Perspective

Where we're finding value in Asian equities after turbulent time


As we approach mid year, it’s an opportune moment to consider what’s next for Asian stock markets. Macro events are likely to have a big bearing on markets but on these questions we can offer limited insight.

Will zero-Covid policies in China lead to new lockdowns? Will the Ukraine-Russia war escalate? Will the consumer in Europe and the US remain resilient (given tight labour markets), despite high oil prices and rising food costs? And will China-US tensions escalate to a full-blown trade/cold war? We don’t have the answers. Predicting “black swan” events and endlessly discussing tail risks is, we believe, pretty futile.

Instead, we’re trying to look through the maelstrom of economic and geopolitical noise to discuss where we see the best long-term investment opportunities in Asian stockmarkets, particularly given the big correction in valuations over the last 12 months.

Time to “be greedy while others are fearful”?

It has been a difficult period for Asian stockmarkets. The MSCI AC Asia ex Japan index is now back to pre-Covid levels and to similar index levels as five years ago. It does feel like we are at a capitulation level in the region and there is a lot of fear in markets.

While we might not want to be greedy yet, our appetites are rising. Using another Warren Buffet maxim, we are now seeing opportunities to “buy a wonderful company at a fair price”. This was opposed to 18 months ago when we were often looking at buying “a fair company at a wonderful price”.

phases-of-a-bubble-Webchart-1.png

The next chart shows more detail by sector. The black spot shows current price-to-earnings levels of the various Asian sectors versus peak to trough trends. What is interesting is most sectors are now cheap or fairly valued compared to history.

asia-ex-japan-sector-valuations.png

This contrasts with 18 months ago when nearly all sectors other than the out of favour “value” areas (banks, insurance, property etc… ) were expensive.

This ties in with the following chart where we can see stocks classified as “growth” and “value” by MSCI have now fully mean reverted back to their pre-Covid levels. At the current time, given the size of the correction, we see the best opportunities in stocks typically classified as more “growth” businesses.

value-and-growth-revert-to-mean.png

Still cautious on China

Looking within the market, there is certainly scope for a short-term rebound in Chinese stock markets given the extent of the sell-off and negative sentiment. However, we remain structurally cautious on Chinese equities.

This is due to multiple factors. These include short-term cyclical ones like the weak housing market, continued adherence to “zero Covid” policies, and slowdown in exports as global demand for manufactured goods declines.

But there are also more serious structural factors. These include the increasing role of the state in the economy, challenging demographics, elevated debt levels and macroeconomic risks, and geopolitical tensions and commercial cold wars.

Given the weak domestic Chinese picture, we want to buy stocks when they are genuinely cheap and once the more difficult earnings outlook is fully discounted. In light of the current backdrop we are still not convinced we are there yet.   

Look for the IP in tech

By sector we continue to favour technology. We have a preference for Taiwan semiconductors (both foundries and chip designers), Korean memory chip makers, and Indian IT software and services. This is the part of the technology sector in Asia where we view there is real intellectual property or “IP”. It is also where we expect to see both the strongest growth and, most importantly, highest returns on capital through the cycle.

By contrast, we view technology hardware equipment and assembly as having relatively low IP.  When we look at the battery and solar industries - the current “hot” tech sectors – many of the Asian stocks are hardware assemblers rather than long term high return businesses.

Interest in India if sell-off continues

An area of technology that looks attractive in the current weakness is Indian software and services. We do expect demand for consumer technology products to soften but we are currently not seeing any material slowdown in corporate spend. IT capital expenditure spend is strong. Most Indian IT companies are reporting rising backlogs and are struggling to cope with demand, which is resulting in wars for talent and rising costs. A moderate slowdown would be welcomed by most companies.

In addition, we are still at the beginning of the cloud migration and digitalisation process in India. Most companies, especially financial services, view this as vital. Government expenditure in this space for areas such as healthcare, taxation, services provision is also going to be large.  

We have been mindful of high valuations combined with unrealistic earnings expectations for a number of Indian stocks. If the current re-set continues, we would also see opportunities in Indian consumer stocks, private sector banks or potentially some of the internet names.

Another market piquing our interest in the current sell-off is Australia. Whilst the overall market has held up reasonably well, this has masked some very divergent performances. Resources and financials, which comprise around 60% of the MSCI Australian index, have done relatively well. However, some of the internet, healthcare and overseas (mostly US) exposed names have fallen sharply. 

Optimistic on scope for returns

Overall, we are optimistic on the potential to make returns in Asia in the next 12 months, assuming we avoid black swan events and global recession. Valuations are increasingly attractive and reflect a fairly pessimistic outlook for earnings.

China clearly has the possibility for a short-term rebound if Covid policies are relaxed, reformed or successful. However, we believe the best opportunities in Asia in the current sell-off are to pick up best-in-class businesses/global leaders in Taiwan, Korea and Australia.

 

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