The near-term outlook for Asian equities doesn’t appear to be a great deal better than in 2022 at a time when interest rates are rising around the world. However, it’s not all bad news. Valuations in many areas are now cheap, sentiment towards Asian equities is already depressed, and any improvement in the macroeconomic backdrop could spark a sharp rally from current levels over the medium term.

Globally challenged

The global macro environment remains very difficult. Central banks in major Western economies, are being forced to raise interest rates aggressively to slow growth and curb the inflationary pressures that have built up in the past 12-18 months. The US may be tipped into recession as the Federal Reserve (Fed) continues to raise interest rates at a very aggressive pace and the country’s housing and labour markets slow. Europe is under even greater strain as rapidly rising energy costs and disruption from the Russian-Ukraine conflict heap further pressure on living costs.

Coming after a long period of very low inflation and near zero interest rates, this sharp regime shift is presenting a major challenge for consumers, corporates, governments and investors worldwide and has raised volatility across capital markets.

Asian exports under pressure

Slower global growth and weaker demand for durable consumer goods is already significantly impacting Asian exports, particularly products from the technology sector. 

The market has moved rapidly to price in a sharp downturn in semiconductor demand over the next few quarters.  This has been much to the detriment of equity markets in Korea and Taiwan, both of which are dominated by export-related industries.

In mainland China, the world’s second largest economy and the biggest in the Asia region, ongoing Covid-19 measures have dampened domestic demand, especially affecting those industries that are more consumer-related.

Meanwhile, a deliberate clampdown on leverage in the property development sector has caused a liquidity crunch. Subsequently, sales have collapsed, so too new construction activity as buyers defer buying flats and developers hoard cash. With property construction driving more than 20% of economic growth in recent years, this has further depressed economic activity and market earnings. 

Outlook for Asian equities

More immediately, there are two key variables that could determine the 2023 outlook for Asian equities. The first concerns mainland China’s response to Covid-19 outbreaks. Any sign that mainland China is to relax its dynamic zero-Covid policy is likely to be received very positively by the market given the potential boost to earnings and valuation multiples following the performances seen in the past 18 months.

Our base case expectation is that changes to the policy will be incremental,. However, this could still be enough to improve sentiment and boost economic growth. It would also help support the market in Hong Kong SAR and have a spill-over effect for growth in other regional economies given the close trading links.

The second variable is the extent of future rate hikes required to quell inflation pressures in the West and then the shape of the economic slowdown in the US and the EU, whether it is a soft or hard landing. A peak in the interest rate cycle is also likely to lead to a weakening of the US dollar, which should help liquidity for Asian economies and support equity market valuations. Clearly, the sooner that US inflation and interest rate expectations peak the better the outcome for equity markets globally.

Areas of the market we favour

Despite the near-term challenges, we continue to like global industry leaders in key Asian export sectors, including technology stocks in South Korea and Taiwan that have favourable long term secular growth drivers.

The Hong Kong SAR market also offers considerable value and strong businesses that can ride out the current downturn. Financial companies in Hong Kong SAR, Singapore, and parts of Southeast Asia will also be beneficiaries of higher interest rates and offer attractive valuations and yields. 

The Indian market also offers some attractive long-term opportunities given the low levels of credit penetration and significant ‘catch-up’ potential for the economy. However, after a very strong performance in last 2-3 years valuations are now more stretched. Australia also offers attractive buying opportunities and a more defensive profile.

We are focused on a subset of the mainland Chinese market that offers either an attractive risk-reward from any eventual rebound after the easing of Covid-19 restrictions, or companies that are closely aligned with the government’s strategic priorities.