Easing inflationary pressure to buoy Asian equities, says BNP Paribas IP’s Arthur Kwong
BNP Paribas Investment Partners’ head of Asia Pacific Equities Arthur Kwong believes inflation will start to slow in the region, to the benefit of Chinese and Indian companies.
Inflation continues to be a top theme for the quarter, though not as a risk factor. We expect to see inflationary pressures ease during the quarter, providing a boost to Asian equities. There are signs that inflation is easing already with many commodity prices holding steady or declining. We don’t expect a repeat of last year’s skyrocketing food prices, which were caused by unusually adverse weather conditions. Weather patterns in Asia have been more predictable this year and the monsoon season in India and Pakistan fairly typical, without the catastrophic flooding seen a year ago. All this should mean decline in food prices – the major factor behind higher Asian CPI. As the spot price on soft and hard commodities stays steady, this underlying inflation driver will lose steam. This
process is starting to happen, but it will take some time for headline CPI to decline because of normal lags in the market.
We remain bullish on emerging market stocks, which are trading at about a 10% discount to developed equities but are in higher growth markets. Emerging markets have also shown resilience during the global economic crisis.
China and India Top Beneficiaries of Easing Inflation
We remain overweight on emerging markets, particularly Asia. Asian markets were harder hit by inflationary concerns and should thus be among the first to benefit from easing inflation. Within Asia, we are keeping a close watch on Chinese and Indian equities, which are poised to rally on signs of easing inflation.
Chinese stocks are currently among the cheapest in Asia, pressured by overreaction to negative factors such as inflation. Valuations for Chinese equities are now around nine times forward earnings, considerably below peak levels of 32.8. We’re looking closely at the Chinese banking sector. Despite strong earnings results, Chinese banks have seen stock prices decline to lows not seen since the global financial crisis because of concerns about central bank tightening measures, non-performing loans and fears of dilution from expected rights issues. Easing inflation will lift one large overhang off the sector and ease funding pressure for smaller banks. One positive indicator for bigger Chinese banks: the tier one ratio is improving from 8.7% in 2nd quarter last year to 9.59% 2nd quarter this year.
Among Indian equities, the rally from easing inflation is likely to be more broad-based. Valuations are supportive though, at 13 times forward earnings, below peak levels of 15 to 16 times but not cheap. Valuations are higher relative to other Asian markets, but supported by India’s attractive long-term outlook. The Indian economy is fairly isolated from developed markets and the country is growing off a low base in metrics such as gearing ratio, infrastructure development and
labor costs. Moreover, the country’s large labor force is young. India’s main concern is execution and the country’s poor infrastructure, which hinders development. But we see India as an attractive investment for global investors looking for growth.
Overweight On ASEAN
ASEAN stocks look attractive for similar reasons as Indian equities: ideal demographics with young populations and growing workforces. The region also has lots of room for growth in areas such as credit card gearing and banking service. Moreover, the region is rich in resources. Indonesia is rich in coal and is a key supplier to neighboring India, which is seeing fast-paced growth, while The Philippines has abundant gold and copper. ASEAN stock valuations are also supportive at 13 times forward earnings, on par with the average in the region.
Within the ASEAN region, we’re most keen on Indonesia, Southeast Asia’s largest economy. Inflation is within official target range of 4% to 6% and showed signs of peaking during the first half of the year. Indonesian inflation fell to a 12 month low of 4.6% in July though it rose again in August, typical during the Muslim fasting month of Ramadan. Assuming food prices do not surge in the coming months, inflation rates may well drop lower. Easing inflation pressure means the central bank now has more flexibility in monetary policy. In other key statistics: the country has a very low debt-to-GDP ratio and GDP is expected to grow about 6% this year. Indonesian sovereign debt is also nearing an investment grade rating, which will make it less expensive for Indonesian companies to borrow going forward.
Meanwhile, the country is also seeing rapid growth in consumer spending, which is fueling economic growth. Robust coal and palm oil prices have strengthened Indonesian income boosting spending power. Indonesian companies are posting double-digit profit growth.
Thai equities also continue to be a favorite. Political unrest has weighed on Thai stocks for years yet the country’s economic fundamentals have remained strong with companies showing healthy balance sheets and growth outlooks.
Thailand is continuing to see some inflation pressure but we remain optimistic. The Bank of Thailand increased interest rates by 25 basis points to 3.5% points in August, its 10th rate increase in 11 meetings. The move precipitated a stock sell-off in August but we see the move as positive sign of the central bank focusing on long-term issues. The rate of further rate hikes is also expected to slow as inflation shows signs of easing.
Increasing Caution On Korean Stocks
Korean equities, like Chinese, remain among the cheapest in the region. Yet the outlook for the two countries couldn’t be more different. We are softening our overweight stance in Korea as the outlook is becoming less positive for the industrial country. Korean companies are largely dependent on exports that are closely tied to global growth: ships, automobiles and electronic goods. As concerns about US unemployment and US and European debt increase, we’ve become less positive on Korean equities.
Arthur Kwong is head of Asia Pacific Equities at BNP Paribas Investment Partners.