By Elizabeth Soon is head of Pacific Basin equities at Standard Life Investments The downturn in...
By Elizabeth Soon is head of Pacific Basin equities at Standard Life Investments
The downturn in world equity markets has extended to the Pacific Basin. Over the past quarter, this area has shown increasing correlation with the US, a classic feature of a bear market.
The change has brought equity valuations to levels that look attractive on a range of measures, both relative to other asset classes and on an absolute basis.
While this tells us the market is not optimistic about the current situation, we believe a cyclical upswing in the economies and rising return on equity through restructuring and industry consolidations makes the region a buy.
The key driver for equities justifying this stance remains what Asian markets are best known for: exports.
Asian exports are on a recovery path, driving cashflow and earnings. The outlook for the dollar may reduce the local currency impact of this somewhat but the recent corrections are pricing in overly negative growth assumptions. Continuation of trade trends and a robust US economy will trigger re-pricing.
In China, exports are growing in excess of 20% year on year, while Korea, Singapore, Hong Kong and Thailand are seeing export growth of more than 10% per year. Only in Australia have monthly exports shown a flattening in the growth rate.
We monitor the numbers closely for signs of softening in external demand, particularly from the US, which would pose a significant threat to Asian cyclical recovery and overall growth rates.
Coupled with lowest-cost production advantages and market share gains by Asian exporters such as Samsung Electronics, the outsourcing of production to Asia should continue to drive growth for Asian companies at a higher rate than the global average.
Taiwanese hardware companies, in particular, should benefit and a stronger yen will accelerate the Japanese outsourcing trend. Companies such as Johnson Electric are acquiring production facilities in, say, the US and re-locating them to China, thereby supplying the same customers at much lower cost and enabling manufacturers to maintain margins in the face of price deflation.
What we are also seeing across the region is a secular rise in domestic consumption, with Korea the most advanced example.
Structural reform post the Asian financial crisis has led to the increased availability of consumer credit at historically low interest rates. Retail consumption has become another driver of growth in Asia, with important implications for stock and sector selections.
This theme is at risk from the feedback mechanism of weaker exports. Asian economies remain open and cyclical. There is also a risk of hitting an air pocket as pent-up demand post the Asian financial crisis is met and growth rates undergo a temporary setback.
As ever during the recent global equity falls, correlation between Asia and Wall Street has risen significantly. Markets with the highest beta to the US, rather than just correlation, are Taiwan, Hong Kong and the Philippines.
Indonesia and the Philippines have been affected by rising EMBI spreads caused by Latin American problems.
Signs of export recovery.
Outsourcing theme, primarily technology.
Secular change in domestic consumption.
Softening export demand.
Weaker dollar would prove negative.
Higher oil prices a possibility.
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