Money managers spent much of the past year avoiding emerging markets, including Asia’s, on concerns ranging from the scope and timing of the U.S. Federal Reserve’s reduction in quantitative easing to fears of a hard landing for the Chinese economy. Now that these particular worries have subsided, for the most part, bargain hunters have been coming back — but whether they will stay remains to be seen.
“This year is shaping up to be at least as volatile as 2013, if not more so,” contends Neil Perry, head of Asia-Pacific research at Morgan Stanley in Hong Kong. “In the first four months, we have already seen some major performance-relative differences. From the troughs last year, both India and Indonesia have rallied significantly ahead of key elections.”
At the sector level, he notes, investors poured money into growth stocks in the first quarter but have since reversed course and begun to prefer value. But that could change too. “For China, while growth looks relatively poor for the first half, an interest rate cut at the midyear, as in 2012, might lead to improved performance in the second half,” Perry says.
China’s Shanghai Stock Exchange Composite Index slid 6.5 percent in the 12 months through April, compared with the 1.9 percent rise for the region as a whole.
Damien Horth, who directs coverage of Asian equities (including Japan) at UBS, also offers a mixed outlook. “The economic diversity of the region, attractive demographics and ongoing structural reform all provide scope for unique investment opportunities,” he observes. “That said, Asia also faces a number of structural headwinds, including a maturing credit cycle in Southeast Asia, tapering in the U.S. and the challenges presented by a slowing property sector in China. The development and implementation of economic and corporate reform will be important to solidifying investor confidence over the course of 2014.”
As will stable earnings growth, adds Ernest Fong, head of Asia-Pacific equity analysis at Credit Suisse. “Another important reason foreign investors pulled out of emerging markets was large earnings-per-share misses relative to developed-market equities,” the Hong Kong–based research director explains. “But now this gap is shrinking as EPS downgrades in emerging markets start to slow and as some developed markets like Japan have seen a reversal in EPS revisions. If the EPS momentum stabilizes in Asia and indeed starts to see some upgrades — China plateauing, optimism around postelection economic activity in India and Indonesia — then we believe investors are more likely to stay.”
They’re also apt to look to the sell side for help in deciphering the many signals in these markets. The firm that provides the most highly valued assistance is Bank of America Merrill Lynch, which leads Institutional Investor’s All-Asia Research Team for a fourth consecutive year.
The firm secures a spot in all but one of the survey’s 33 sectors, Autos & Auto Parts, and is deemed the best in 13 of them.
Rising one rung to second place is Morgan Stanley, the only firm in the top five whose team-position total increases this year. Its researchers rank in 29 categories, two more than last year, and are on top in seven — more than triple the number of first-place finishes the firm earned in 2013.
Two banks share the third tier, Credit Suisse and UBS. Their 26-position totals reflect a loss of two spots for the former and one for the latter. Citi rounds out the top five, advancing one level even though its total falls by two, to 22. Survey results reflect the opinions of roughly 2,940 investment professionals at more than 950 institutions managing an estimated $1.58 trillion in Asian equities.
It’s worth noting that this year’s lower firm totals are attributable at least in part to ballot changes rather than suggestive of declining research quality or coverage. Three sectors were removed: Infrastructure and Transportation were combined with Industrials, and Conglomerates was eliminated.
Perry, of Morgan Stanley, says his researchers anticipate “moderate upside” for the MSCI Asia-Pacific index this year. “The key problem the region faces is a relatively subdued [real gross domestic product] growth outlook — in fact, slower in aggregate than last year — at a time when developed economies are seeing acceleration in growth,” he says. “Earnings revisions momentum is on the whole negative regionwide.” The exception to this trend, he adds, is Taiwan, on which the firm’s analysts have an overweight rating. “It is the most levered to developed-market growth economically through its heavy weighting toward the technology sector,” Perry explains. “As a result, Taiwan is the only major market in the region with strongly positive earnings revisions.”
Credit Suisse strategists also predict a modest upside for the region, Fong reports, but hold a different view on which markets will be standouts. “We believe India and South Korea are likely to outperform as [return on equity] troughs in 2014,” he says. “For India we believe a change in government could boost domestic growth, particularly capital expenditures. In South Korea global recovery and rising house prices are likely to lead to an inflection point in ROE.”
Horth reiterates the importance of corporate profits. “Valuations in Asia ex-Japan are below long-run averages, which leads us to believe that earnings development will be the key driver of performance over the course of 2014,” the UBS research director says. “Given north Asia’s greater exposure to recovering export markets, we prefer [South] Korean and Taiwanese cyclicals over defensives. In the context of less attractive valuations, slowing growth and the credit cycle, we are underweight Singapore, Indonesia and Malaysia.”
In early May, UBS trimmed its China GDP growth forecast from 7.5 percent to 7.3 percent for 2014 and from 7.0 percent to 6.8 percent for 2015. “The process of financial reform and credit quality are major issues that we are watching closely, but the biggest risk to the Chinese growth outlook is slowing property sector activity,” Horth emphasizes. “To some extent, the slowing activity in recent months was expected after a strong rebound in the second half of 2012 and in 2013. However, property supply has been growing faster than underlying demand, while investment demand for housing is being eroded and inventories are building.”
David Cui and Ting Lu, who guide the BofA Merrill team to a third straight appearance at No. 1 for coverage of China, echo that view. A “significant drop in new home sales and property investment growth,” Lu attests, is one of the key risks to the Chinese economy. Other hazards include an escalation of the government’s anticorruption crackdowns, which dents consumption and discourages local officials from engaging in even socially beneficial projects, he says, and worsening pollution, which might compel policymakers to step up antipollution efforts. “These risks can materialize if more potential homebuyers hold off on purchases by expecting falling home prices, more local government officials choose to sit idle if they feel increasingly insecure, and more campaigns break out in protesting polluting investment projects,” adds Lu.
The Hong Kong–based analysts expect such rate-sensitive sectors as banks, building materials, property and resources to underperform this year, says Cui. “Investors became increasingly wary of China equity markets last year as growth slowed and financial system risk rose,” he observes. “In addition, the government’s reform program also created some uncertainties in certain sectors dominated by large state-owned enterprises. As a result, many investors tried to avoid many big-cap names, including those in banking and energy. From this perspective bottom-up stock ideas based on relative earnings certainty became somewhat more important. The trend probably will moderate this year, as relative valuations of the growth names have become much more expensive.”
To Morgan Stanley’s Perry, the real issue in China is “how low GDP growth could fall if the government continues to accept the short-term pain and resists overinvestment as it tries to transition the economy to a more sustainable consumption- and services-driven model.”
Market watchers are asking the opposite question about India’s economic growth rate; namely, how high can it go? In early May the nation’s Finance minister, Palaniappan Chidambaram, predicted that India’s GDP rate would climb to 6 percent in the current fiscal year. That’s quite a jump from the roughly 4.9 percent growth rate of fiscal 2013, which ended in March.
Ashish Gupta, who leads the Credit Suisse crew to a second consecutive year at No. 1 for coverage of that country, says that’s too much of a jump. “While we do believe that India’s GDP growth has bottomed out, we do not expect a sharp recovery from the existing sub–5 percent levels to 6 percent in one year,” the Mumbai-based leader says. Gupta and his associates think expansion in the range of 5 to 5.5 percent is far more likely.
Nonetheless, India will remain an attractive investment destination, he believes. “In a year marked with taper concerns and falling currency, India still garnered more than $20 billion of inflows, in excess of its weight in regional and global indexes,” he points out. His team is urging clients to overweight such defensive sectors as consumer durables, energy and utilities, information technology and pharmaceuticals. “We remain underweight on cyclicals — financials, industrial and materials — primarily as investment cycle woes are far from being over, and asset quality issues haven’t been acknowledged.”
Much-needed government reforms are also on the minds of Gupta’s colleagues Stephen Hagger and Ting Min Tan, who pilot their squad to a fourth straight appearance at No. 1 for coverage of Malaysia.
“We expect domestic demand to continue to be lackluster and for surging exports to support the Malaysian economy,” Tan maintains. “Domestic demand is undermined by rising prices as the government reforms the subsidy structure and implements a 6 percent general sales tax in April 2015. While we might see some short-term pain arising from higher inflation and lower purchasing power, the long-term gain stems from an improving budget deficit and trade surplus, thus stabilizing the ringgit and avoiding a ratings downgrade.”
The Credit Suisse troupe, which is based in Kuala Lumpur, is forecasting GDP growth of 5.3 percent this year (up from 4.7 percent in 2013) and 5 percent in 2015, “driven primarily by strong private investments and a recovery in the global economy,” says Tan. “Private investments grew at 14 percent year over year in 2013, and corporate balance sheets remain robust — but high household debt remains a concern.” The best way to play this market, the analysts advise, is to overweight companies in the banks, construction, health care, media and telecommunications sectors and to underweight consumer discretionary and transportation names.
“As Malaysia is seen as a defensive and low-beta market, it is a place to hide rather than a growth market,” she adds. “However, there is scope for huge outperformance if a bottom-up strategy is adopted.”
Similar opportunities abound in the Philippines, according to Alfred Dy, captain of the CLSA crew that for six straight years has been deemed the best at reporting on the market. The island nation is still recovering from November’s Typhoon Yolanda, one of the most powerful storms ever recorded, but “the country has been bouncing back ever since the typhoon hit us,” he says. “It will not affect our exports and domestic spending. In fact, as a result of the storm, government spending has increased, and this could be taken as a positive for the domestic economy as well as domestic consumption.”
Key drivers of consumer spending, the Manila-based leader adds, include overseas Filipino worker remittances and business-process outsourcing, which “were not affected by the typhoon and, in fact, are growing quite well.” The analysts expect OFW remittances to rise by 5 percent year over year, to $23.94 billion, and BPO revenues to surge 20 percent, to $19.2 billion. These account for 9 percent and 7 percent of the Philippines’ GDP, Dy says.
Which sectors are poised to outperform? “We like banks, given the early credit cycle story in the Philippines, which is supported by low inflation and a low-interest-rate environment. We believe that inflation and interest rates will not spike up any time soon,” he says. “The property sector should also do well, given strong demand, a growing population, rising per-capita income and a low-interest-rate environment. And consumer [stocks] should be okay, given that 75 percent of GDP is consumption.”
All of these forecasts could change, of course, as the year unfolds; the lone constant is the demand for timely analysis, Credit Suisse’s Fong maintains. “While macro uncertainties continue to dominate, leading to challenging markets, we have noticed the value placed on strong research ideas has increased, as evidenced by strong individual stock and sector performances across the region,” he says. “We see this trend likely to continue to grow, especially as the market outlook isn’t as clear.” • •
