The region has been hit by concerns over a US slowdown and rising risk aversion in the wake of the US sub prime mortgage crisis, with many investors seeing Asian markets as a high beta play on US Growth. Foreign investors have consequently sold down Asia aggressively as a way to reduce risk in their portfolios.
Rising inflation has also negatively affected Asian equity markets. Inflation, especially food inflation, is now at multi-year highs in most Asian countries, with inflation numbers in China, India and Indonesia particularly high. The possibility of further monetary tightening around the region and the impact of rising input prices on corporate profitability have to be monitored closely.
Finally, valuations had begun to look stretched, sparking some profit taking. After a 40% run in 2007, Asia ex Japan started 2008 with a PE (price-to-earnings) of 16x, the first year since the start of the decade where Asia entered the New Year trading at a premium to most other global equity markets. It is therefore perhaps not a surprise that Asia, particularly China and India, experienced the most profit-taking/foreign-led selling in the first quarter of 2008.
The global economy is weakening and inflation in China remains a threat. Therefore, Asian markets are likely to remain volatile over the next couple of months. Several Asian markets, especially the Indian equity market, also remain vulnerable to changes in global risk appetite as foreign inflows have been the major driver of these markets. We therefore continue to monitor fund flows and global risk sentiment closely, while cash levels in our portfolios have also risen marginally.
However, Asia should be supported by still strong corporate earnings growth, as there is no sign of any immediate impact from the US subprime crisis on Asian earnings. In fact earnings growth in Asia remains strong, led by China and India, which are forecasted to grow earnings by around 20%2 in 2008 according to our estimates.
As well as offering strong earnings growth, Asian valuations are looking much more attractive after the sharp recent correction. Valuations are back down around 14 times forward earnings on many markets. In particular, valuations in Korea and Thailand look very attractive at around 11x forward PE, and these two markets remain among our preferred markets on an asset allocation basis.
Historically, Asia’s status as a region that performs particularly well when the US economy is strong was warranted. This was because the Asian equity universe was dominated by technology/export related stocks, while Korea and Taiwan, the two markets with the biggest technology weightings, dominated Asian equity indices.
A sharp US slowdown would hurt the whole world, and Asia would not be spared. Nevertheless, Asia is less linked to the US than in the past, supported by increasing intra-regional trade. In terms of economic decoupling, many Asian markets are less dependent on exports than before thanks to the growth of domestic demand. Even in China, exports only make up a relatively small amount of over GDP, while less than 20% of China’s exports go to the US. Instead, China’s growth over the past several years has been led primarily by household consumption and investments rather than by net exports.
Continued strong investment spending to boost growth across Asia due to secular urbanisation and industrialisation trends that are not linked to the export-sector or to the US housing market. There is the need to upgrade infrastructure (India), to address the rising demand for housing (China) and to develop the resource sectors (Indonesia, Malaysia).
In addition, incomes are rising strongly across Asia, particularly in China and in India. This is translating to strong retail sales and consumption growth in these countries. Portfolios are generally structured to gain exposure to these secularly growing sectors and countries.
Asia remains a compelling investment choice.
Although further volatility is likely in the short term as slowing US growth, rising inflation and volatile investor risk appetite impacts sentiment, we believe that, on balance, the outlook remains positive for
the Asia ex Japan region.
Although the global economy is weakening, Asia’s growth still looks strong, corporate earnings are well supported and valuations look reasonable. Also, over the longer term, we continue to believe in Asia’s attractive fundamentals – strong balance sheets, high levels of savings, appreciating currencies, and positive demographics – as well as other long-term structural growth drivers such as urbanization and industrialization.
As a result of the emergence of these positive long-term fundamental factors, I also believe that Asia should weather the US slowdown better than it has in the past. In fact, more than at any other time in the past, there is now a strong case for Asian economies and markets to slowly decouple.