There are opportunities in Asia amid global economic uncertainty
The region’s markets will outperform, but recovery is unlikely to be smooth and straightforward
WITH a cross-current of dynamic factors ranging from the war in the Middle East to stronger than expected corporate earnings results, financial market volatility has picked up. We believe that an active and nimble approach towards asset allocation and risk management is required to navigate the current environment.
Road to recovery
Looking ahead, numerous factors will support the recovery in markets.
- US Federal Reserve’s policy stance: The Fed has ruled out the possibility of rate hikes in the near term. This has removed market concerns of the Fed considering raising rates as a main option.
- Market expectations: Market expectations of Fed cuts this year have been lowered significantly to only two expected cuts, a stark contrast to expectations for up to six Fed cuts at the start of the year. A key positive is that market expectations are lower than the Fed’s base case of three cuts. This provides an avenue for the Fed to deliver a positive surprise should it decide to proceed with three rate cuts this year.
- Treasury yields: Treasury yields have likely reached a near-term ceiling. With the Fed ruling out rate hikes, and with the tapering of quantitative tightening from US$60 billion per month to US$25 billion per month, there is less support for yields to go up.
- Earnings resiliency: The technology sector has demonstrated resilience during earnings season. The Magnificent 7 companies have surpassed expectations. Growth from cloud computing and artificial intelligence (AI) related offerings are strong drivers.
- Geopolitical normalisation: Conflicts in the Middle East and the Russia-Ukraine war are ongoing, though tensions have subsided somewhat. Gradual normalisation of tension results in a fading of the geopolitical risk premium, and supports a better investment climate.
Asia and emerging markets to outperform
Historical market patterns indicate that Asia and emerging markets (EM) can outperform the US. On average, in a Fed pause and cutting cycle, EM equities have delivered returns of 29 per cent versus more than 14 per cent for US equities. There is potential for a repeat of such an outperformance this year because in addition to policy support from rate cuts, investors in EM get higher growth and earnings potential; more attractive valuations; and exposure to currencies with higher carry relative to the US dollar and developed markets.
However, not all EM countries are equal, and we believe that active management and a selective approach are required. We are of the view that India, China, South Korea and Taiwan have the potential to deliver strong performance this year.
India: strong on its own
India’s economic growth remains robust, with the purchasing managers’ index (PMI) consistently above 60 and supported by government-led capital expenditure (capex) plans.
The market’s projected earnings growth for FY24 is one of the strongest in the region, and is not dependent on the performance of the technology sector.
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India also benefits from strong policy support. Unlike other central banks that have set policy rates at very restrictive levels, the Reserve Bank of India’s policy rates are at 6.5 per cent, and in line with India’s projected real gross domestic product (GDP) growth of 6 to 7 per cent for this year .
What is important is that there are numerous market catalysts that are yet to be priced in by the market. First, the result of the ongoing elections will be released on Jun 4. Historical trends show that a majority government formed by Prime Minister Narendra Modi and the National Democratic Alliance will be positive for sentiment and the execution of the government’s plans laid out during the interim budget in February.
Second, the inclusion of Indian government bonds in global bond indexes, starting from June over 10 months, will be supportive for the rupee and is positive for domestic equities.
Finally, the government in power post-elections will announce a full Budget in July, with scope for further improvement in capex, translating into a further pick-up in corporate earnings.
China: cautiously optimistic
The rally in Chinese equity markets has been supported by better-than-expected macroeconomic performance in the first quarter of 2024. First-quarter GDP growth came in at 5.3 per cent year on year, outperforming market expectations of 4.8 per cent.
We have also had market rescue efforts by the authorities, with the creation of a market stabilisation fund. This has placed a downside buffer in the markets.
In addition to improving economic growth, from a fundamental perspective, the recent fourth-quarter earnings results season was strong with 10 per cent growth in earnings per share year on year.
We have also seen broad-based re-engagement between China and the US, both diplomatically and at the business level. The recent bilateral agreement to have an intergovernmental dialogue on AI further supports this thawing of tension.
Valuations are also still very supportive, with the forward price-to-earnings ratio at one standard deviation below long-term averages.
South Korea and Taiwan: beneficiaries of initiatives
Both South Korea and Taiwan offer attractive potential driven by the following key factors:
- Robust earnings growth, driven by the structural trend of AI adoption. AI requires sizeable computing power and cloud storage. South Korea and Taiwan are key parts of the value chain, with South Korea being the lead manufacturer of high bandwidth memory chips, and Taiwan being the leader in semiconductor manufacturing.
- South Korea also benefits from structural reform. The Corporate Value-up programme could be a meaningful catalyst. On May 2, the Financial Services Commission announced draft guidelines on disclosure, similar to what the Tokyo Stock Exchange has asked of Japanese corporates. Taking the results thus far in Japan as a guide, South Korea’s initiative will unlock shareholder value and benefit investors. Later this year, as part of the Value-up programme, the government is likely to deliver tax incentives such as dividend credits for companies that increase dividends as a result. This will further support investors.
Risks to watch
Despite our view that markets are on the road to recovery and that in a Fed cutting cycle, Asia and EM markets will outperform, recovery is unlikely to be smooth and straightforward.
A re-escalation of the Middle East conflict could drive oil supply shocks, affect inflation and result in unforeseen Fed policy changes. The geopolitical impact of the US election outcome on markets is also a risk that we continue to watch closely.
As market leadership will change based on the key risk factors driving markets, navigating this environment requires an active and nimble approach to asset allocation and risk management.
The writer is head of multi-asset investment solutions (South-east Asia), abrdn
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