It’s a curious thing when the world’s biggest growth market, Asia, has dramatically underperformed American and European stock markets, this year and over the past 12 months. Particularly as it should be a key beneficiary of any green shoots of global economic recovery. More curious still is that Asia’s most cyclical markets – China, South Korea, Taiwan and Malaysia – which should be the largest winners from any economic pick-up, have been among the worst performers in Asia.
How can this be? There appear to be four factors at play: 1) there’s little evidence of an economic upswing in the region 2) yen depreciation has altered the landscape for key export competitors in Asia 3) there are fears over inflation and tighter monetary policy in key economies such as China 4) politics has played a part with leadership transitions in China and South Korea adding to policy uncertainties. Asia Confidential doubts these factors will turn around this year and suggests investors stick to countries/stocks exposed to domestic consumption and which are available at a reasonable price – such as India, Thailand banks and Singapore dividend plays.
Lagging Asian Markets
While the so-called animal spirits are back in the U.S. as the Dow reaches new highs, the same can’t be said for Asia. This year, Asia (ex Japan) has barely budged, up just 0.2% (as at March 14). That compares with increases in the MSCI World, S&P 500 and Europe’s Stoxx indices of 6.8%, 9.4% and 5.8% respectively. Granted that we’re only 10 weeks into the year. But even over the past 12 months, Asia’s 3.1% return has badly lagged that of MSCI World, S&P 500 and Europe’s Stoxx at 9.5%, 11.5% and 6.6% respectively.
And Asia’s supposed to be the world’s largest growth market! Delving deeper into the numbers though, it’s evident that there’s somewhat of a north-south divide when it comes to stock market returns. South-East Asia has continued its barnstorming run, with the Philippines, Indonesia and Thailand again leading the way, up 17.4%, 12.4% and 9.5% year-to-date (YTD) in USD terms respectively.
Some of the laggards have been in the more export-oriented economies in North Asia. China has been the second-worst performer in U.S. dollar terms this year. That’s after being the worst performing Asian market last year. South Korea has also been a poor performer. The other lagging market, Malaysia, is the primary exception to north-south divide. Though it is one of the region’s heaviest exporters.
The MSCI Asia-ex Japan index detailed in the table below gives heavier weightings to larger economies such as China, South Korea and Taiwan. Being poor performers, they’ve helped to drag down the performance of the overall Asia index.
Source: Credit Suisse, IBES estimates. Note performance figures are in USD.
It’s also interesting to note some of Asia’s cheapest valuations are now found in some of the most export-dependent countries, principally China and South Korea.
Possible Explanations
At first glance, Asia’s poor relative performance seems somewhat counter-intuitive. After all, there is seemingly a recovery in the world’s largest economy, the U.S., and some stabilisation in the worlds’ second largest economy, China. Shouldn’t Asia, a growth market still heavily reliant on exports, be benefiting from this? And shouldn’t the region’s most export-dependent countries, be among the largest beneficiaries?
For us, there are four reasons for Asia’s under-performance:
1) Though data in some developed markets suggests global economic growth is picking up, there’s little evidence of that in Asia. Many will point to the recent surge in Chinese exports as evidence, but this writer would beg to differ. Though official figures suggest China’s exports increased by 22% in February, many sell-side analysts have rightly caste doubt on the figures. They point to strong China money inflows, which suggests exporters overstated their business to get funds back into the country and avoid capital restrictions.
Importantly, more reliable export figures from South Korea and Taiwan indicate little in the way of recovery. In February, South Korean exports fell 8.6% year-on-year (YoY). Combining January and February, thereby smoothing out the impact of the Lunar New Year, exports from South Korea grew 0.6% YoY, marginally better than the 0.4% decline recorded in the fourth quarter of last year.
Source: Ministry of Knowledge Economy, CEIC and Morgan Stanley Research
Similarly, Taiwan exports in February fell 15.8% YoY. Combining January and February, exports increased 2.1% YoY compared with the 2.5% rise recorded in the fourth quarter last year.
2) The substantial fall in the Japanese yen is beginning to impact key exporting rivals in Asia, including South Korea and Taiwan. These countries sell similar products to Japan and they’re not only significant exporters to nations outside Asia but also to Japan itself. Yen depreciation explains some of the weakness in the export figures of these countries. It certainly explains much of the weakness in their stock markets.
Source: Bloomberg
3) There are concerns about tighter monetary policy given rising inflation in some countries. Developed markets continue to benefit from easy money policies with interest rates still at very low levels. In Asia, the cycle of lower interest rates appears to be coming to an end. This is particularly the case in China, where there are growing concerns of a credit bubble and with inflation again rearing its head. Credit tightening in China is already happening and interest rate rises may soon be on the way.
4) Political uncertainty hasn’t helped. In China and South Korea, the new leaders are still settling in and any significant economic reforms are yet to be pushed through. In Malaysia, an election looms and the current government’s hold on power looks decidedly shaky. Investors have been fearful of the uncertainty that a potential regime change may bring.
Underperformance to Continue
Asia Confidential thinks there’s a good chance that Asia’s underperformance versus developed markets continues for the remainder of this year. None of the factors behind the underperformance shows signs of turning around.
A sustainable upswing in the world’s largest economies is the key to better stock market returns in Asia. Better growth would not only help the region’s exporters but a normalisation in rates and reduction in quantitative easing (QE) would help stem hot money flows into Asia and thereby limit inflation.
But I remain sceptical that these events will happen any time soon. While better growth appears more likely out of the U.S., an end to QE seems some way off. Also, other key economies including the EU, China and Japan are showing no signs of genuine improvement.
In addition, Japanese yen weakness appears to be a structural change. Most financial observers think that Japan will succeed with its 2% inflation target and the depreciation in the currency will be gradual. My own view is that whether Japan succeeds or not with its inflationary policies, its debt endgame is near. If successful, bond yields will rise and all you need is 2% bond yields for interest costs to eat up 80% of Japanese government revenues. If unsuccessful, Japan’s debt will spiral higher and at some point, the bond market will revolt, demanding higher returns for the extreme risk that it’s taking on. Either way, a much lower yen can be expected. And the pressure on other Asian exporters will remain.
Tighter monetary policy in Asia also looks to be more likely than not from here on. This is particularly the case in China, where a credit bubble is at risk of popping. Expect inflation to rise much further in China and for tighter monetary policy for the rest of 2013. Inflation issues in other Asian countries, such as India and South Korea, also leave limited scope for easing.
Finally, political uncertainty should ebb somewhat but not enough turn markets around. China’s political handover is complete and the new leadership can now deal with the significant issues that it’s inherited. The largest uncertainty is in Malaysia, where an election looms. A toppling of the ruling National Front party, in power since the country’s independence in 1957, would be a historic event. While markets would hate an Opposition win initially, it could represent a potential buying opportunity as Malaysia desperately needs change (whether under this government or another one).
In India and Indonesia, elections scheduled for next year may bring further uncertainty as the year progresses. In both countries, the ruling parties hold on power is far from assured.
Where to Find Winners
Given the above, Asia’s best story, in the short and long term, remains the domestic consumer (it’s probably the world’s best growth story too). It’s here where investors should focus their attention rather than the export-intensive countries/stocks.
The problem is that many countries and stocks exposed to domestic consumption have been bid up already. Credit cycle upswings and buoyant consumers in the Philippines and Indonesia have clearly caught investor attention. The Philippines now trades at an 81% premium to Asia ex-Japan on a forward price-to-earnings (PER) basis. Indonesia trades at a 27% premium. And while Thailand trades at less than a 10% premium to the rest of Asia, its consumer stocks trade at 2x the Asia ex-Japan PER.
Better value is likely to be found elsewhere. India appears reasonable value at 12x forward PER, with earnings at depressed levels. While consumer staples are expensive here, consumer discretionary stocks, particularly autos, are inexpensive. Banks are also cheap, but a number are cheap for a reason (state-owned and/or badly run).
You’re also likely to find value in Thai banks. They’re trading at historic averages and are a good way to play the rising Thai consumer. Thailand’s economy is travelling well and its politics is stable for the first time in a long while.
I also like some Singapore stocks offering high dividend yields. Some of the REITs offer value though be careful which segment you have exposure too (I prefer industrial and retail). In addition to the yield, you’re likely to get an appreciating currency given Singapore’s fortress balance sheet and sensible monetary policies (it refuses to print money while the rest of the world goes crazy).
As I mentioned previously, Malaysia is also worth keeping an eye on. An Opposition win would see the market tank, but this could prove a good opportunity. Be wary though of companies which have benefited from the current government’s largesse (many of them).
Source: Asia Conf.
