March 2020 / INVESTMENT INSIGHTS
Asia Equities: Looking Beyond the Coronavirus
Volatility may provide longer-term investors with opportunities
- We remain constructive on the long‑term prospects for Asia ex‑Japan equities despite the short‑term disruption and uncertainty created by COVID‑19.
- Timely policy responses from China and other Asian countries support our positive long‑term outlook, although market volatility may persist for some time.
- We believe the Asia ex‑Japan region continues to offer good opportunities for longer‑term investors in top‑quality companies with strong earnings potential.
Despite the short‑term disruption and uncertainty created by the new coronavirus (COVID‑19), we remain constructive on the long‑term prospects for Asia ex‑Japan equities. We expect timely policy responses to the outbreak from China and other Asian countries, cyclical recoveries in the global auto and semiconductor industries, and continued monetary and liquidity support from central banks, supporting our positive longer‑term views. While market volatility may persist until we see clearer indications that the coronavirus outbreak is coming under control in China and in other regional COVID‑19 hotspots like South Korea, meaningful corrections to quality Asian stocks due to COVID‑19 fears may provide longer term investors like ourselves with good opportunities.
In mid‑January, investors were confronted by the coronavirus (COVID‑19) outbreak in China that has since spread to a growing number of other countries. The full impact on global and regional economies is still unclear. This will remain the case until we have a better idea of the duration and severity of COVID‑19 in each country and the extent to which it is disrupting global supply chains.
Just as the news from China on containing the outbreak was starting to improve, the rising number of cases in South Korea and Japan has complicated the outlook for the region considerably. Korea and Japan both play an important role in Asian supply chains, and quarantine restrictions in these countries could delay China’s own efforts to return to normal by restricting imports of key intermediate goods, especially electronic components.
Timely Policy Response From China
China was quick off the mark in early February with policy measures to support the economy. We are hopeful that China’s policy support measures should be enough to reverse much of the damage to the economy from COVID‑19, although their impact may not be felt until the second half of the year. We believe that Beijing will do all in its power to avoid a hard landing for the economy, since maintaining social stability is of paramount importance to Xi Jinping and the Chinese government.
In early February, the Chinese authorities announced a package of 30 financial measures intended to both support the economy and alleviate some of the pressures from the coronavirus. China’s central bank, the People’s Bank of China, cut short term interest rates by 10 basis points and injected RMB 1.2 trillion of liquidity into the banking sector. These early measures were aimed at relieving some of the immediate financial stress by ensuring ample liquidity in money and credit markets and by providing interest rate subsidies and loan forbearance for companies and mortgage holders in temporary financial difficulty. Development and policy banks, such as the Export‑Import Bank and Agricultural Development Bank, pledged to increase their lending support to the economy. Wuhan, the city at the epicenter of the coronavirus outbreak, was granted RMB 300 billion in loans from the central government. A number of provincial and local governments in China announced financial measures in support of their local economies.
Allowing for a policy‑driven recovery in the second half, the negative impact on China’s full year GDP growth in 2020 may ultimately prove limited. Meanwhile, China economists are in the process of lowering their 2020 growth forecasts, typically by around 0.5% to 1.0%. From recent speeches, it is clear President Xi Jinping still wants to achieve China’s long‑term target of doubling the country’s 2010 per capita GDP by 2020, a target popularly associated with China becoming a “moderately prosperous nation.” Following recent benchmark revisions to historical GDP data, growth this year needs to be around 5.6% to achieve Xi’s goal and provide a political victory. This may look difficult now, but it could still be possible given additional policy stimulus.
SARS May Be An Imperfect Guide
For investors in Asian equities, the key point to note is that although COVID‑19 may present a bigger economic shock than Severe Acute Respiratory Syndrome (SARS), it nevertheless will be a one‑off event. As such, the impact on China and other Asian economies should start to reverse once the outbreak dies down and policy support kicks in later in the year. We believe a temporary drop in economic activity in the first half of the year should not have a lasting impact on Asia’s positive long‑term economic performance. Since the 1980s, Asia ex‑Japan has contributed a rising share of global GDP growth, a trend we expect to see continue (Fig. 1).
Following the peak of SARS cases in 2003, equity markets bottomed and began to rally ahead of better economic news once it was clear that the outbreak was coming under control (Fig. 2). A similar sequence of events was initially expected for the coronavirus in 2020, although the subsequent spread of COVID‑19 to more countries is a new factor for markets to digest.
There are also a number of key differences between circumstances today and those prevailing at the time of SARS. Above all, China is a much more important growth driver for Asia and the global economy than it was in 2003, when a strong global upswing helped cushion China against the negative impact of SARS via strong demand for Chinese exports. Today, global growth is more subdued. The Chinese economy is also more consumer and services oriented than in 2003, implying greater regional sensitivity to reduced tourism, transport, travel, and entertainment expenditure. Share prices in these sectors have already adjusted to the COVID‑19 shock.
Asia Stands Out in a Low Growth World
(Fig. 1) Asia Ex-Japan as percent of World GDP Growth
The bigger uncertainty today lies with the disruption to global supply chains following Chinese factory closures after the Lunar New Year and the strict domestic travel and quarantine restrictions. The “supply side” aspect of the coronavirus shock via widespread factory closures was absent in 2003. At this stage, it is not possible to gauge the full extent of potential supply chain disruptions in industries like semiconductors and autos. Recent surveys suggest that perhaps 70% of factories in China will have restarted by early March, though not all will be operating at normal capacity as returning migrant workers will face two weeks quarantine.
Asia ex‑Japan Earnings
Besides the economic uncertainty created by the coronavirus, there is uncertainty over the short‑term earnings outlook for Asia ex‑Japan. While the region had disappointed on earnings relative to developed markets in recent years, the earnings outlook prior to the coronavirus outbreak had improved, supported by a recovery in margins and greater capital expenditure discipline. The consensus estimate for earnings growth in 2020 is currently about 16% (FTSE Asia ex‑Japan index as of February 25. See Fig. 3). While the aggregate number will be revised down as analysts adjust their estimates for COVID‑19, the share prices of many of the stocks likely to be most affected have already fallen a long way. As such, they may be less sensitive to future cuts in analyst earnings estimates for 2020, a potential investment opportunity.
Asian Investors Should “Look Across the Valley”
Our advice to investors is to “look across the valley” of short‑term disruption and weak economic data due to the coronavirus. Keeping to our long‑term, fundamentally driven approach to investing in Asia, we prefer not to be swayed by short‑term market dislocations such as COVID‑19. With this in mind, we are not likely to make major changes in our Asian equity strategies. Given our bottom‑up focus on fundamentals, however, we are comfortable taking positions in China and other Asian markets that we feel have sold off excessively on the negative investor sentiment arising from the coronavirus outbreak.
The long‑term case for investing in Asia ex‑Japan has not changed. Overseas investors remain very underweight in China, the world’s second largest economy and the most successful in Asia. China’s contribution to global growth is expected to remain significant as it continues to outpace developed economies. Over the medium term, we think China can continue to successfully transition its economy, striking an appropriate balance between growth stabilization and financial deleveraging. China’s focus on greater self‑reliance, encouraging companies to move up the value chain, and the shift towards domestic consumption are long‑term positive growth drivers for the region.
Asian Markets Before SARS and Now
(Fig. 2) MSCI AC Asia ex Japan index and number of new cases.
We favor cash‑generative companies in Asia that show they can continue to grow market share and compound their earnings regardless of macroeconomic or trade policy uncertainties. As a result, our portfolio tends to have a natural bias toward domestically oriented businesses that are expected to benefit from the strong growth in Asian disposable incomes. We still intend to keep a close watch, however, on developments in U.S.‑China trade relations and their potential impact on company earnings.
Chinese Fiscal Policy to Drive Regional Growth
China’s fiscal policy is likely to drive 2020 growth in the Asia ex‑Japan region. Implementation of fiscal policy support—such as additional infrastructure investment financed by local government special purpose bonds—has to wait until the outbreak has been contained enough for factories and the construction sector to resume activity. Other Asian countries are likely to use their available fiscal policy tools to protect their economies against COVID‑19. Singapore and Hong Kong have introduced expansionary budgets, and South Korea is expected to follow suit with a fiscal package of around 0.5% of GDP.
Asia EPS growth in 2019 and 2020
(Fig. 3) Contribution by country to Asia ex-Japan regional EPS growth
However, much remains uncertain about the impact of COVID‑19 and policy responses. As a result, equity markets in Asia and elsewhere are expected to remain volatile in the months ahead. After their recent correction, valuations in Asia ex‑Japan equity markets appear reasonable relative to past history and to developed markets, if not cheap.
We believe the Asia ex‑Japan region continues to offer good opportunities for longer‑term investors in top‑quality companies with strong earnings potential. Many of the stocks that we favor have been supported by strong domestic demand trends that should not be impacted by the coronavirus beyond the short term and are also less vulnerable to a resumption of China‑U.S. trade tensions.
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