Asia ex Japan equities extended their losses in a volatile quarter for world markets. The MSCI AC Asia ex Japan index recorded a negative return though it outperformed the MSCI World index. Persistent concerns over the US-China trade conflict and the pace of US interest rate hikes dominated sentiment. The darkening global economic outlook further troubled investors. Notably, China’s economy recorded its weakest quarterly growth since the global financial crisis. Industrial production and retail sales also slowed more than expected, heightening growth concerns. Policymakers responded with measures to support the economy, including cutting banks’ reserve requirement ratios and boosting credit for small and private companies.
Across the region, export-oriented markets Taiwan, South Korea and China posted sharp declines. Taiwanese and South Korean stocks were dragged lower by steep falls in technology heavyweights. In China, healthcare and energy were the worst performing sectors. Hong Kong equities retreated but outpaced the region as strong gains in consumer staples stocks helped mitigate losses.
Meanwhile, the plunge in crude oil prices lifted some net oil importers; Indonesia, the Philippines and India bucked the downtrend to close higher. The Indonesian rupiah was also buoyed by Bank Indonesia’s surprise interest rate increase. In India, a widening rift between the government and the Reserve Bank of India culminated in the unexpected resignation of the central bank governor.
Since the middle of 2018, Asian equity markets have corrected sharply due to a deterioration in the outlook for growth at a time when the cost of capital in many markets was increasing due to upward pressure on US dollar interest rates.
The weaker growth outlook stems from four factors. First, China’s growth has eased due to the lagged impact of slower credit growth in the last 18 months as authorities have moved to rein in the shadow banking industry. Second, higher oil prices have acted as a tax on consumption and pressured corporate profit margins. Third, emerging markets like India, Indonesia and the Philippines have experienced upward pressure on interest rates as central banks have been forced to react to higher US dollar rates and deteriorating trade balances to support local currencies. Fourth, the escalation in the trade war between the US and China has hurt corporate confidence and is starting to exert a drag on capital investment decisions.
Meanwhile, despite these local headwinds in Asia, the US economy has performed very strongly as the recent tax cuts have flowed through the corporate sector and unemployment has continued to fall to new cyclical lows – all of which, until very recently, have increased the Federal Reserve’s confidence in raising rates and pushed US long bond yields to a seven-year high in November. In a world where the US dollar remains the most important reserve currency, these higher borrowing costs and generally tighter US dollar liquidity conditions have put pressure on capital flows to emerging markets and tightened local liquidity in Asia as well, which has been a further headwind for markets.
Although earnings growth in 2018 still looks set for 10%+, at the margin revisions have turned negative in recent months and markets have moved very quickly to price in the more difficult outlook, with valuations for regional benchmarks correcting sharply in the last six months as a result. P/E multiples have dropped from above average levels in January to around 1 standard deviation below longer-term averages today, while many of the more highly rated growth stocks have seen an even sharper pullback.
In the near term, market performance is likely to remain dominated by the interplay of these same factors. On the positive front, expectations for Asian growth have now adjusted a long way. In addition, Chinese authorities have moved at the margin to a slightly more pro-growth stance, with recent cuts in reserve requirement ratios and encouragement for the banking sector to lend to private enterprises. Expectations are also increasing for further cuts in taxes and a pick-up in infrastructure spending. This slightly looser Chinese policy will take time to show up in the macro data due to the normal policy lag in the real economy, with headline growth still expected to slow in coming months, but the change in signalling from the authorities to support growth is still important for markets.
Oil prices have also corrected sharply from their recent highs, which alleviates much of the current account pressure on the more fragile emerging economies and will reduce the drag on consumption more widely. At the same time, US bond yields and rate expectations have moderated significantly in the last few weeks, partly in response to the crack in the US stock market and due to the ongoing slowdown in growth outside the US. All of this is helping to stabilise sentiment towards risk assets.
Much harder to read is the outlook on the trade front. We now have a three-month standstill until early March 2019, after the recent meeting of US President Donald Trump and Chinese President Xi Jinping at the G20 meeting. There is some renewed optimism that an outline framework for a longer lasting trade agreement can be agreed on in this period, which could avoid further escalation in tariffs. This would clearly be positive for markets in the near term. However, there is far less confidence that it will really be the end of trade frictions given the longer-term concerns held by many in the US over China’s threat to US national security on different fronts and the Chinese administration’s reluctance to alter its model of state-sponsored economic development and its desire to build its own expertise in key technology sectors.
Lower valuation multiples for Asian markets today should raise the potential for longer-term stock market returns. However, investors are likely to remain cautious near term given the likelihood of further cuts in earnings forecasts as analysts adjust to the weaker macro backdrop in 2019 and the persistent uncertainty on the trade front, alongside continued increases in US dollar interest rates in the next few months.
Given this difficult backdrop, we continue to tread carefully in equity markets and have not moved to significantly increase risk despite the recent correction. As bottom-up investors, our focus remains on those businesses best equipped to survive the current slowdown and exploit the favourable longer-term trends we continue to see in the region – be it the continued growth in domestic consumption and growth of service sector industries in countries like India, Indonesia and China, or the technological leadership of Chinese players in the online space, or the growth potential for industry leaders in the Korean and Taiwanese tech hardware sectors.
The fund posted a loss and underperformed the MSCI AC Asia ex Japan index over the quarter.
Looking at countries, stock selection in Korea and India were major contributors to performance. The overweight to Hong Kong also worked well. Conversely, the investments in China and Taiwan were key headwinds. The underweight to Indonesia also detracted.
Sector wise, the portfolio benefited most from stockpicking in information technology and healthcare. Industrials stocks also added value. By contrast, stock selection in real estate was negative but was partially offset by our overweight. Other key detractors included the lack of exposure to the utilities and the underweight to consumer staples.
|Q3/2017 - Q3/2018||Q3/2016 - Q3/2017||Q3/2015 - Q3/2016||Q3/2014 - Q3/2015||Q3/2013 - Q3/2014|
|Net Asset Value||3.3||23.3||41.3||-3.3||10.9|
|MSCI AC Asia ex Japan (NDR)||4.4||18.8||36.6||-6.0||8.4|
Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.
Investors in the emerging markets and the Far East should be aware that this involves a high degree of risk and should be seen as long term in nature. Less developed markets are generally less well regulated than the UK, they may be less liquid and may have less reliable arrangements for trading and settlement of the underlying holdings.
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The trust Invests in smaller companies that may be less liquid than in larger companies and price swings may therefore be greater than investment trusts that invest in larger companies.
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Gearing will increase returns if the value of the investments purchased increase in value by more than the cost of borrowing, or reduce returns if they fail to do so. Investments such as warrants, participation certificates, guaranteed bonds, etc will expose the fund to the risk of the issuer of these instruments defaulting on paying the capital back to the fund.