Asia's equity market has further room to run

EQUITY markets in Asia ex-Japan have had their best start to the year since 2009, rising almost 22 per cent in US dollar terms in the first half of 2017. China and South Korea - our preferred markets - have led the pack, posting gains of 24 per cent and 17 per cent respectively. A key question for investors is whether this pace of gains can be maintained. To answer this, we need to identify what has driven the gains so far this year, and assess the sustainability of these drivers and the potential for new catalysts.

The drivers of Asian market trends in the first half include US dollar weakness, a solid earnings recovery and diminishing chances of implementation of a punitive US import tariff considered by the new administration. The US dollar has declined almost 9 per cent against its main trading partners from its peak in late 2016. A weaker dollar, besides allowing Asian central banks full control of their monetary policy, is generally supportive for regional asset markets as it results in an increase in capital inflows, boosting demand for stocks and bonds.

The flows have been supported by a strong earnings recovery. Consensus forecasts suggest earnings growth in Asia ex-Japan is likely to increase by 18 per cent this year, following a one per cent decline in 2016. China is leading the earnings recovery. Meanwhile, South Korean equities, for which exports are an important growth driver, have been re-rated by investors amid easing of political risks and reduced likelihood of the implementation of a new system of US import tariff.