Market Views: Asia's most attractive EM equity bets

Asian emerging market equities have pulled in a lot of investment in recent times, even though the picture is mixed when it comes to China. Where are they headed next?
Market Views: Asia's most attractive EM equity bets

Asian emerging equity markets ex-China have experienced a foreign investment boom over the past 12 months, with net inflows of $41 billion knocking China off its perch as the top regional investment destination, according to a Financial Times report that cites Goldman Sachs data.

During the same period, China attracted just $33 billion.

The development marks a sharp reversal of regional investment flows in the previous 12 months, during which Asian emerging equity markets outside China saw net outflows of $76.6 billion while China sucked in $42.8 billion, according to the FT.

The reasons for this U-turn are several, but the one that arguably looms largest is the gloom surrounding China’s underwhelming economic performance since it abruptly exited its harsh regime of COVID-19 restrictions.

Compared to China’s slow momentum, investment destinations elsewhere in the region have looked promising.

Meanwhile, non-Chinese emerging Asian economies have picked up on the back of a trend towards “friendshoring” that has seen supply chains shift away from China, contributing to equity market gains.

The high interest rate environment has also played a part in boosting the appeal of Asian emerging equity markets more broadly, since inflation in many emerging market economies has cooled sufficiently for their central banks to edge closer to cutting rates, which remains stubbornly high in developed markets.

Interest rate increases in developed markets have historically been bad news for emerging markets.

But the lack of volatility in emerging market assets suggests that those markets have weathered the series of developed market rate hikes, without a “taper tantrum” such as the one that erupted a decade ago when the US Federal Reserve put the brakes on quantitative easing.

All in all, it seems there’s a lot to like about Asian emerging market equities -- including Chinese stocks, depending on developments -- so we asked asset managers where they think they’re going next.

The following responses have been edited for clarity and brevity.

Mike Shiao, chief investment officer, Asia ex-Japan

Mike Shiao

We remain constructive on the broader Asia macro outlook for the second half of 2023.

Asian economies, which have much lower inflation and lower pressure from rising interest rates, should continue to grow more quickly than developed markets, which are still working to tame inflation at the expense of growth.

Asia is well positioned to benefit from digitalisation, artificial intelligence and “smart” trends.

China is advancing its digital infrastructure, while South Korea and Taiwan are at the forefront of major technology segments including memory, semiconductors, dynamic random access memory components and the internet of things (IoT).

Meanwhile, India’s digital economy is transforming quickly, having grown at more than twice the rate of its broader economy, and digital adoption in financial services is rising especially rapidly.

Under India’s financial inclusion policies, the number of bank accounts has risen from 100 million in 2015 to 480 million in 2023. India’s large, young population should drive domestic demand and higher discretionary spending.

ASEAN is another bright spot when it comes to domestic consumption.

Over 60% of the population is under the age 35, and their disposable incomes have also been rising. Healthy household and corporate balance sheets, plus decent credit growth, signal a willingness to spend. We expect that retail demand, particularly in Indonesia, will keep rising, and the outlook for the region remains robust.

Meanwhile, valuations of Asian equities are in a comfortable range and are trading at a discount relative to those in developed markets.

Alexander Treves, head of emerging markets & APAC equities investment specialists
J.P. Morgan Asset Management

Alexander Treves

Overall, we see an expanding differential between economic growth in Asia and that in developed markets. Within Asian emerging market equities, there are a couple of key focus areas.

First, the pace and magnitude of economic recovery in China. Households are still rebuilding confidence.

We think the data has been less disappointing than the market perceives, as our focus had been on consumption, and we were not relying on exports and construction.

It seems that the market has been expecting a bit more, which could explain a measure of frustration with the pace of recovery, but we advocate persistence, with a focus on discretionary and high-end consumption before mass-market, and on structural growth areas such as technology self-sufficiency and carbon transition.

If the data continues to be tepid, the government may stimulate further. In the meantime, a more pro-policy business stance is apparent.

ASEAN remains somewhat neglected by many investors, which means there are plentiful marginal buyers. The underlying structural and cyclical theses are still intact: a large and heterogenous region with attractive demographics and internal diversification between markets, which dampens volatility more than most people realise.

In the near term, there is more to come from Southeast Asia’s leverage to a recovering China and supply chain diversification in ASEAN’s favour.

Xin-Yao NG, investment manager, Asian equities

Xin-Yao Ng

I lean towards the consensus view that the Fed’s rate tightening could reach its worst this year – maybe another 50 basis points of hikes. With that, the chance is that the US dollar has peaked and that its softening will continue, which helps emerging markets.

At the same time, that’ll leave less pressure on central banks elsewhere to defend their currencies by constraining monetary conditions. In Asia, economic expansion and inflation have remained steady in most parts, and that can continue if there’s no pressure to tighten excessively.

Asia is thus in a good place. For the remainder of this year, we remain positive on India and Indonesia, where the economies are robust, despite already performing fine this year and valuations rising high, especially for quality companies.

We also like Vietnam, which should be firmly recovering from its property-related debacle last year, although it’s a much smaller universe. These are also structural views, as we see favourable demographics, supply chain shifts, supportive government policies and expanding capital markets continuing to push these economies.

The big unknown is China, where economic recovery has been short-lived, and Beijing still seems reluctant to boost the economy, although it could be the biggest positive surprise for the remainder of this year if the government decides to provide stimulus, just as they surprised us last year.

Our stance is to bet on stock selection rather than take too much of a market view, where it is hard to gain an edge over insights into politics.

There are good reasons for the gloom about the economy, but it’s a huge market that will always have brighter spots that we’ll focus on, such as electric vehicles, software and the recovery of internet businesses.

The overwhelmingly negative market sentiment has compressed valuations substantially, allowing stock pickers like us to find much better free cash flow yields than anywhere else in Asia.

SooHai Lim, head of Asia ex-China equities

SooHai Lim

We are constructive on Asian equities over the remainder of the year, driven by a more favourable macro environment and investor sentiment. We expect performance laggards in the first half of 2023 to catch up, while the winners may consolidate and build on the rally this year.

The earnings cycle may stabilise in the next six months, and investors may look towards 2024 for numerous exciting structural growth opportunities across Asia.

Weak economic activities in China in recent months may prompt regulators to introduce additional policy stimulus. It is worth nothing that domestic consumption continues to recover alongside improving consumer confidence.

India’s valuation premium has been justified by its economic and corporate resilience.

Foreign investors have returned as the market’s long-term structural appeal remains compelling. With the domestic investment cycle back in an upswing, we see banks and industrials among the more attractive opportunities.

South Korean and Taiwanese equities are expected to benefit from a bottoming out and growth in the semiconductor cycle in the next 18 months, while valuations look somewhat expensive. The recent pace of artificial intelligence development has added conviction to artificial intelligence-exposed South Korean and Taiwanese companies.

Tourists are returning to Southeast Asia, driven by supportive government policies and pent-up demand from North Asia.

ASEAN is a growing recipient of the world’s capital investments, ranging from low value-added manufacturing all the way through to the hardware technology supply chain.

The longer-term thesis of Southeast Asia as a beneficiary of supply chain diversification remains well intact, with Chinese companies extending their supply chains to the region.

Haider Ali, associate portfolio manager for emerging markets discovery equity strategy
T. Rowe Price

Haider Ali

A strong US dollar, disappointing earnings growth and slowing global growth have been significant headwinds for emerging market equities, but these headwinds are likely to abate as we move through the next stages of the economic and equity cycle.

Emerging market equities have historically been an early beneficiary of global economic recoveries. Any improvement in economic conditions may represent a signal to increase allocations to the asset class.

China remains the key market to watch, in our opinion.

Despite frustration over its slower-than-expected post-pandemic economic recovery, current undemanding valuations and overly pessimistic sentiment, developments suggest a bottoming out of China’s equity markets.

We believe the recovery hasn’t stalled, but started to move in a new direction where consumption, rather than investment, will drive growth.

We like the structural growth story of India, but sentiment appears to be euphoric. Valuations, especially for small-/mid-cap stocks are stretched and, at times, at odds with underlying earnings trends.

Indian equities may continue to outperform in the near term, especially if sentiment on China equities remains weak, but we will be selective in our approach.

Elsewhere in the region, we believe Indonesia has emerged stronger out of COVID-19 relative to other ASEAN economies. The political cycle is a bigger risk in this region, which is otherwise well-positioned to benefit from growing opportunities in trade and tourism.

We believe focusing on stocks with asymmetrical risk/reward characteristics will serve us in good stead in capturing opportunities that may arise from these divergent trends in the region.

Vicki Chi

Vicki Chi, portfolio manager, Asian stars equities

Market sentiment remains subdued, with concerns around a global slowdown, recession in the US and a slower-than-expected reopening in China. Rate concerns around data releases and “Fedspeak”, along with geopolitics, is unlikely to go away soon, so volatility is likely to remain elevated.

Consumption, economic activity and stimulus will remain the focus in China.

Our focus continues to be earnings, and although it will be selective, we believe reopening will provide some good bottom-up stock opportunities.

After the recent pullback, it’s a great time for global investors to allocate to Asia.

Recession-level valuations, more prudent monetary and fiscal policy, and the benefits of reopening put Asia in a good position. Also, the Asian supply chain is fully participating in the most exciting developments in artificial intelligence, with attractive valuations that are just beginning to be recognised.

India is a good long-term story, although we remain selective and disciplined with our value approach.

Asian markets still offer good value for investors, despite the large move in equity markets.

The recent earnings season was met with very bearish sentiment. Some stocks dropped on better-than-expected earnings, which we believe presents good entry opportunities for long-term investors.

Asian markets are still 30% cheaper than global markets. We focus on bottom-up stock picking and on companies with solid cash flow generation that are trading at good prices with positive earnings and price momentum.

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