This article is part of Morningstar’s Guide to Investing in Asia where we navigate the potential risks for the chance of fantastic rewards from across the region.
Asia ex Japan investors have had a difficult time for the bulk of this year, with returns lagging world markets.
Within the region there were negative returns across the board, but the relative winners were the Philippines and India, while Indonesia and Malaysia saw the largest falls.
The Philippines has seen strong economic growth driven by domestic demand and a healthy current account position. India has seen some shorter term issues, with concerns over the impact of a potentially bad monsoon and over the rate of economic reform, which has led to some disappointments in terms of company earnings expectations.
That said, however, India remains an area of longer term growth. The reform agenda remains in place and there is scope for further monetary easing, with GDP growth forecasts for 2015 and 2016 remaining at high levels compared to both emerging and developed markets. It is of no surprise that Indonesia and Malaysia continue to struggle as both are net commodity exporters and have been significantly impacted by continued weak pricing. This has negatively influenced equity and currency markets, while political issues in Malaysia have exacerbated the problems.
Is China Slowdown to Blame?
In terms of impact on the Index, China, with a 28% weighting, has been significant and dragged returns firmly into negative territory. However, weakness in other large markets such as South Korea and Taiwan also contributed.
Following a strong end to Q2, Chinese data for July was a real disappointment and caused weakness in the equity market. The worst hit sectors were those industries with overcapacity problems, exactly what should be expected given the government’s economic rebalancing programme. This data was accompanied by the PBOC’s devaluation of the yuan, which many observers took to be a sign of a deeper deterioration.
This raised further questions over the true health of the economy and also the abilities of the Chinese authorities to control developments. Further monetary support, interest rate and RRR cuts and liquidity injections, have been aimed at stabilizing confidence in the economy, but have yet to yield convincing results.
Despite the continued slowdown in growth most estimates of H2 GDP remain very healthy in a global context, within a 6.5-7.0% range. However, all seem to acknowledge that forecast error risks are to the downside without further substantial stimulus.
The market in South Korea also weighed on index returns over the year to date. Growth slowed significantly as private consumption was depressed, in part due to the MERS (Middle East Respiratory Syndrome) outbreak, and exports were weaker than expected due to slack global demand. Sluggish exports also impacted returns in Taiwan, together with some weakness in the technology sector that makes up over 50% of the MSCI Taiwan Index.
What Has Done Well?
Looking at the region as a whole, it is clear that on average, winning stocks have continued to outperform, with price momentum being a significant positive factor over the year to date. Value has not been a successful style as stocks with high short-term valuation metrics have done well, together with high earnings growth and earnings momentum stocks. Surprisingly, despite the widespread market weakness, large-cap names have not fared better than their smaller counterparts. Mid-caps, in particular, have done well versus the larger and more liquid parts of the market. This has been taken by some as suggesting widespread selling via ETFs or index derivatives.
What Can Investors Expect from Asia?
In terms of the outlook, most investment managers highlight the overall attractiveness of the Asia ex Japan region in terms of valuation, with the region as a whole being cheap relative to its history over the past ten years. That said the main concern remains future growth. Although in aggregate margins have seen some improvement and capex has been reduced, sales growth has continued to decline. Clearly the region is not immune to global economic conditions, despite pockets of strong domestic demand. Looking at GDP growth estimates, commentators retain relatively high growth rates for India and China - Asia ex these two countries shows much less impressive growth, estimated at around 2.9% for 2015 and 3.2% for 2016.
Given the above, it should come as little surprise that within our Asia ex Japan peer group, the average shows an overweight allocation to both of these markets. Most active managers remain positive on India although rotating within this market based on valuations. Although reforms may take longer than at first envisaged to materialise and expectations may at times be too high, there is a clear consensus over future growth potential. Within China the outlook is less clear. The country is continuing on its rebalancing path, seeking to move away from an export and manufacturing driven economy towards services and domestic demand. In doing so there has been a clear aim to have a greater reliance on market forces and the recent yuan devaluation can be viewed as a step in this direction, but some investors remain concerned about the methods employed, the motives of the policymakers and the overall effect of the transition on growth. The recent interventions in the A-share market have only served to strengthen these concerns.
Clearly for a meaningful advance, markets will require a pick-up in global exports and some stabilisation in China.
A version of this article originally appeared in International Adviser magazine
