Commenting on the Asian backdrop of current events
Monetary Policy Backdrop
- Recent abrupt movements in equity markets have been driven primarily by sentiment and liquidity than by economic fundamentals.
- Behind the current weak global growth is tighter monetary policy in the U.S. and Europe during recent years, particularly since the Fed began to discuss tapering in May 2013. As China pegs its currency to the US Dollar, China has also faced tight monetary policy at a time (at least since it got its credit binge under control last year) when it would like to stimulate its economy to response to weakness in the manufacturing sector, low inflation and overall slowing growth.
- Accordingly, one reason for last week’s ‘devaluation’ (in addition to efforts to get into the SDR basket) is to provide Chinese monetary authorities with more flexibility to pursue an independent monetary policy.
- We expect that the stock market declines will prompt reaction from central banks around the world, including China, the ECB and even the Fed (through deferral of the interest rate hike or modification of its statements about tapering).
- We believe that talk of currency wars is misleading. What is really happening are steps to reflate local economies – because devaluations typically lead to more stimulative monetary policy. Arguably, Asia needs some inflation at this point in time and the currencies in Emerging Asia have priced in even more ‘devaluation’ than has taken place to date.
- We have seen the monetary cycle start to reverse in some of the large economies in China and India. With inflation falling, there may be an opportunity to further cut rates.
- The recent economic growth in Asia has been challenging and we are seeing some downgrades of companies in certain parts of the region.
- However, a lot of those challenges are concentrated in the industrial/investment side of the Asian economies.
- We do see some hopeful signs emerging. For example, the monthly indicators in India seem to be turning positive, albeit these can be volatile. In China, the real estate sector (which has been a significant drag for the past two years) is showing signs of stabilisation. We also see signs of wage growth in Japan (although Japan has not necessarily been lumped together with ‘Emerging Asia’ and China in the recent market discourse).
- Consumption across the region is a lot more resilient than investment. We have yet to see any significant slippage in wage growth across China – if anything, the demand for labor continues to outpace the availability of labor. As a result, services (defined as tertiary industries) now account for a bigger chunk of the Chinese economy compared to industrial (defined as primary industries).
- Revenues (perhaps a reflection of demand) remain uneven across corporate Asia, but the fall in commodity prices, continuous efforts at cost reduction, and further relaxation in interest rates are key factors that may support profitability and return on capital. Asia remains the part of the world where productivity is growing fastest and the region’s fundamental strengths of high savings rates and a thriving entrepreneurial culture remain intact, as does the rise of incomes and consumption across the region.
- Given the recent fall in equity markets, and currencies across the region, the absolute and relative valuation across Asia is starting to look attractive. The unfortunate linkage of Asia with the rest of the EM may continue to act as a headwind in short term, but we see opportunities across our portfolios as fundamental performance is not as bad as the stock price reactions indicate. Certain names are looking outright cheap.
- By certain measures, MSCI AC Asia ex –Japan Index is trading at the lowest point in the past 10 years. (for reference, MSCI AC Asia ex-Japan Index’s P/E is at about 11x and S&P at about 17x)
- This is perhaps the softest point for Asia at the moment, especially if the Fed starts to raise interest rates (which is looking less certain after the past few days’ events). However, it is worth noting that real interest rates in many parts of Asia have increased compared to the taper tantrum of 2013. Furthermore, FX reserves have generally increased over the past two years – again suggesting some buildup of defense against likely outflows.
- We do observe bearish sentiment in the marketplace. From a liquidity perspective, however, over recent trading days we have not experienced difficulty in adjusting positions or raising cash when required for the portfolios. A number of our portfolio managers would not mind having additional capital to deploy.
Robert Horrocks is CIO at Matthews Asia