Asian Equities

Equity | September 26, 2017

Ronald CC Chan, CFA, Chief Investment Officer, Equities, Asia (ex-Japan)

Global Intelligence Autumn 2017 - Asian Equities: The Backdrop Icon

THE BACKDROP

Earnings for companies in Asia- Pacific have outpaced market expectations in 2017, rising from around 13% at the start of the year to the current level of 21%.3

Asian equities posted steady gains in the second quarter that have accelerated further in the third quarter, although at a somewhat slower pace than the robust 13% increase registered in the first quarter.1

Two main factors drove performance:

First, the resilience of China’s economy, which grew by 6.9% in both the first and second quarters, beat market expectations.2 The reflation achieved in the first half of 2017, reflected in a gradually increasing Producer Price Index, has (partially) filtered downstream: retail sales remain buoyant, with auto sales rebounding in June and July.

Second, markets have benefitted from synchronized growth globally. As economic growth prospects improved, South Korea and Taiwan, two export bellwethers, have both posted economic gains. South Korea’s exports expanded for the ninth consecutive month in July, growing by 19.5% yearon- year. Taiwan posted 2.1% GDP growth in the second quarter on the back of strong technology exports to developed markets.2

These factors contributed to a “Goldilocks” scenario for Asia: steady growth, low interest rates, muted volatility, and a weaker US Dollar. As a result, earnings for companies in Asia-Pacific have outpaced market expectations in 2017, rising from around 13% at the start of the year to the current level of 21%.3 Earnings growth estimates for 2018 range from higher single digits to lower double digits, partly due to the base effect.3

Global Intelligence Autumn 2017 - Asian Equities: The Opportunities For Investors Icon

OPPORTUNITIES FOR INVESTORS

The previous regional export model of primary products has changed to include more sophisticated products in IT, consumer staples, and healthcare.

Net Foreign Buying in Emerging Asia (ex-China), 2016-2017

Net Foreign Buying in Emerging Asia (ex-China), 2016-2017
Source: Credit Suisse, as of August 31, 2017

The asset class’s outperformance in the first half of the year attracted capital inflows as a result of the reflation trade (see previous chart)4. This initially benefitted upstream industries such as energy and materials. As valuations in these sectors lifted however, reflation in Asia gradually filtered through to mid-and-downstream sectors such as industrials and processing.

Currently, some in the market are focusing on large, first-tier conglomerates in downstream industries. But we are readjusting our portfolios to seize opportunities at a more granular level in the following sectors:

Information technology

Large Chinese IT companies, particularly e-commerce platforms, have performed well in 2017. E-commerce sales in China grew by 10.4% year-on-year in the first half of 2017 after robust expansion in 2016.5 As profits and competition in the space increased, platform companies have aggressively struck mergers and acquisition deals with a wide array of service providers to expand their ecosystem offerings for consumers.

Although top-tier IT companies will continue to grow, we believe better growth opportunities exist in second-tier companies that provide services and products. Examples include game companies, app developers, and software developers that will provide the innovative ideas and products that drive platform and sector growth over the long-term.

Healthcare

We believe healthcare is a potentially high-growth sector that has not witnessed a rapid run-up in valuations. We especially like pharmaceuticals and biotechnology companies that are researching cutting-edge therapies. The potential market for these therapies is vast: many of these companies have plans to export products regionally and to developed markets. In our view, the rise of innovative, smaller healthcare firms in China will continue in tandem with the country’s rapidly greying population, playing a key role in the economy’s transition to a service-based economy.

Overall, growth in these sectors, particularly at the granular level among smaller companies, validates our broader investment thesis of Asia’s sound structural fundamentals.

The previous regional export model of primary products has changed to include more sophisticated products in IT, consumer staples, and healthcare. This structural upgrade will not occur overnight, but the region’s growing interdependence and innovation may lead to a further narrowing of the regional underweight by international investors.

Global Intelligence Autumn 2017 - Asian Equities: The Risks Icon

RISKS

Following the launch of a North Korean missile over Japan in late August, volatility on the Korean Peninsula has once again intensified.

Geopolitical and economic risks remain a concern. Following the launch of a North Korean missile over Japan in late August, volatility on the Korean Peninsula has once again intensified. US-China relations also pose risks: the Trump administration, currently in the process of renegotiating NAFTA, also announced an investigation into China's trade practices related to intellectual property protection in August. It is a long-term issue that could increase market volatility at any time.

G3 Central Banks in US, EU and Japan may offer up policy surprises to investors in the final quarter of 2017. The US Federal Reserve faces a potential conundrum over whether to raise rates further: steady economic growth with a tightening labor market is at odds with inflation persistently below the target level. The European Central Bank (ECB), meanwhile, will decide how and when to taper asset purchases as the Eurozone economy recovers. Any unexpected move could trigger increased market volatility and capital outflows from the region as liquidity has been a key factor driving positive market conditions.

ON OUR RADAR

In India, economic deceleration is amplified by the lingering effects of demonetisation and the implementation of the Goods and Services Tax (GST) bill.

Southeast Asia has been an economic bright spot in 2017. In the latest quarter, economic growth decelerated in some countries, along with lower inflation, leading to monetary moves. The Reserve Bank of India and Bank Indonesia both cut interest rates by 25 basis points (bps) in August. In India, economic deceleration is amplified by the lingering effects of demonetisation and the implementation of the Goods and Services Tax (GST) bill on July 1. While there is room for further interest rate cuts, government policy will be closely watched – especially fiscal stimulus.

The first few months of President Moon Jae-In’s tenure has seen several notable events in South Korea. A fiscal stimulus package that would boost total government spending in 2018 to roughly US$400 billion was proposed in late August.6 These policies, coupled with potential changes in the nation’s traditional government-business relationship, could represent the beginnings of a change in South Korea’s economic growth model: from corporate-driven growth to consumer-driven growth.

1 Bloomberg, as of September 6, 2017. Total returns for MSCI Asia Pacific ex Japan in US Dollar terms: Q1 12.84%; Q2 6.28%, Q3 to date 7.23%.
2 Bloomberg, as of August 29, 2017.
3 J.P. Morgan, as of September 4, 2017.
4 Bloomberg as of August 29, 2017.
5 Technode: China Online Retail Sees Rapid Growth In The First Half Of 2017, July 24, 2017.
6 Reuters: South Korea To Boost Government Spending In 2018 To Fund Welfare, Create Jobs, August 29, 2017.
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About the Author

The opinions expressed are those of Manulife Asset Management™ at the time of publication, and are subject to change based on market and other conditions. The information in this article including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Asset Management disclaims any responsibility to update such information. All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment or legal advice. Clients should seek professional advice for their particular situation. Neither Manulife Financial, Manulife Asset Management, nor any of their affiliates or representatives is providing tax, investment or legal advice. Past performance does not guarantee future results. This material was prepared solely for informational purposes, does not constitute an offer or an invitation by or on behalf of Manulife Asset Management to any person to buy or sell any security and is no indication of trading intent in any fund or account managed by Manulife Asset Management.

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