Optimism despite geopolitical woes

Asia ex-Japan equities had a rough 2018, but strategists are still sanguine about the prospects

RISKS loom large for virtually all markets this year, but nowhere is this more evident than in Asia ex-Japan equities where uncertainty over the US/China trade conflict and a weaker China economy are a worrisome overhang.

Strategists, however, remain generally upbeat based on their recommendations for the region at the start of the year, with many issuing an overweight call on the region's equities and fixed income assets. This is partly thanks to the downdraft late last year which burnished stock valuations and pushed up bond yields.

To recap, Asia ex-Japan equities went from being a market darling in 2017 with a stellar gain of 42 per cent, to a loss of over 14 per cent at end-2018.

For the 12 months to end-2018, Morningstar Direct data on funds registered for sale in Singapore showed a negative 14.9 per cent return for Asia ex-Japan funds and minus 3 per cent for Asian fixed income funds.

As at mid-January, markets took heart from indications that the US Federal Reserve has embarked on an "extended pause", and optimism also rose for the US/China trade talks in January. Year-to-date up to Jan 21, the MSCI AC Asia ex-Japan Index is in the black, up by 4.44 per cent. The MSCI Emerging Markets is up by 5.4 per cent, and the MSCI AC World by about 6 per cent.

But the IMF has downgraded its forecast for global growth - its second downward revision in three months. IMF projects a 3.5 per cent growth rate for 2019 and 3.6 per cent for 2020.

These forecasts are 0.2 and 0.1 per cent, respectively, below its last forecasts in October. Here are some strategists' views:

Credit Suisse
Asia Pacific chief investment officer John Woods

Mr Woods remains "constructive" on Asian equity markets and believes a confluence of stabilisation in China's macro environment, agreement in the US/China trade conflict and stable Asian currencies should support a market recovery. Valuations are attractive and foreign investor positioning seems underweight after last year's US$35 billion in outflows from Asia ex-China.

He notes, however, that low consensus earnings growth of 7.5 per cent for 2019 "constrains our constructive outlook".

"Given a slowing in regional economies and the expected slump in global industrial production growth, earnings downgrades could continue ... Therefore, in a growth-scare environment, we recommend sticking with a growth-at-a-reasonable price strategy and prefer China and Singapore equities over Taiwan."

Bank of Singapore
Chief investment officer Rajeev De Mello

Mr De Mello says asset valuations have become more attractive since the selldown at end-2018. He expects global equities to return "reasonable gains" in 2019, although a recession does not look imminent. "We turn more risk-positive (in 2019) across multiple asset classes where we see opportunities to gain inexpensive exposure to potential upside from the more-constructive tone in US-China relations and the Fed's dovish tilt."

On a tactical allocation standpoint, BOS has increased its overweight on Asia ex-Japan equities, and upgraded Japan equities to overweight from neutral.

Union Bancaire Privee
Chief investment officer Norman Villamin

Mr Villamin notes that the outlook for Asia and the emerging markets is improving, which lays a foundation for optimism in 2019. He expects the Chinese economy to stabilise this year, helped by "incrementally supportive policies following an aggressive deleveraging focus early last year".

"A key headwind that remains for these asset classes is the elevated expectations for earnings in the coming year. While this issue is not unique to either Asia or emerging markets as a whole, disappointment and downgrades may remain an overhang as these expectations adjust early in the year. Once adjustments to these expectations are made and expected policy support emerges in the months ahead, the foundation for a more sustained rally should emerge."

Standard Chartered Bank
Head of Wealth Management
ASEAN and South Asia, Sumeet Bhambri

Mr Bhambri notes that Asia's corporate balance sheets have improved over the past few years. "We believe default rates are likely to edge only modestly higher and are unlikely to spill over to the Asia USD bond market." Asian equities are expected to benefit from the Fed's likely pause on further rate hikes in 2019.

"This may help to ease the liquidity squeeze which has negatively impacted markets such as India and Indonesia. Any improvement in the liquidity environment, less downward pressure on currencies as well as positive developments on US-China trade tensions, could act as catalysts for a re-rating."

Head chief investment office APAC Tan Min Lan

Ms Tan draws attention to the potential for a realignment of global supply chains as trade tensions continue. For individual firms, she writes that the overall impact of supply chain reconfigurations away from China is important but hard to quantify.

"Corporate margins in Asia will fall - we estimate by 25 to 30 basis points in 2019 - and capex spending will eventually rise as firms are forced to diversify production bases to avoid tariffs or to ensure the security of inputs."

"We are tactically overweight Asian and global equities given favourable valuations, but this view is contingent on trade tensions not escalating further. To manage this risk we combine these positions with relative value trades and portfolio hedges."

Strategist Jason Low

On valuation basis, Mr Low said Asia ex-Japan valuations are at around 12.1 times forward PE at mid-January, close to one standard deviation below their 10-year average.

"High cash levels among Asia ex-Japan funds suggest there is "dry powder" for markets to stage a rebound, once some of these uncertainties are gradually resolved. The Asian equity risk premium - the gap between earnings yield and the 10-year US government bond yield - suggests the region's equities are inexpensive against current rate conditions."

Schroders on Asia US dollar corporate bonds

Schroders says USD corporate bonds now offer one of the "most enticing entry points" for several years. Yields have reached attractive levels relative to other markets and in the context of the region's overall credit quality.

Based on valuations, the firm said Asian investment grade (IG) corporate bonds in aggregate offer better credit spreads than either US IG or euro IG. As at the end of Dec 31, 2018, the spread on the Asia IG Index was 183 basis points (bps), with duration of 4.8 years. This compared to a spread of 159 bps and duration of 6.9 years for the US IG market.

Manu George, Schroders senior investment director, Asian fixed income, said: "Given that Asia and US dollar IG have the same average credit rating, these discrepancies in yield, spread and interest rate risk would appear to reflect a degree of mispricing in the market." In the high yield (HY) market, Asia offers yields over 10 per cent (USD terms) and a spread of 759 bps, while US dollar HY, which has the same average credit rating, yields 7.9 per cent for a spread of 533bps. W

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