Asia ex Japan equities rebounded strongly from the sell-off in the previous quarter. All markets in the region closed higher, except Malaysia. Sentiment was helped by progress in US-China trade negotiations and the dovish shift by major central banks. Global growth concerns remained a drag, however. In particular, China’s economy grew at its weakest pace since 1990 last year. January-February data pointed to a continued slowdown. The Chinese government lowered its full-year growth target to 6-6.5% and outlined higher public spending and tax cuts, while the central bank cut the reserve requirement ratios for banks.
Against this backdrop, markets in China and Hong Kong fared best. Aside from easing trade tensions, Chinese stocks were further buoyed by index provider MSCI’s move to increase the weighting of China-listed shares in its benchmark indices. Gains were also fuelled by anticipation that Chinese authorities would continue to introduce supportive policies to counter the economic slowdown.
Elsewhere, Taiwanese stocks also advanced. Indian markets were pressured by geopolitical tensions with Pakistan, but they staged a late rally on optimism that the current coalition government would return to power in upcoming elections. South Korean stocks underperformed amid the abrupt end to the US-North Korea summit and concerns over corporate earnings.
ASEAN markets also trailed the broader region. Malaysia and Indonesia were the biggest laggards. The Philippines and Thailand fared better though the latter was held back by uncertainty surrounding the election outcome; official results are not expected until May.
After a difficult second half last year, Asian equity markets have had one of their best starts to a year in 2019. Key to this major reversal in sentiment has been the shift in policy stance from the US Federal Reserve (Fed) and the Chinese authorities. Both have moved towards a more accommodative position, which is supportive of medium-term growth and should offer favourable liquidity conditions. At the same time, trade tensions between the US and China have eased somewhat as a deal of sorts appears more likely in coming weeks.
In the US, subdued inflation data and more dovish Fed commentary have significantly lowered market expectations for future interest rate increases. Tapering of the Fed balance sheet is also likely to end sooner than previously thought. In line with this more accommodative stance, long bond yields have sold off from their November highs. In a world where the US dollar remains the key reserve currency and many Asian economies need to adjust their own policy stance (at least loosely) along with the Fed to support their local currencies, this shift in US dollar money markets has positive implications. Not only does it reduce the need for further local rate hikes, it also improves the outlook for global capital flows into non-US markets.
We have also seen an important shift in China’s policy stance in the last few months, where macro policy had been previously focused on deleveraging in the shadow banking sector and aggregate credit growth had slowed sharply. Reserve requirement ratios have been cut and banks have been encouraged to lend more aggressively to small and medium-sized enterprises (SMEs) and the private sector. The sharp pick-up in total social financing in January’s credit data suggests that local financial institutions are responding to this top-down guidance. Fiscal spending also appears to be picking up to support growth, with lower taxes for consumers and SMEs being announced and an acceleration of some infrastructure spending coming through.
At the same time, the oil price has corrected from its October highs, which is a big benefit to the trade balances of the many oil-importing economies in Asia. The weaker oil price also reduces inflationary pressure and improves disposable incomes for consumers around the region.
Meanwhile, there remains a lot of hostile rhetoric emanating from the US regarding China’s alleged theft of intellectual property and the risks that China’s technology ambitions pose to the US’s security and superpower status – most apparent in the ongoing pushback against Huawei’s 5G rollout around the world. However, in recent months, some of the heat has been taken out of the narrower arguments over the bilateral US-China trade deficit, which was the initial justification for the tariffs introduced last year. It now looks more likely that the two countries will reach some form of framework agreement to try to reduce the scale of the deficit and open up more of China’s market to overseas companies. This will hopefully remove the risk (for now at least) of higher tariffs and could even eliminate the 10% increases introduced last year. This progress seems to reflect domestic incentives on both sides for some sort of deal; in the US, after all the pressure exerted so far, President Trump would likely benefit from some sort of “win” as we approach presidential elections in 2020, while in China there is pressure to limit the drag on the economy from the ongoing uncertainties over tariffs.
All of the above developments have dramatically altered the outlook for investors, who only a few months ago were worrying about rising US rates, a stronger US dollar, higher oil prices, slowing Chinese growth, a weaker renminbi, escalating trade wars and a lack of policy flexibility for Chinese authorities.
As the backdrop for Asian markets has improved, it makes sense that risks priced into valuations late last year have been reduced. We have gone from the top of the trading range in early Q1 2018 to the bottom in Q4 2018 and have now mean reverted this year as risks have reduced.
The most dramatic shift in recent market behaviour has occurred in the onshore China A-share market, where the Shanghai Composite index has rebounded sharply year to date, having been one of the weakest global performers in 2018. Domestic Chinese investors were very early to react negatively to China’s growth slowdown that became more apparent through last year. They were also seemingly very sensitive to the escalating trade war, so the policy shifts on these fronts have had an outsized impact. The recent market turnaround has also been helped by Chinese leaders’ encouragement of equity market reforms, which is seen as an endorsement of the market rally, and index provider MSCI’s recent decision to increase the weight of A-shares in their global indices. The latter move is likely to attract significant offshore flows into the market in the months ahead and should support valuations, especially for the narrower subset of favourite foreign stocks within the market.
Looking forward, however, now that valuations have mean reverted and much of the trade risks have been priced out of stocks, we have potentially a more lacklustre environment for equities again. Although policy in China may be loosened this year, it will take several quarters for the impact of any stimulus to show up in the economic data or corporate earnings. Moreover, we still face a very high base of comparison in many industries for the upcoming first-half results. Earnings revisions across the region have remained negative in recent months as analysts have adjusted to the weaker economic backdrop and the difficult operating environment in many parts of the technology sector. We also believe that the extent of any stimulus in China in this cycle is likely to be more moderate than before as the levels of gearing in the system are already elevated and the authorities’ room for manoeuvre is much more limited as they continue to push for reforms within the financial sector. As such, we are not expecting a V-shaped rebound in Chinese activity later this year but rather a stabilisation of growth at a level below the average of the last few years. Lower global bond yields are also reflective of the weak macroeconomic data across most developed markets in the last quarter, with investors paying particular attention to the recent inversion of the yield gap in the US which has historically been a good leading indicator of recession.
Given these headwinds and valuations that are far less compelling after the recent market bounce, we are cautious about chasing markets higher from here and will remain disciplined about trimming positions in stocks where prices exceed our analysts’ fair values. Across the region, we remain focused on selective areas of longer-term secular growth that offer opportunities for attractive compounding of returns in what could be a dull environment for broader economic growth. As interest rate expectations have moderated, the attraction of growing dividend yields has also become more apparent again.
The fund posted a gain and outperformed the MSCI AC Asia ex Japan index over the quarter.
In terms of countries, stockpicking in China contributed most to performance though our underweight position pared gains. The overweight to Hong Kong and investments in Taiwan also added value. Conversely, stock selection in India was negative.
At the sector level, most sectors had an overall positive impact. Consumer discretionary was the main driver of outperformance, where we benefited both from stockpicking and our overweight position. Our materials holdings further lifted performance. The main detractors were stock selection in industrials and energy.
|Q1/2018 - Q1/2019||Q1/2017 - Q1/2018||Q1/2016 - Q1/2017||Q1/2015 - Q1/2016||Q1/2014 - Q1/2015|
|Net Asset Value||0.8||16.5||41.9||-6.1||26.1|
|MSCI AC Asia ex Japan (NDR)||2.0||12.2||35.3||-8.7||24.7|
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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.