Invesco avoids value traps in AsiaÆs stock markets
Investment Outlook Series: Paul Chan, CIO for Asia ex-Japan at Invesco Hong Kong, says consensus estimates have underestimated the slowdown in earnings growth next year.
This is part of an AsianInvestor series on the 2009 investment outlook of fund managers with Asian portfolios.
Paul Chan is the CIO for Asia ex-Japan at Invesco Hong Kong. He joined Invesco in November 2001 as an investment director and head of Hong Kong pensions and assumed his current role in July 2007. Chan has 19 years of experience covering the Hong Kong and China markets.
Invesco Limited, the Atlanta-based parent company of Invesco Hong Kong, manages around $410 billion globally.
ChanÆs Asia ex-Japan team manages around $8.3 billion. Chan is personally responsible for Hong Kong institutional and pension mandates.
What are the biggest opportunities that you see in the coming 12 months?
Chan: With the year-to-date correction, weÆre now finding opportunities to invest in companies with industry leading positions and pricing power, solid balance sheet, sustainable cash flow, and attractive dividend yields that are trading at very reasonable valuations. WeÆre prepared to leverage on our bottom-up stock selection skill to identify these opportunities.
How has the global financial crisis affected the way you manage your portfolios?
We have maintained a defensive positioning in our portfolios since the beginning of the year. While Asian investing has been traditionally focused on earnings growth, we believe that looking at earnings ratios û i.e. P/E û is not very reliable in this environment as earnings visibility remains low for 2009. We would pay greater attention to price-to-book (P/B), cash flow, and company-by-company fundamentals that give us the confidence that the company will have the competitive advantage to weather this economic turmoil.
What is the biggest lesson you have learned from the US credit crisis?
It has been 11 years since the Asian financial crisis and we are mindful of the devastating impact it had on Asian economies. Although the root of current crisis originates from the US and some would argue the decoupling theory, the magnitude of the impact is much greater.
Despite the huge year-to-date correction, what we have learnt is that the stock market might not have bottomed yet. We believe that the impact of full scale financial system deleveraging on the global economy has yet to be seen. Historically, stock market performance has been a reliable economic leading indicator. If the relationship between stock market and economic performance holds this time, the economic slowdown is probably in the first inning.
Have you made any significant changes to your asset allocation in terms of markets or sectors in the past few months?
We have been underweighting materials and industrials. We are bearish on commodities prices with the conviction that the early-2008 rally was very much driven by speculative inflow as well as derivative gearing, and that organic demand cannot support a prolonged period of, say, a $140+ oil price. The cyclical nature of commodities would also suggest that demand will moderate with the global slowdown. We are also underweight in industrials.
At the expense of these two sectors, we have been overweighting Chinese financials and selected leading telecom carriers as we believe earnings visibility in these sectors are relatively transparent and predictable.
What are your favoured markets in Asia?
Our top down models reveal that China, Hong Kong, and Thailand are most resilient to a downward revision in earnings.
What markets are you bearish over?
We believe India is still too expensive, Korea is vulnerable to cyclicality and IndonesiaÆs sovereign environment is less solid than other Asia counterparts.
What are your market weightings within an Asia ex-Japan equities portfolio?
China - Overweight
Hong Kong - Overweight
India - Underweight
Indonesia - Underweight
Korea - Underweight
Malaysia - Overweight
Pakistan - N/A
Philippines - Underweight
Singapore - Overweight
Sri Lanka - N/A
Taiwan - Overweight
Thailand - Overweight
Vietnam - N/A
Which sectors do you expect to outperform in the coming year?
We expect sectors which have the nature of generating stable and recurrent cash flow û such as telecommunications, consumer staples, and utilities û to perform well in a low interest rate, and yield seeking environment.
Which sectors do you expect to underperform?
We expect cyclical companies, such as materials and commodities to trail broad markets as global demand slows. Industrials are also facing a very tough environment due to rising input costs, leading to margin squeeze in an environment where it is increasingly difficult to pass on costs to end users. Also, companies with high gearing will also suffer as corporate lending cost rises with banks deleveraging their books.
What are the main challenges that you expect to face in the coming 12 months?
The main challenge is to avoid the value traps that exist in the markets. Whilst headlines reiterate that valuation has reached historical lows, our view is that valuation, measured by forward P/E, should become expensive again for companies to become attractive again. For that to happen, the denominator, being the projected earnings, will have to be revised down to a realistic level. Our argument is that, consensus is underestimating the magnitude of contraction in FY2009 earnings growth.
As forecast earnings are revised downward, forward P/E will rise, further pressuring share prices. Asian equities are most attractive during the earnings trough where pick up in earnings will warrant a momentum driven, cyclical market rally. We believe that we have not reached that stage yet as the market is still over optimistic in forward earnings.
What are the main risks of investing in Asia at the moment? How are you managing those risks?
We believe that Asian countries are experiencing a cyclical downturn at the moment, whilst the US and Europe are undergoing a structural change that may take many years to turn around.
Near-term, government imposed fiscal and monetary policies will stimulate growth, however, should government run out of solutions or reserves to boost the domestic economies, the key risk to investing in Asia is that exports may possibly be dampened by a prolonged global recession.
However, with AsiaÆs fundamentals remaining solid alongside a healthy financial system, the region shall be able to weather this global financial crisis.
Paul Chan is the CIO for Asia ex-Japan at Invesco Hong Kong. He joined Invesco in November 2001 as an investment director and head of Hong Kong pensions and assumed his current role in July 2007. Chan has 19 years of experience covering the Hong Kong and China markets.
Invesco Limited, the Atlanta-based parent company of Invesco Hong Kong, manages around $410 billion globally.
ChanÆs Asia ex-Japan team manages around $8.3 billion. Chan is personally responsible for Hong Kong institutional and pension mandates.
What are the biggest opportunities that you see in the coming 12 months?
Chan: With the year-to-date correction, weÆre now finding opportunities to invest in companies with industry leading positions and pricing power, solid balance sheet, sustainable cash flow, and attractive dividend yields that are trading at very reasonable valuations. WeÆre prepared to leverage on our bottom-up stock selection skill to identify these opportunities.
How has the global financial crisis affected the way you manage your portfolios?
We have maintained a defensive positioning in our portfolios since the beginning of the year. While Asian investing has been traditionally focused on earnings growth, we believe that looking at earnings ratios û i.e. P/E û is not very reliable in this environment as earnings visibility remains low for 2009. We would pay greater attention to price-to-book (P/B), cash flow, and company-by-company fundamentals that give us the confidence that the company will have the competitive advantage to weather this economic turmoil.
What is the biggest lesson you have learned from the US credit crisis?
It has been 11 years since the Asian financial crisis and we are mindful of the devastating impact it had on Asian economies. Although the root of current crisis originates from the US and some would argue the decoupling theory, the magnitude of the impact is much greater.
Despite the huge year-to-date correction, what we have learnt is that the stock market might not have bottomed yet. We believe that the impact of full scale financial system deleveraging on the global economy has yet to be seen. Historically, stock market performance has been a reliable economic leading indicator. If the relationship between stock market and economic performance holds this time, the economic slowdown is probably in the first inning.
Have you made any significant changes to your asset allocation in terms of markets or sectors in the past few months?
We have been underweighting materials and industrials. We are bearish on commodities prices with the conviction that the early-2008 rally was very much driven by speculative inflow as well as derivative gearing, and that organic demand cannot support a prolonged period of, say, a $140+ oil price. The cyclical nature of commodities would also suggest that demand will moderate with the global slowdown. We are also underweight in industrials.
At the expense of these two sectors, we have been overweighting Chinese financials and selected leading telecom carriers as we believe earnings visibility in these sectors are relatively transparent and predictable.
What are your favoured markets in Asia?
Our top down models reveal that China, Hong Kong, and Thailand are most resilient to a downward revision in earnings.
What markets are you bearish over?
We believe India is still too expensive, Korea is vulnerable to cyclicality and IndonesiaÆs sovereign environment is less solid than other Asia counterparts.
What are your market weightings within an Asia ex-Japan equities portfolio?
China - Overweight
Hong Kong - Overweight
India - Underweight
Indonesia - Underweight
Korea - Underweight
Malaysia - Overweight
Pakistan - N/A
Philippines - Underweight
Singapore - Overweight
Sri Lanka - N/A
Taiwan - Overweight
Thailand - Overweight
Vietnam - N/A
Which sectors do you expect to outperform in the coming year?
We expect sectors which have the nature of generating stable and recurrent cash flow û such as telecommunications, consumer staples, and utilities û to perform well in a low interest rate, and yield seeking environment.
Which sectors do you expect to underperform?
We expect cyclical companies, such as materials and commodities to trail broad markets as global demand slows. Industrials are also facing a very tough environment due to rising input costs, leading to margin squeeze in an environment where it is increasingly difficult to pass on costs to end users. Also, companies with high gearing will also suffer as corporate lending cost rises with banks deleveraging their books.
What are the main challenges that you expect to face in the coming 12 months?
The main challenge is to avoid the value traps that exist in the markets. Whilst headlines reiterate that valuation has reached historical lows, our view is that valuation, measured by forward P/E, should become expensive again for companies to become attractive again. For that to happen, the denominator, being the projected earnings, will have to be revised down to a realistic level. Our argument is that, consensus is underestimating the magnitude of contraction in FY2009 earnings growth.
As forecast earnings are revised downward, forward P/E will rise, further pressuring share prices. Asian equities are most attractive during the earnings trough where pick up in earnings will warrant a momentum driven, cyclical market rally. We believe that we have not reached that stage yet as the market is still over optimistic in forward earnings.
What are the main risks of investing in Asia at the moment? How are you managing those risks?
We believe that Asian countries are experiencing a cyclical downturn at the moment, whilst the US and Europe are undergoing a structural change that may take many years to turn around.
Near-term, government imposed fiscal and monetary policies will stimulate growth, however, should government run out of solutions or reserves to boost the domestic economies, the key risk to investing in Asia is that exports may possibly be dampened by a prolonged global recession.
However, with AsiaÆs fundamentals remaining solid alongside a healthy financial system, the region shall be able to weather this global financial crisis.
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