Asia outperformance to persist

We continue to believe that Asian equities are poised for further outperformance; we prefer exposure to Hong Kong/China and emerging ASEAN.
Joanne Goh, Jason Low18 Apr 2018
Photo credit: AFP Photo

After underperforming Developed Markets (DM) since 2010, Asia equities began to outperform in late-2016 and have continued this trend year-to-date (as of 19 February), despite the sharp and swift correction in early February. Macro and corporate fundamentals remain solid. Asia earnings are still in the mid-cycle at a time when economic growth backdrop remains robust. Valuations are attractive both on an absolute and relative basis. With a gradual US rate hike outlook still in place, despite fears of rising inflation, we continue to believe Asia equities are well poised for further outperformance. We prefer exposure to Hong Kong/China and emerging ASEAN (Indonesia, Thailand, and Philippines).

Still in a sweet spot. Synchronised global growth, rising earnings, undemanding valuations, and relatively accommodative monetary policies from major central banks place Asia equities in a sweet spot. While inflation fears have surfaced and could potentially adversely affect risk appetite for Asia equities, we believe as long as global growth continues above trend, they could take on a relatively higher US interest rate environment on the back of favourable economic fundamentals, abundant liquidity, strong earnings, and relatively stable currencies. The recent sharp correction - caused by inflation concerns and exacerbated by forced liquidation from strategies that were leveraged to low volatility - has made it easier to find value. Indeed valuations, post-correction, are now 13.3x forward price-to-earnings (P/E), which is slightly above the long-term average valuation of 12.9x (Figure 1).

Positive macro backdrop. Asia economic fundamentals remain strong. After suffering an extended period of slowdown in investment growth, the region’s prospects are now brighter – led by China’s above-consensus 6.9% full year gross domestic product (GDP) growth in 2017. In the world’s second-largest economy, investment by private firms rose 6% in 2017 – a sign that the private sector outlook could be improving. Asia’s other economic giant, India, is poised to grow 7.2% for the fiscal year ending March 2019, according to our estimates. Indeed, Asia’s output gaps are generally negative with growth potential, and without concerns of overheating.

Gradual rate hike outlook supportive of Asia equities. While there have been recent fears over inflation surprise on the upside that would force the Federal Reserve to raise rates faster than expected, consensus is still expecting three rate hikes in 2018, which is very gradual in our view. New Fed Chairman Jerome Powell is expected to bring about a relatively high degree of continuity and gradual monetary normalisation. The risk here is if inflation were to surprise significantly on the upside and US Treasury 10-year yields were to break and stay above 3% for an extended period. We would then
review our positive stance on Asia equities. For now, that is not our base case.

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