Asia ex Japan equities gained in the second quarter in GBP terms, despite weakness in China. The MSCI Asia ex Japan index underperformed the MSCI World index. Trade tensions and economic risks dominated investor sentiment, while global monetary policy was another key focus. In particular, the US-China trade war escalated in May after the US raised tariffs on US$200 billion worth of Chinese imports and added Chinese telecommunications group Huawei to a trade blacklist. China countered with retaliatory tariffs on US goods. Both countries subsequently agreed to a truce and will resume trade negotiations following a meeting between their leaders in June.
Against such a backdrop, ASEAN markets outperformed. Thailand and Singapore notched the biggest gains in the region. The Philippines was helped by strong advances in communication services and consumer staples stocks. Indonesia, where President Joko Widodo was re-elected, also fared well.
In Greater China markets, Hong Kong benefited from the rally in financials stocks, while investors also cheered the suspension of a contentious extradition bill. Taiwan edged up as gains in consumer staples and industrials stocks outweighed declines in the healthcare sector. Conversely, Chinese stocks fell and were among Asia’s worst performers, though losses were pared in June thanks to easing trade tensions and hopes of further stimulus measures.
Indian stocks posted slim gains as Prime Minister Modi’s Bharatiya Janata Party was re-elected with a stronger mandate. Separately, the central bank cut its benchmark interest rate twice to spur growth. Elsewhere, South Korean stocks underperformed, weighed down by poor corporate earnings.
After a difficult second half last year, Asian equity markets had one of their best starts to a year in 2019. Key to this major reversal in sentiment was the shift in policy stance from the US Federal Reserve (Fed) and the Chinese authorities. Both have moved towards a more accommodative position, more supportive of medium-term growth and liquidity. Until early May this year, there was also greater optimism among investors about the prospects for a trade deal between the US and China, although more recently negotiations have stalled and restarted again, indicating that the threat of a further increase in tariffs remains a major overhang for markets.
In the US, subdued inflation data and more dovish Fed commentary have significantly altered market expectations for future interest rates, with a cut in rates now considered likely in the next 12 months in contrast to the path of steady rate hikes expected six months ago. Tapering of the Fed balance sheet is also likely to end sooner than previously thought. In line with this more accommodative stance and concerns over the impact of the trade war on global growth, long bond yields have fallen dramatically 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. At the same time, the oil price has corrected from its October highs, which is beneficial for the trade balances of the many oil-importing economies in Asia and improves disposable incomes for consumers around the region. Supporting this view, we have recently seen interest rate cuts in India, Malaysia and the Philippines – reversing hikes put through in 2018 when external conditions were more hostile.
We have also seen an important shift in China’s policy stance in the last six months. Until late last year, macro policy had been apparently more focused on deleveraging in the shadow banking sector, with aggregate credit growth slowing sharply from high-teens rates in early 2017 to closer to 10% in Q4 last year. More recently, however, 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 recent acceleration in credit data indicates that local financial institutions are responding to this top-down guidance, albeit on a less dramatic scale to what was seen in previous bouts of stimulus. Fiscal stimulus is also increasing to support growth, with lower income taxes for consumers and reduced value-added tax for corporates being announced for 2019 and an acceleration of infrastructure spending coming through as constraints are eased on local government financing.
This improving monetary backdrop explains the big bounce in markets this year, which by end-April took multiples almost back to the 2018 highs, having touched the (non-crisis) lows of the last 20 years at the bottom in November. In other words, we almost completed a round trip in investor risk appetite from “greed” to “fear” and back towards “greed” again. The most dramatic shift in market behaviour occurred in the onshore China A-share market, where the Shenzhen Composite index, for example, rebounded more than 45% from its lows, 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 and the escalating trade war, so the policy shifts on these fronts had an outsized positive impact earlier this year.
Given the much more positive investor expectations and more demanding valuations that were in place at the end of April, it is therefore not a surprise that markets have subsequently corrected sharply as trade negotiations broke down and the US suddenly increased tariffs on Chinese imports again. Although the direct impact of the announced tariffs on earnings of listed Asian companies is relatively small given the dominance of domestic businesses in the regional equity indices, higher tariffs have a much broader negative impact on growth expectations given the impact on corporate and consumer confidence, not just in China but across the region and the rest of the world. Higher tariffs will raise many end-product prices for consumers in both countries which will likely dampen demand and further reduce already weak trade volumes, while heightened uncertainty will deter corporate investment as companies adopt a wait-and-see attitude. The Chinese renminbi has also started to weaken since April, and this could have a knock-on deflationary impact globally. All of this undermines the earlier optimism around the outlook for growth and earnings for the second half of the year.
A trade deal remains possible as there appear to be clear incentives for both sides to show progress given the downside risk to domestic growth in the current environment. However, it is impossible to be certain about this today given the unpredictability of those involved and the sudden hardening of the US position in May. Given the inherent volatility of the trade negotiations, markets are likely to remain very sensitive to daily headlines with many investors taking a wait-and-see attitude as a result. Although markets could correct further if we do see the imposition of tariffs on all US$500 billion-worth of imports from China, we can take some comfort from the fact that unlike last year when the trade war first blew up, central banks in the US and China have already moved to a more pro-growth stance, and we can expect to see further stimulus announced in China if economic momentum slips from here.
Given the lack of clarity on the macro front, and the risks to Chinese and global growth from a continued escalation of the trade war, we remain focused on selective areas of longer-term secular growth that offer opportunities for attractive compounding of returns and are less reliant on a pick-up in headline GDP growth rates. Within our China holdings, the vast majority of exposure is to domestic businesses with little or no export exposure to the US, in areas such as e-commerce, hotels and travel, education, insurance and healthcare. Where we do have export exposure across the region, it is to industry leaders that we believe will be able to sustain their competitive positioning in the event of higher tariffs being imposed and that have clear, company-specific growth drivers over the medium to long term. As interest rate expectations have moderated, the attraction of growing dividend yields has also become more apparent again and we continue to see attractive value in names where management is taking a more progressive attitude to dividend payouts given improving free cash flows and better capital discipline across the region.
The fund (NAV) posted a positive return and outperformed the MSCI AC Asia ex Japan (NDR) index over the quarter.
In terms of countries, stockpicking in Hong Kong and an underweight in China contributed most to performance. Our overweight to the Hong Kong market also added value. An overweight exposure to Australia was also beneficial.
Conversely, stock selection in Korea and Taiwan was negative. Selection in China also detracted, offsetting some of the benefit from being underweight.
At the sector level, the main contribution came from stock selection in financials. Our holdings in the IT and communication services sectors detracted, meanwhile.
|Q2/2018 - Q2/2019||Q2/2017 - Q2/2018||Q2/2016 - Q2/2017||Q2/2015 - Q2/2016||Q2/2014 - Q2/2015|
|Net Asset Value||1.3||11.0||38.7||10.6||12.8|
|MSCI AC Asia ex Japan (NDR)||3.2||8.1||30.6||3.9||13.2|
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