Despite fears of a slowdown fueled in part by rising inflation, Asia continues to enjoy robust economic growth and attract institutional investors from around the globe. Stronger-than-expected year-over-year growth in China’s first-quarter real gross domestic product — 9.7 percent, compared with 1.8 percent in the U.S. — prompted the World Bank last month to raise its 2011 forecast for the region’s largest economy from 8.7 percent to 9.3 percent, and from 8.4 percent to 8.7 percent for 2012.
“Asia stands at the intersection of three fundamental drivers: dynamic economies, increased global focus and significant variation in maturity of markets and participants,” observes Joseph Osha, head of Asia equity research at BofA Merrill Lynch Global Research. Those factors help make Asian stock exchanges star performers: The MSCI Asia ex-Japan index gained 16.9 percent year-over-year through March, in dollar terms, compared with a 13.4 percent rise in the Standard & Poor’s 500 index over the same period. The Bangkok SET index led the region, surging 32.9 percent, while Vietnam’s Ho Chi Minh stock index brought up the rear by lodging a 7.6 percent loss.
Soaring prices of food, fuel and commodities could prove to be a drag on local economies and drive more markets down. The Asian Development Bank noted in a report last month that inflation in developing Asia could cut into GDP growth by as much as 1.5 percentage points. Curbing inflation remains the region’s biggest economic challenge, with prices expected to rise at an average rate of 5.3 percent this year before slowing to 4.6 percent in 2012, according to the Manila-based lender. The ADB anticipates regional GDP growth of 7.8 percent in 2011 and 7.7 percent next year.
“Developing Asia will continue to spearhead the global recovery,” the ADB stated in its “Outlook 2011” report. “Private demand is sustaining growth even as monetary and fiscal policies are normalized. The region’s growth in 2011 will remain vigorous, albeit somewhat slower than in 2010. Inflation pressures are building, however, and overheating is an emerging threat in some economies.”
Given Asia’s mix of significant upside and potential trouble on the horizon, investors need timely, accurate research to help them make the most of all that the region has to offer. Portfolio managers say the analysts who provide the best guidance and most helpful insights can be found at BofA Merrill Lynch Global Research, which skyrockets from eighth place last year to capture the top spot on the 2011 All-Asia Research Team, Institutional Investor’s 18th annual ranking of the region’s best researchers. The firm wins 31 total team positions — ten more than last year — including eight teams in first place in their respective sectors. Morgan Stanley, with 28 team positions (four more than last year), jumps two spots, to second place; while the firm with which it shared fourth place in 2010, J.P. Morgan, rises to third, with 26 positions. UBS, with 24 positions, also enjoys upward momentum, climbing from No. 6 to No. 4. Rounding out the top five is Citi, with 23 positions; the firm tied for second place last year. Survey results are based on responses from nearly 3,000 buy-side analysts and investment professionals at some 935 institutions managing an estimated $1.6 trillion in non-Japanese Asian equities.
BofA’s heightened prominence in the eyes of investors is perhaps not surprising in light of the firm’s efforts to increase coverage of Asian equities. Though Osha declined to disclose the number of analysts he has covering the region (and whether that number has increased or decreased over the past year), he acknowledges that his teams track 874 companies — a whopping 170 more than they covered last year at this time.
Morgan Stanley's analyst head count has held steady, at 113, but the firm has increased coverage by about 10 percent, to 840 stocks, according to Marcus Walsh, the firm's head of Asia- Pacific research. “As Asia becomes ever more integrated intraregion and with the greater global economy, we hope to continue to develop our research and collaboration regionally and globally,” he says. “We feel confident that the structural trends of growth and interdependence will continue into the foreseeable future as the region continues to play a vital role in the global economy and capital markets.”
The firm emphasizes cooperation among its researchers, regardless of analytic discipline. “Collaboration is key — across sectors, across asset classes, across regions,” Walsh says. “Exemplifying such collaboration, we have focused globally and regionally on the Morgan Stanley Blue Paper reports. In these our research analysts, economists and strategists use their collective expertise to fulfill investors’ need for informed debate on complex, interrelated investment ideas. The Blue Papers help clients wanting to see global effects analyzed and food chains explored as Asia becomes ever more important in — and linked to — the world.”
One such Blue Paper, published in March, is “Asia Inflation: Consumers Adjust as Inflation Worsens,” in which 40 of the firm’s analysts weighed in with their views on inflation’s impact on each of the region’s countries and industry sectors. Among the report’s conclusions: Energy and mining stocks are likely to continue to outperform consumer discretionary, financials and utilities until inflation peaks.
Analysts at J.P. Morgan are also focusing more on collaboration. “Following a period of macro uncertainty in 2008 and 2009, since 2010 bottom-up stock-selection strategies have worked better and investors have increasingly focused on sector- and stock-specific research,” says Sunil Garg, head of Asia ex-Japan equity research. “Investors have also relied on research that looks at both cross-sector and cross-asset-class linkages. In response we have focused on strengthening company research and added to coverage.” The firm increased its analyst head count by six, to 76, and expanded its coverage universe by 25 companies, to 750, Garg says.
UBS reported the biggest growth in research operations over the past year; the firm added 22 analysts, to bring its total to 100, and expanded coverage to about 800 stocks, up from 689. The Swiss bank has focused much of that expansion on China and India, according to Damien Horth, head of Asia and Japan equity research.
“This reflects ongoing investor demand for in-depth, stock-specific coverage that is informed by a regional and global perspective,” Horth says. “Beginning in the latter half of 2010, we started to aggressively expand our presence in mainland China, and over the coming 18 months we plan to expand our A-share coverage from 100 stocks to approximately 350.” The firm has also encouraged coordination among its equity and fixed-income researchers “to ensure that we are meeting investor needs for cross-asset ideas and insight,” he adds.
That holds true at Deutsche Bank as well, which leaps from No. 11 last year to No. 8, picking up 12 team positions, for a total of 19. “For the last two to three years, we’ve noticed rising demand for macro research at both a regional level across Asia and also at the individual country level,” says David Clark, who oversees the bank’s research operations in China. “We’ve also noticed increasing demand for regional and global sector research. Specific stock recommendations clearly remain important, but increasingly our clients want these recommendations in a broader context.”
The firm picked up 13 analysts over the past year, bringing its total to 86, and expanded its coverage universe from 618 to 693 stocks.
China has become the key driver of growth in the region, thanks in part to the 4 trillion yuan ($584 billion) economic stimulus package the government unveiled in November 2008. More than half of that money is allocated to infrastructure projects, including bullet trains capable of topping 350 kilometers per hour. China, which already has eight high-speed rail corridors that span 12,000 kilometers, plans to invest up to 2 trillion yuan building an additional 15 high-speed corridors. Earlier this year the Ministry of Transport announced that it would spend 1.5 trillion yuan to build new airports over the next five years.
“The Chinese government will continue to invest significantly into infrastructure, but with a change in focus after the big investment done in the previous five-year plan,” says Xiang (Edmond) Huang, who with Bharat Parekh leads BofA’s Infrastructure team from runner-up all the way to No. 1. “We see two directions after the huge investment in railway — especially high-speed rail — in the past five years. One is geographically shifting to west and central China as infrastructure in coastal areas is more established, and the other is sectorwise, shifting to metro, intercity rails, hydro projects, power grids and infrastructure serving massive low-cost housing projects.”
Huang says one of his team’s top stock recommendations for 2011 will be China Communications Construction Co., a bullet-train contractor headquartered in Beijing. The company, which floated an H-share listing in 2006, announced in December that it planned to issue up to 3.5 billion new A shares in Shanghai this year to fund the purchase of the remaining shares of crosstown rival CRBC International Co., in which it was already a major stakeholder.
“China Communications Construction has a well-diversified business portfolio to further support moderate but quality order growth,” Huang says. “It has forward-looking management with appropriate incentives in place, excellent cost control and risk management. It is the most misunderstood and underowned construction name, and this is reflected by its cheap valuation.” China Communications closed at HK$7.42 at the end of March, with a price-earnings multiple of 9.45 — well below the sector average of 14.8, he adds.
China also figures highly in the books of Christopher Wood, who pilots the CLSA Asia-Pacific Markets squad back to the top spot in Equity Strategy after spending last year in second place. The team’s top picks include repeated reiterations of Beijing-based Baidu, an Internet services provider that operates one of China’s most popular search engines. The analysts first recommended Baidu’s American depositary receipts in January 2008, at a split-adjusted $26.50, on rising demand. By the end of March 2011, the ADRs had soared to $137.81 — an eye-popping 420 percent advance that trounced the sector by a whopping 396 percentage points. Another winner: China National Building Material Co., a state-run manufacturer headquartered in Beijing. First recommended in August, at HK$13.98, on strong growth in the domestic housing market, the stock had bolted 104.2 percent, to HK$28.55, and shot past the sector by 79.8 percentage points by the end of the first quarter.
“In terms of the outlook for the next 12 months, I have recently increased weighting in China on the view that monetary tightening is nearing an end, and I have also included the China A-share tracker fund in my long-only portfolio,” says Wood. “My focus remains on the domestic sector. In China I would highlight cement companies, construction-machine makers and sellers of household goods. In India and Indonesia I continue to like banks and infrastructure plays.”
China’s infrastructure expansion is indeed a key driver of growth not only in China but also throughout the region. China State Construction International Holdings, a Hong Kong–based construction and engineering outfit, is among the winning recommendations made by Citi’s top-ranked team in Small- & Midcapitalization Stocks. The analysts initiated coverage with a buy rating in July, at HK$3.12; by the end of March, the share price had skyrocketed 127.6 percent, to HK$7.10, and bested the sector by a jaw-dropping 102.3 percentage points.
“China State Construction is a direct proxy for emerging China’s affordable-housing theme,” explains Tak Hung (Eric) Lau, who leads the team to its third straight appearance in the winner’s circle. In February, China’s Ministry of Housing and Urban-Rural Development announced plans to build 10 million low-income housing units this year, a 70 percent increase over 2010.
Building more subsidized housing will be critical to chipping away at the growing gap between China’s rising number of wealthy merchants and the rest of the population, especially as many consumers are suffering from the effects of accelerating inflation, explains Qing Wang, co-leader — with Chetan Ahya — of Morgan Stanley’s No. 1 team in Economics for a second consecutive year. Consumer prices surged 5.4 percent year-over-year in the first quarter, according to China’s National Development and Reform Commission, and are expected to rise between 4.9 percent and 5.1 percent in the second quarter. Last month the People’s Bank of China raised its benchmark interest rate from 6.06 percent to 6.31 percent, in an effort to control inflation; it was the fourth such increase since October.
“We expect a year of reflation as the postcrisis economic normalization and rebalancing continue,” says Wang. “We expect the lagged effect of massive monetary expansion in 2009 and 2010 to continue to provide strong tailwinds for inflation in the near term, while the headwinds stemming from weak external demand are letting up.” Looking beyond the near term, Wang adds, China’s economic rebalancing — which features a shift in growth drivers from tradable to nontradable sectors — points to higher inflation. “We forecast 9 percent GDP growth and 4.5 percent inflation for 2011, with consumption and investment equally important in terms of contribution to growth,” he says. “We expect inflation to rise in the first half, peak midyear and then start to edge lower by year-end.”
China isn’t the only major market that will suffer from surging prices. “India has been witnessing high inflation,” observes Ahya. “Policymakers in India have been relatively slow in reversing loose fiscal and monetary policy, risking pushing inflation higher. We were among the first on the Street to highlight rising macro stability risks in India in the form of higher inflation, a rise in the current account deficit and tightening of interbank liquidity.” Inflation may average 7.5 percent for the 2010 fiscal year, which ended in March, according to the Reserve Bank of India; in January the central bank had projected a rate of 6.6 percent for fiscal 2010.
Nonetheless, India holds plenty of opportunities for global investors, especially in its infrastructure sector, according to BofA’s Parekh, who is based in Mumbai. His team urged investors to buy Adani Enterprises in April 2010, at 537.27 rupees, citing the Ahmedabad-based conglomerate’s plans to expand its mining, ports and power generation and transmission units. By the end of March, the stock had shot up 23.6 percent, to 664 rupees, and led the sector by 6.6 percentage points.
The team’s top picks for this year include Suzlon Energy, a wind-turbine manufacturer headquartered in Pune, Maharashtra. The analysts upgraded the stock to buy in February as a “nonconsensus turnaround story,” Parekh says, led by an uptick in India’s wind-turbine market, which the analysts believe will benefit from regulatory changes that will accelerate wind power development and help the company turn around after seven quarters of losses.
“I see significant pickup in investments in infrastructure capital expenditures after a lull led by regulatory, political and macro headwinds and on-ground challenges,” says Parekh.
Despite the challenges, many analysts remain optimistic about Asia and the prospect for Asian companies to outperform in the year ahead. J.P. Morgan’s Garg, who leads the firm’s top-ranked team in Banks for a second consecutive year, says that within his sector “the main drivers will be a return to leverage and balance-sheet growth.” Among his squad’s recommendations for 2011: Jakarta-based Bank Danamon Indonesia, whose shares advanced 14.9 percent and outperformed the sector by 12.4 percentage points in the first quarter, and Beijing-based Industrial & Commercial Bank of China, which was up 11.6 percent and ahead of the sector by 9.1 points. The latter institution — the largest bank in the world as measured by market value — announced plans in March to raise 25 billion yuan through a convertible bond issue, to voluntarily strengthen its capital reserves. China’s central bank has increased reserve requirement ratios seven times since the start of 2010, in an attempt to control liquidity and reduce inflation; the move is also an attempt to ensure that the country’s banks — which extended 7.95 trillion yuan in credit last year and 9.6 trillion the year before, the central bank reported — don’t get dragged down by nonperforming loans.
“Main worries relate to central banks’ monetary response to supply-side inflation,” Garg adds. “So far Asian central banks have been running a relatively accommodative monetary policy, and I believe it is too soon in the credit cycle to worry about asset quality.”
That is certainly good news not only for Asian banks but also for the entire regional economy, which is reliant on finance to fuel economic expansion. With sluggish growth forecast for developed markets, which will remain mired in debt for years to come, the world can’t afford for Asia to slow down anytime soon. • •
