Asia Pacific: Low rates, solid growth
2017 was a strong year for the Asia-Pacific region, underpinned by solid global growth and Chinese demand. We expect the region’s economy to post another year of high growth in 2018, with good support from Australia and Japan, though with developing economies outpacing developed.
The Asia-Pacific economy continues to move along at a brisk pace, with GDP growing by 5% in 2017 through the third quarter. The strength of the global economy, along with inter-regional trade, has been beneficial. The region’s outlook for 2018 is solid, with industry consensus expectations of 10% earnings growth on the MSCI Asia Pacific Index and GDP growth expected to come in at just under 5%. A sharp slowdown in China remains a risk, although the outcome of the 19th National Congress indicates the Chinese government will not be aggressively pursuing deleveraging. Tensions with North Korea persist in the background, despite having dissipated in recent months.
The outlook for China, in our opinion, remains positive. The National Congress revealed a Chinese government that will continue to focus on sturdy growth rates. The goal of doubling GDP per capita requires 6.5% per year in the three years to 2020, which we expect the Chinese economy will achieve. The move toward a consumption-led economy will continue at a gradual pace, which will benefit many countries in the region that produce consumer goods. In an equivalent manner, Japanese export growth has been driven higher in recent months by Chinese demand for machinery and electronic equipment. The key risk to the Chinese economy remains the elevated levels of leverage, however we think the deleveraging effort will be gradual.
We remain constructive on other developing Asia-Pacific economies. With more than 55% of Chinese imports coming from the region, according to Thomson Reuters Datastream, our positive outlook on China will result in strong external demand for Asia-Pacific developing economies. Additionally, domestic demand across most of these countries is reasonably healthy, supported by accommodative monetary policy.
Investors have been piling into Japanese equities in the second half of this year, with the Nikkei Stock Average rising by 11% (as of November 20, 2017). We expect further strength in the Japanese economy through 2018. The one cylinder of the economy that is not currently firing is the consumer (which was a detractor from Q3 GDP growth). But with a tightening labor market and a very gradual inflation pulse putting pressure on wages, we expect to see an improvement in consumption.
Source: Thomson Reuters Datastream, as of November 25, 2017.
Our 2018 outlook for investment in Japan is also bright, with business surveys pointing to an increasingly confident business sector. Additionally, the 2020 Tokyo Olympics is expected to inject further stimulus into the economy. We also think the Bank of Japan is going to maintain an accommodative policy, even in the face of tightening policy elsewhere in the world. This will have a two-pronged benefit, in that it will continue to pump liquidity into the Japanese economy and put downward pressure on the yen, both of which we expect to be beneficial.
Further south, we continue to be constructive on the Australian economy. Strong business confidence has been translating into solid payroll gains, and we are starting to see the signs of improving capex plans. The economy may start the year in a ‘Goldilocks’ zone, with solid growth and a low inflation pulse. However, we expect to see signs of re-emergent wage and price inflation over 2018, which will see the Reserve Bank of Australia hike rates twice. The Australian equity market has lagged global markets in 2017. We see potential for the market to catch up through 2018, driven by improving commodity prices.
In New Zealand, we think the best economic growth has been seen for now. The economy’s impressive performance over the last three years had been driven by migration and the housing market. The new Labour government has announced a reduction in migration to New Zealand and a ban on foreign purchases of new property, which should moderate these drivers of growth. On monetary policy, the government has also announced a review of the Reserve Bank of New Zealand’s (RBNZ) mandate, and it is likely that full employment will be added as an objective (along with price stability). This will provide the central bank with more flexibility, which we think will lead to a more dovish approach. Our base case is that the RBNZ will raise rates once in 2018.
As highlighted in our previous quarterly outlook report, there remain a couple of risks for the region: 1. The continued demand from China. For China itself, the risk of some sort of trade altercation with the United States has not completely disappeared. 2. Tensions with North Korea still have the potential to flare up, although we are giving this a lower probability following the implementation of trade sanctions by China.
For regional equities, we make an assessment of business cycle, value and sentiment considerations as follows:
- Business cycle: We expect 2018 will be another strong year for the region. Developing countries will continue to set the pace, but we will be looking for further incremental improvements in Japan and Australia. Central bankers will remain highly supportive.
- Valuation: The region as a whole continues to look a tad expensive, in part driven by the Chinese technology sector which is extremely expensive. Within the region, we think Japan remains fairly valued, but is moving toward expensive territory following the impressive run this year, while Australian equities remain slightly expensive.
- Sentiment: Strong momentum in regional equities has triggered contrarian indicators, suggesting that some markets have become overbought. This has become particularly apparent in Japan. Despite this, we note that a late-stage cyclical upswing in the global economy would be a driver for momentum in the region.
- Conclusion: The Asia-Pacific region is set to continue its impressive performance through 2018, underpinned by robust growth in China and the global economy. Valuations are looking a bit expensive, but within the region there remain pockets of fair value. Late-cycle dynamics in the global economy will further boost regional growth.