How will Asia cope with the global downturn?
David Urquhart, Portfolio Manager with Fidelity, discusses how Asia is braced to cope with a global economic slowdown and more turmoil on financial markets.
To what extent is Asia insulated from a global slowdown?
Although Asia is not immune to a slowdown in the West, it is now more resilient to withstand a global economic downturn than it was a decade ago. Firstly, the Asian economy is significantly less reliant on the West than in the past. While the export-to-GDP ratios of most Asian countries have increased over the past decade, over half of their exports are intra Asia or other emerging countries nowadays. Therefore, as long as the US and Europe can avoid a recession, Asia’s exports should expand in 2012.
Secondly, Asian policymakers still have more growth-supportive policy options at their disposal than their developed market peers. As most Asian central banks have tightened monetary policy in recent times, they have the flexibility to relax the interest rates and credit policy in case of a severe economic slowdown.
Last but not least, following the Asia crisis in 1997 and the global financial crisis in 2008, Asian companies have built large reserves of cash and reduced debt on their balance sheets. The stronger balance sheets represent a robust buffer in the event of an economic downturn. Lower capex and higher capacity utilisation also make them better prepared for a downturn this time around.
Overall, Asia’s healthy financial system, robust domestic demand, low debt levels, high savings rates and the emergence of China as a new anchor of growth for the region will support a multi-year growth cycle. In the longer run, we expect a polarised world where growth will be driven by developing markets like Asia especially China, whereas developed countries such as the US and Europe will remain sluggish.
What are the biggest risks that Asia is facing now?
Asian equity markets fell in recent weeks mainly due to the contagion of debt problems and slower-than-expected economic recovery in the US and Europe. However, investors in Asia are also concerned about the impact of rising inflation and the resultant monetary tightening on the region’s economic growth.
Inflation is a concern in some parts of Asia, but not everywhere. It is particularly sticky in China and India, but it remains well contained in, for instance, Indonesia and the Philippines. Indonesia has raised interest rates only once and the Philippines twice in the current cycle, whereas India has made 11 increases. Also, it is widely believed that inflation is expected to peak in the second half of 2011. Money-supply growth in the region has already started to decelerate. Also, commodity prices have fallen in response to softer economic growth data in the West, reducing pressure on inflation from rising resource and energy prices.
One of the key risks for the region is slower-than-expected growth in OECD economies. While Asian economies have decoupled from the West to some extent, they are not immune to events in developed economies. A slowdown in the West would hurt exports and hamper capital flows, and thus slow growth. That said, the long-term growth prospects of Asia remain intact. While stock markets could remain volatile in the near term, the region’s superior growth rate, solid fundamentals and low debt levels may well be attractive to global investors when they compare Asia with developed markets. The region’s domestic demand is robust and is likely to support strong growth.
How do corporate earnings in Asia look so far?
According to Citigroup, out of the 1,112 companies that had reported their quarterly results by August 24, around 50% of them have beaten estimates, translating into an aggregate earnings surprise of US$2.64 billion across Asia Pacific ex-Japan. Country-wise, China, Hong Kong, Malaysia, Taiwan and South Korea missed their earnings marginally, while Singapore reported the largest aggregate positive surprise. Sector-wise, the financial sector has had the largest positive surprise thus far, while healthcare, industrials, IT, telecoms and utilities missed estimates.
In terms of guidance from companies, downward earnings revisions within Asia ex-Japan have been insignificant so far. Over the eight weeks to August 25, the 2011 and 2012 earnings estimates across the region have only been revised downwards by 0.9%. Overall, Asia ex-Japan is still expected to deliver mid-teen earnings growth in 2011 and double-digit growth 2012.
Are ASEAN markets better positioned to withstand the global economic downturn nowadays?
The outlook for ASEAN countries is good for two reasons. First of all, none of the five key countries within the ASEAN region (Indonesia, Malaysia, the Philippines, Singapore and Thailand) suffers from a twin deficit situation. Instead, these ASEAN countries have low public debt that allows their governments to come up with policy responses. Second, the banking systems in ASEAN remain healthy. Private sector leverage is also low, which means Asian companies can withstand any global economic downturn.
Third, the ASEAN economies have undergone significant structural change over the past decade. Pre-1997, they were heavily geared towards exports to the US and Europe. However, given that ASEAN’s key trading partners are Asia and emerging markets nowadays, these countries are not as vulnerable to slower demand growth from the US and Europe. For ASEAN, in the worst case, this is a profitability challenge and not the balance-sheet challenge that the developed world might face.
Thus, ASEAN as a bloc is well positioned. The key will be China. As long as China does not have a hard landing, the ASEAN bloc should withstand slower global growth.
What about the Asian market valuations?
Asia’s stock markets are attractively priced following the recent market correction. The region is now trading at a forward price-earnings ratio of 10.5 times, which is at a discount to the five-year average of around 13 times. On a price-to-book basis, valuations are 1.8 times book value versus a five-year average of 2.1 times, while returns on equity are much higher than that of 10 years ago. From a valuation standpoint, this is the second best time to be buying Asian stocks in 10 years.
There are risks to global growth coming from the US and Europe but these risks are more than priced in. The increased possibility of recession is now built into share prices. I am still comfortable that growth will continue in Asia, and should significantly outpace the rest of the world in the coming years.
How likely is a hard landing in China?
While China is unlikely to stay completely unaffected by the weaker growth outlook in the developed markets, a hard landing is not a great risk at the moment. Despite the aggressive monetary tightening over the past year, economic data releases through to July 2011 show that China’s economic growth momentum remains healthy. Fixed-asset investment in particular is surprising on the upside (rising by 25.4% in the past seven months of the year from a year ago), helped by sizeable investments in social housing. Despite slowness in manufacturing growth, China’s output is 50% above the pre-2008 crisis level. Growth in retail sales and wages has remained resilient as well.
Although China’s inflation will be structurally higher than in the past owing to higher wage levels, the recent increase in inflation is mainly attributable to rising food prices. These increases, however, are likely to peak in the near future – items such as pork have already shown some signs of reaching the tipping point. Moreover, the global economic downturn should help quell inflationary pressures. Accordingly, China’s inflation should start to slow in the fourth quarter of this year. Chinese authorities may loosen its monetary policy by then. In addition, government debt levels appear to be manageable when examined in the context of global debt levels.
Relative to the heavily indebted western economies, cash-rich China still has ample fiscal room to respond to contain the downside risk to growth for the region. The Chinese government may initiate selective fiscal expansion to support social housing, consumer spending and urbanisation projects. The central authority could also accelerate implementation of longer-term policy measures to structurally boost private consumption.
What is the Chinese market outlook?
Although China is not insulated from the global economic downturn, solid domestic demand fundamentals driving the long-term growth should provide ample grounds for funds to flow back into China once the initial flight to safety abates. China is trading at a forward price-earning ratio of 9.3 times, which is at a significant discount to its five-year average of 13.5 times.
Our analysts are seeing more attractive buying ideas in China. Given China’s relatively solid fundamentals, we think Chinese equities will be among the first ones to come out from the market correction.
Any references to specific securities should not be taken as recommendations and may not represent actual holdings in the portfolio at the time of this viewing.
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