Asian stock prices fair to slightly undervalued, says Batterymarch
Ray Prasad is senior portfolio manager at Batterymarch with primary responsibility for Asian markets, having joined the firm in 1997 as a quantitative analyst. He became a portfolio manager in 2000 and was promoted to senior portfolio manager in 2005.
Headquartered in Boston, Batterymarch Financial Management is a quantitative equity asset manager and an affiliate of Legg Mason. As of 30 September, it managed $20.4 billion for institutional and sub-advisory clients worldwide.
Following recent stock-market falls and tightening measures in China, Prasad gives AsianInvestor his views on the region's markets.
Could you share your earnings outlook for Asian markets this year? Do you see further upside?
Analysts began upgrading their earnings growth estimates from the middle of 2009, although this trend has slowed in the last couple of months. Current estimates appear quite strong for this year and beyond. According to our data, earnings per share growth for Asian markets now stands at more than 20% over the next two years.
What is your outlook for inflation? Is it the biggest risk to the Asian stock markets?
Inflation in Asia is very much a function of higher commodity prices, since the region is a net importer of oil and raw materials. We expect inflation to peak around mid-year and then taper off.
To help combat inflation risk, China and other countries have begun to pull back some stimulus measures. In January, for example, both China and India put new limits on loan growth by mandating higher bank cash reserves. We expect China to continue a gradual withdrawal of its stimulus programmes over the next year or so, although officials are unlikely to raise interest rates any time soon. They'll be keeping an eye on the US economy, looking for improvements in export demand, before removing their domestic growth drivers.
Markets in Asia are already experiencing higher inflation. Some countries, including India, will need to tighten in order to control spiralling prices, which disproportionately hurt the poor. In addition, stock prices could potentially be affected by inflation, which we consider to be the major risk to Asian market performance in the coming months.
The recent tightening can be seen as proof of the improvements in Asia's economic prospects following the global crisis. Growth and confidence is solid and palpable across the Asian region, and it is prudent to control liquidity at the edges to prolong and sustain economic activity and head off overheating and inflation.
Is the Asia-Pacific region already overpriced? Which country is the most attractive, and why?
In our opinion, regional stock prices are fair to slightly undervalued. The premium valuations that Asia typically enjoys relative to global equities have narrowed. Asia ex-Japan is currently valued at 13x forward earnings, with an expected growth rate of close to 20%. With plenty of liquidity in the domestic and global capital markets, we anticipate that Asian markets will remain well supported through much of this year.
Based on our bottom-up, fundamentals-based criteria, we are finding good opportunities across Asia. These are not only in China but also in smaller markets such as Indonesia. We especially like Indonesia because of its political stability, structural improvements and strong domestic growth. Valuations are attractive, and we believe analysts have been underestimating the growth prospects there.
Are you concerned about the threat of inflation and asset bubbles in China?
China carefully managed its economy throughout the global slowdown, and we expect it to continue to do so during this period of significant growth. The Chinese government has already taken steps to prevent overheating and keep inflation in check.
As for a possible bubble, stock prices often go up toward the end of a recession in expectation of a recovery, but that doesn't necessarily mean the market is overvalued. Chinese stock trading levels -- of 13x forward price-to-earnings -- are much lower than bubble valuations. Furthermore, the consensus 20% one-year earnings growth estimate for China is somewhat conservative in our view.
In any event, it wouldn't be surprising to see some volatility in China and other Asian markets until the global economy is on a steady course and investors recognise the level of growth in the environment. The current market environment is jostling between the macro news that is getting a lot of attention and what corporates are actually delivering.
The current sell-off presents another opportunity for investors on the sidelines to increase their exposure to the fast-growing Asian economies. This approach has typically been rewarding for investors with longer-term horizons.
What are your main country and industry positions in the Asian markets portfolio?
Indonesia is currently our largest overweight, for the reasons I just described. We're essentially neutral in China and Hong Kong and underweight in Taiwan, which doesn't score as well in our model due to less attractive valuations. Our biggest underweight is in Malaysia, because of its expensive valuations and low-growth environment. Growth is much better in India, but we're also underweight in that market because inflation is creating a headwind.
At the industry-group level, we've been focusing for some time on companies involved in domestic consumption and infrastructure development. Because much of the growth in Asia -- and emerging markets in general -- is now driven internally rather than by global factors, these two areas have held up well and should continue to flourish regardless of what happens globally.
In addition, improvements in economic activity at the industrial and consumer levels should benefit consumer-discretionary and capital-goods companies along with financials. We're also starting to focus more on companies like exporters, which will benefit from improvement in global demand.