio of 1.5 compared with 2.2. This is despite a strong rally in Asia ex Japan stocks in January. Today’s valuations also compare favourably with those over the past decade.
Under-valued Currencies. Foreign investors can also take heart from generous currency levels. Over the past couple of years, the Korean won has depreciated by 5%, the Indian rupee by 8% and the Chinese renminbi by 9% versus the US dollar. As trading nations, these currency declines have given exporters an edge and also reduced the risks for overseas equity investors.
Investment Conclusion. Leaving aside active funds, many investors will seek to invest via an MSCI Asia ex Japan ETF rather than pick individual stocks. 85% of the index covers five economies (China, South Korea, Taiwan, Hong Kong and India) and over 60% is in three sectors (information technology, financials and consumer discretionary). Thus, exposure is concentrated in a few economies and industries.
True, there remain concerns over how China handles its transition and also rising private sector debt ratios. There are also worries over US-China relations in the Donald Trump era. However, the fundamentals seem good and both equities and currencies offer fair value. The only caveat is the 8% rally for sterling investors since Christmas. It may be wise to wait for a setback.
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