Growth and deflation realization behind Asian sell-off
Following the global rout in share prices, we believe the most recent sell-off in Asia has been caused by structural changes which are leading to slower GDP growth and deflation in the region. This is resulting in a sharp (downward) reappraisal of the earnings outlook. This has come at a time of institutional and policy failures in many countries which have also caused a reappraisal of the “risks” of investing in Asia.
We don’t think this is rocket science. It results from three areas of disappointment and worry:
1. Deflation, sluggish growth and its impact on earnings
2. Serial policy and institutional failures across Asia
3. Emerging market debt woes
We believe Asian stock markets, and global stock markets in general, are only really now taking on board the full implications of what looks like a structurally deflationary environment.
This deflation comes from the excess debt levels in the global economy resulting from the madness of QE (quantitative easing) policies continued into perpetuity in many countries. This has prevented any deleveraging and ‘cleansing’ in the global economy.
We think the penny is finally dropping that with real GDP growth structurally lower in Asia, and inflation negligible, earnings growth is going to be much harder to achieve, and thus stocks should trade on lower earnings multiples.
On a slightly more positive note we are less worried about an Asian debt crisis. We had the misfortune to manage Asian funds during the 1997/98 crisis and the numbers this time round, whilst undoubtedly worrying, don’t look anything as bad as in 1996. It is also the case that the recklessness and hedonism we saw in ASEAN in 1993-97 in the run up to crisis has been broadly absent this time round.
However, Asian stock markets are now unequivocally cheap versus history. We don’t think the structural issues of deflation and slower growth are going away but we do think valuations broadly now reflect this ‘new normal’. We continue to believe the situation in China is manageable if the government accepts the pain and moves swiftly to deal with the bad debts that will spiral rapidly in China as liquidity tightens due to capital outflows and the slowing economy. We do, though, admit the risks in China of a worse outcome than our muddle-through scenario are clearly rising and the current policy flip-flops do not inspire confidence.
So what do we buy? This is easier to answer. In a world of deflation and disruption, we want cash flow, sustainable yields, innovative/adaptable companies and strong balance sheets.
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