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Allure of Asia ex-Japan equities strengthened in Q3

In the last two quarters (Q2 and Q3), Asia ex-Japan equities ranked third for European investors, behind infrastructure and private equity, according to Last Word Research.

And investor buying intention rose most recently in Q3 (see graph below).

Source: Last Word Research

Expert Investor asked asset managers why investors seem to favour Asia ex-Japan equities.

Q: Why do you believe that European investor sentiment towards Asia ex-Japan equities increased in the last quarter?

Nicholas McConway, portfolio manager Asian equity at Amundi Asset Management, said: “North Asia, such as China, Korea, Taiwan and Hong Kong, have all managed the covid pandemic very effectively, limiting outbreak numbers and allowing both production and consumption to rebound relatively quickly. Some South Asian economies have been less successful in containing virus numbers.

“Indeed, exports from the region have also performed better than expected, possibly down to supply chain advantages stemming from better overall management of the virus and heightened demand from some specific sectors such as IT and medical supplies. This has led to rebounding gross domestic product and also expectations of rebounding earnings in the coming quarters.”

John Malloy, managing the global emerging markets fund at RWC Partners, said: “From a macroeconomic perspective, central banks and governments in developed markets continue to provide economic stimulus at unprecedented rates. Furthermore, history shows that the expansion of developed market central bank balance sheets has resulted in large capital inflows into Asia ex-Japan and other emerging markets.

“The outlook for Asia ex-Japan remains encouraging. Most governments and authorities in Asia are dealing with covid-19 effectively and these economies are recovering quicker than many developed markets in Europe. For instance, in China, industrial profit growth has risen 19% year-on-year, PMIs remain above 50 and exports have recovered. Similar dynamics can be seen in other North Asian markets such as South Korea, Taiwan and some South East Asian economies, such as Vietnam.”

Robert Horrocks, chief investment officer and portfolio manager at Matthews Asia, said: “Partly, it is as simple as the fact that they have seen improved performance versus global equities. This always makes investors take notice.

“However, I also believe that many were getting interested in A-shares (for benchmark reasons and for the overall opportunity set) over the last two years. Just as that interest started to crystallise into allocations, covid-19 happened.”

 

Q: How much diversification can Asia ex-Japan equities provide for European investors in a time of covid-19 and accelerating US-China trade tensions?

Matthews Asia’s Horrocks commented: “Correlations across markets remain high. However, that is because benchmarks contain a high percentage of financial stocks, tech exporters and raw materials companies which can be sensitive to global liquidity and growth. To the extent that you stick to mostly domestic demand businesses, you can get much better diversification.

“It is also true that the US-China tensions have caused people to look at China as a strong, independent economy – much more than they would in the past – and therefore the attraction of single-country China portfolios has increased, in no small part due to perceived opportunities to diversify over the long run.”

RWC Partners’ Malloy explained: “US-China trade tensions have impacted sentiment towards the asset class in recent years, but the majority of Asia ex-Japan equities in our portfolio are domestically focused with encouraging growth profiles.

“For instance, Sangfor Technologies, one of China’s leading IT infrastructure companies, is growing at a 40% earnings CAGR, taking advantage of the growth in cloud computing and cyber security. This impressive secular growth is something that is relatively insulated from variables such as trade tensions, despite market movements.”

Amundi’s McConway said: “Asia ex-Japan is a very diverse universe, with broad exposures to both domestic economies and to Western demand in the form of exports. This domestic recovery, which in many cases has been healthier than Western economies, means there is less pressure on central banks, local currencies and corporate debt accumulation.

“Indeed, the deflationary forces are much more minimal. We believe economic nationalism and trade tensions will not go away, however we hope there will be more transparency and bilateral negotiations in the future, which may end up benefitting all parties.”

 

Q: What is your view on USD and how does it impact Asia ex-Japan equities?

RWC Partners’ Malloy explained: “We believe that covid-19 related stimulus, the resulting US fiscal deficits and an improvement in the global growth outlook will be some of the factors that will likely lead to a weaker dollar over the medium term. The uncertainty surrounding the upcoming US presidential elections should continue to pressure the dollar, leading to increased capital flows into emerging markets.

“Furthermore, emerging market currencies have stabilised and remain competitive, considering a recovery in current accounts as export market share remains well-supported.”

Amundi’s McConway said: “The USD has been quite weak reflecting the relative deteriorating growth outlook as covid has progressed. A weak dollar is typically positive for Asian assets. In the near term, there are certainly some binary outcomes that may impact the USD, however we do not see the USD as being structurally weak.

“We think a stable dollar is a sufficient condition for Asian markets to perform.”

Matthews Asia’s Horrocks said: “Typically, a weaker dollar is beneficial for Asia ex-Japan market performance. It particularly helps current account deficit countries like India or smaller open economies such as those of Asean. A weak dollar is therefore associated with a broadening of market performance.

“It is somewhat less important for a large country like China, which is driven by domestic demand. We do not have a strong view on the dollar but expect perhaps a moderate weakness. The market seems to believe that a democratic win would create a somewhat weaker dollar; however, it is hard to be sure.”

 

Q: What will drive opportunities for Asia ex-Japan equities at the end of this year and in 2021, and where do you see the biggest risks?

Amundi’s McConway said: “We continue to like China, where the economy has made a notable recovery; we also like India where the covid experience has been more challenging. But valuations can be interesting when looking at longer term growth opportunities; and we see specific opportunities in technology and clean energy across the region, as longer-term trends have been accelerated and natural consolidation has happened on the supply side.

“We watch very closely the rate of recovery in developed markets, considering the very easy nature of monetary and potential fiscal policy and we keep a very close eye on the shape of the yield curve.”

Matthews Asia’s Horrocks commented: “I continue to emphasise the labour share of GDP, which has risen in Asia ex-Japan over the last decade causing a headwind for corporate profit growth. However, the flip side is that society is less divided and Asia ex-Japan can at this point pursue more balanced policies and spur earnings growth, whilst the developed world and particularly the US may have to turn more pro-labour.

“The risks in the market are probably due to the wide disparity in performance and valuations – some higher growth conceptual stocks will have to justify their valuations. Distinguishing between the real opportunities and the hype is important. Smaller companies may be set for better performance against the mega caps. However, the outlook for the region relative to the rest of the word, over the medium term, looks strong.”

RWC Partners’ Malloy said: “Technology remains a key growth area, as increased penetration of 5G should lead to higher demand for hardware and memory. GDP per capita in Asia ex-Japan economies is still below developed markets and factors such as urbanisation, better education and a rising middle class should result in rising demand for discretionary items.

“Economies such as China benefit from a structural trend of consumption upgrades especially within the auto segment. Food delivery is another sector in which we see significant potential throughout Asia as internet penetration increases. New media, leisure & gaming is also a key area of growth. Despite the impact of covid-19, we expect travel in the region to recover over time further driving economic growth.

“In terms of risks, a substantial increase in covid-19 cases in the region, a deterioration in the geopolitical risk between the US and China and a counter-trend rally in the dollar, but we believe these to be low probability risks.”

Elena Johansson

Senior Reporter

Part of the Bonhill Group.