Asia-Pacific outlook: power without glory
Economies in the Asia-Pacific region are motoring on, with our expectation for full-year 2017 real GDP growth at just under 5%. That’s just a slight acceleration on 2016, as trade continues to improve and as business conditions firm. In our view, Asia-Pacific equity markets are fairly priced, while interest rates are facing upward pressures as global reflation returns.
Motoring on despite concerns
The Asia-Pacific region appears in good shape, with solid recoveries apparent in many areas. We are particularly encouraged to see some growth surprises in economies that had previously been lagging, including Taiwan and Japan. Simultaneously, though, better 2016 performers such as India, Australia and New Zealand are now seeing slight downgrades to growth at the margin. It’s also the case that the region continues to deliver strong growth in the face of widespread concerns about high levels of debt, growing threats of protectionism, and the challenges posed by a tightening cycle from the U.S. Federal Reserve.
In Australia and New Zealand, we are seeing the interest rate and inflation cycles bottoming out, but any moves toward tighter monetary conditions are still some way off. With commodity prices stabilizing and housing still holding up, we look for reasonable performance from those economies through the remainder of the year.
The Japanese economy remains one of the weaker parts of the region, despite slightly firmer GDP data this year and some improvement in exports. Demographic headwinds, a strong yen, as well as stubbornly low inflation and wage growth, leave the overall outlook there somewhat downbeat.
China is seeing a continuation of better growth numbers in 2017, and many indicators of economic activity are looking increasingly healthy. The monetary authorities there have also steadied the capital outflows that were gathering pace earlier in the year. The risk for China is that interest rates are now rising, as seen in the chart below, following a long period of quiescence in 2016. The challenge will be to manage the high levels of debt in an environment of higher rates. On the plus side, we are beginning to see a relaxation of tighter fiscal settings in recent months.
China's short-term interbank interest rate (3-month)
Source: The Shanghai Interbank Offered Rate (or Shibor) as of March 16, 2017. This is a daily reference rate based on the interest rates at which banks offer to lend unsecured funds to other banks in the Shanghai wholesale (or "interbank") money market. There are eight Shibor rates, with maturities ranging from overnight to a year.
For regional equities, we assess cycle, value and sentiment considerations as follows:
- Business cycle: The cyclical backdrop for the Asia-Pacific region remains neutral as we move through 2017. China, together with Indonesia and India, remains an engine of growth, but Japan will be much more sluggish, and the outlook for Australia/New Zealand is mixed. The drivers of official interest rate cuts and of monetary stimulus have now faded.
- Valuation: As of March 10, 2017, using the MSCI Index, the Asia-Pacific region (including Japan) was trading on a forward (2017) price-to-earnings ratio of 14.0x, a price-to-book ratio of 1.4x, and a dividend yield of 2.7%. The value story is losing some of its shine following rises in prices this year, but the region is not yet in expensive territory.
- Sentiment: Regional markets are demonstrating reasonably positive momentum. However, recent buoyancy leaves equities “overbought.” We also believe that perceptions of economic health are at a high watermark and are likely to sour over the year ahead. Consequently, we rate sentiment as a negative.
- Conclusion: The outlook for Asia-Pacific equities over the remainder of 2017 is unexciting. Our investment thesis of “low returns and high volatility” for Asia-Pacific equities for 2016 and into 2017 remains intact. At current prices, repeating what we said in our Annual Outlook in December, we continue to take a slightly positive stance, largely motivated by the value scores.