Asia-Pacific: tortoise and the hare?
The developing Asia-Pacific economies are powering ahead like the speedy hare in the classic fable, although we are less optimistic on the outlook for some of the more developed regional countries that plod along like the fable's tortoise. Resilient global trade continues to be a tailwind, and Asia-Pacific equities currently appear slightly expensive after a strong secondquarter performance.
The Asia-Pacific region remains resilient, and we continue to expect GDP growth of around 5%. Along with strong domestic demand in some countries, global demand (particularly inter-region demand) is proving a significant boost for export-oriented companies. The forward 12-month earnings growth expectation for the MSCI AC Asia Pacific Index is 12% as of June 16, 2017. We expect the developing countries within the region to outperform through 2017, while the outlook for the developed countries is far more mixed. The three key threats to our outlook are a global slowdown, a follow-through on some of the recent protectionist trade threats coming out of the United States, and high levels of debt in a rising interest rate environment.
Looking first at developed Asia-Pacific countries, the Japanese economy is benefiting from strong demand for exports, but remains lackluster as personal consumption lags. Inflation continues to be sluggish; however, we see anecdotal signs of inflation beginning to come through. Some very visible prices are rising for the first time in years (for example, postage stamps and beer). Monetary policy has been accommodative, and we expect the Bank of Japan to maintain this through the remainder of the year.
The Australian economy has been stumbling along recently, while New Zealand finds itself in a better state. New Zealand’s exposure to soft commodities (which have been performing well) is beneficial, as compared to Australia’s exposure to hard commodities (which have struggled). Both countries are facing a slowing housing market, while slow wage growth has meant the Australian consumer is becoming cautious. We look for an outperformance by New Zealand versus Australia through the remainder of the year.
In Singapore, consumption and investment have been declining, despite strong regional demand for exports. We expect to see domestic demand remain weak, as consumers face weak wage growth. The one fully positive story among developed Asia-Pacific economies is Hong Kong, where growth has been accelerating off the back of strong external demand and robust investment. We expect decent growth for the rest of the year, with an overheated property market becoming the key threat to the economy.
In comparison, the developing economies in the region continue to show strength. Growth in China remains robust, and we maintain our constructive outlook on the Chinese economy. Despite concerns around heightened debt levels, industry surveys of business activity and indicators of growth (such as rail freight volumes) point to further expansion. The government will be focused on stable growth in the lead-up to the 19th National Congress of the Communist Party of China later this year, an important planning session for the Chinese government every five years.
Growth in India has been hampered recently by the effects of the demonetization¹ policy. We expect this to filter out over coming months, and an acceleration in economic activity in the second half of 2017. Business and consumer sentiment have been rising in South Korea, which is driving a pickup in economic activity, while monetary policy remains accommodative. Growth in the Philippines and Malaysia is accelerating, while economic activity in Indonesia continues to expand at around 5% per year.
China's rail freight volumes
Source: China's National Bureau of Statistics, as of April 15, 2017.
For regional equities, we assess business cycle, value, and sentiment considerations as follows:
- Business cycle: We have a positive outlook on the developing countries within Asia- Pacific; however, our view on the developed economies is less optimistic, dragging our aggregate view to neutral. China, India and South Korea, in our view, will be drivers of growth. On the developed side, Japan is expected to muddle along, while Australia and New Zealand remain lackluster.
- Valuation: Asia-Pacific equity markets have performed strongly in the second quarter, adding just over 4% through June 9, according to the MSCI AC Asia Pacific Index, pushing the region into slightly expensive territory. The index currently shows stocks in the region trading on a forward price-to-earnings ratio of 16.2X, a price-to-book multiple of 1.6X and a dividend yield of 2.4%.
- Sentiment: Asia-Pacific markets have been riding on a wave of positive momentum since the start of the year, while the market remains in overbought territory. The perception of the Asia-Pacific economy’s health has fallen since our previous quarterly report, which is a positive for our assessment of sentiment, but overall we have a slightly negative rating on sentiment.
- Conclusion: Overall, we are neutral on the Asia-Pacific region. There are pockets of strength in the region, namely the developing countries, although we are cautious to chase the hares. While the tortoise came out ahead in the fable, we expect the slowermoving developed economies to underwhelm. The strong year-to-date performance in 2017 has made valuations less attractive and, in our view, pushed the region into overbought territory.
1 Demonetization is the act of stripping a currency unit of its status as legal tender. It occurs whenever there is a change of national currency: The current form or forms of money are pulled from circulation and retired, often to be replaced with new notes or coins. On Nov. 8, 2016, the government of India announced the demonetization of two widely used banknotes of the Mahatma Gandhi Series.