Asia: a new era of growth

The global economy has reached a crucial inflection point. After nearly a decade of stagnation and contraction, the world has entered a new era of ‘reflation’ – a return to economic growth.

A meaningful pick-up in global economic activities can prove beneficial to emerging markets, especially Asia.

This means looking forward to a brighter outlook in Asia and understanding the impact on your investment strategy and portfolio.

Reflation, or a return to economic growth, brings many new investment opportunities but may also create challenges for portfolios ...
Reflation is a virtuous cycle. Wage rises boost consumer spending; this leads to price increases that feed into higher profits ...
When it comes to your portfolio,
there are winners and losers from reflation, or a return to economic growth. Stocks have ...

Adapting your portfolio to new opportunities

The reflation and steady growth environment clearly means your portfolio needs to adapt.

Obviously, you should focus on winners such as equities, particularly emerging markets equities and Asian equities.

For income, favour shorter-duration bonds given their lower sensitivity to rising rates. Stronger growth also means you should prefer credit over government bonds, and prefer inflation-linked securities (which raise principal and interest payments in line with inflation) over nominal debt.

And in this environment, you might also consider high-dividend-paying stocks to generate income, as well as a wider range of high-yielding debt, such as Asian corporate or emerging-market sovereign bonds.

The return of reflation and steady economic growth is good news in many ways. But it also means reimagining your investment strategy, diversifying, and hunting further afield for both growth and income.

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What's growing, Where?

While economic growth may be more widespread globally, Asia’s economies will stand out. Developed countries should generate low single-digit growth, but India is on track to expand more than 7 per cent this year1. And China remains one of the most important drivers of the global economy.

Asia is experiencing growth across the board and Asian fundamentals are the best they have been for five years. We see resilient dynamics for the region through Asia’s exposure to global growth and positive economic indicators locally. The continuing recovery of nominal gross domestic product growth in China should not be underestimated for its impact on lifting the whole region.

Asia’s leading companies have front-row tickets to this growth transformation. They will be the main beneficiaries of rising demand for everything from e-commerce to infrastructure. We have also seen meaningful earnings growth across the region. This is placing Asia in a much more attractive position than it has been for some time.

The broadly positive economic backdrop and outlook for the region’s businesses will create significant investment opportunities. Globally, the balance of growth is shifting, and it is natural that investment strategies should move to match.

1 Source: IMF, World Economic Outlook, April 2017

Asia benefits from technology and leads the world in digital commerce

Share of global spending on digital commerce

Share of global spending on digital commerce
Source: McKinsey Global Payments 2016

Which sectors to watch

As growth takes hold, cyclical sectors -- industries in which revenues tend to move in line with economic cycles -- should see a revival. These sectors deserve particular attention as growth opportunities emerge, thanks to a combination of macroeconomic forces and changing industry conditions.

Mining and Energy

A number of factors are set to drive long-term demand for resources, not least urbanisation and massive demand for infrastructure in emerging markets, particularly Asia. At the same time, the collapse of the last resources boom has encouraged miners to focus on cost discipline, and technology is helping the industry achieve new levels of automation and efficiency. The return of economic growth and the rationalisation of supply should also support the energy sector.

Asia will account for 50 percent of the 2.4 billion people added to the world’s urban population by 2050

Growth in urban population, 2015-2050, thousands

 

Growth in urban population, 2015-2050

Source: UN World urbanisation Prospects, 2014
For illustrative purpose only. There is no guarantee that any forecasts made will come to pass.

MORE ENERGY: By 2040, emerging Asia will be consuming almost as much oil as the entire OECD

Liquid Fuel Consumption, Million Barrels/Day

Liquid Fuel Consumption, Million Barrels/Day

*Projections
Source: EIA, International Energy Outlook 2016
For illustrative purpose only. There is no guarantee that any forecasts made will come to pass.

Financials

Banks and insurers are at long last emerging from the shadow of the 2008 global financial crisis. The return of economic growth is likely to prompt central banks globally to raise interest rates, which will translate into higher loan profitability for banks. Financial firms are also benefiting from global economic growth recovery, notably in Asia, where a fast-growing population of high-net-worth clients, as well as robust trade and investment prospects, mean surging demand for a range of financial services.

The policy environment is also improving. While financial institutions will continue to contend with a great deal of regulation, many have adjusted to tighter rules post-crisis. There are also indications that regulatory pressures will ease in some key markets, notably the US.

Reflation is generally good for investors, but it can create challenges for income-generating assets in your investment portfolio particularly as inflation emerges. Income can be harder to come by which means you are going to have to look further afield. The good news is that Asia has some of the best income-producing opportunities, both in equities and fixed-income.

Favour dividend growers

Equities generally win during periods of reflation. As business conditions improve, investors grow more confident and stock prices increase. But some stocks perform better than others. Income-producing equities not only deliver income but can be a significant growth driver for your portfolio. Their higher income – along with price appreciation -- boosts overall returns, serving as a natural buffer against inflation.

Total returns (%) with dividends reinvested since 2000

Total returns (%) with dividends reinvested since 2000

Source: CLSA, April 2017

But investors should go one step further and specifically favour ‘dividend growers’; stocks which boast a clear track record of steadily rising payouts to shareholders, and the capacity to continue to raise dividends over time .

Attractive Asian equity opportunities

Fortunately, Asia is home to many dividend growers. These are typically well-established firms with strong balance sheets, steady free cash flows and rising revenue. That description applies to many Asian companies in cyclical industries such as financial services that are conservatively managed and are poised to do well during periods of economic growth. Their financial health also means they’re generally more resilient to rising rates and market volatility.

The fixed income challenge

But the major challenge for income investors during reflation is fixed income.

Government bonds like US Treasuries, tend to lose during reflation. Bond prices fall as investors’ risk appetites rise and shift to equities. While this pushes up bond yields, higher inflation often can offsets those yield gains and real (after inflation) returns fall.

But don’t shun bonds totally. Instead, diversify your approach. Emerging market sovereign bonds and high yield corporate debt both offer investors opportunities to achieve attractive income levels in an inflation-prone environment.

3-year return history of major credit asset classes

3Y return history of major credit asset classes

Source: Bloomberg, BlackRock, June 2017. Index levels are rebased to 100. Asian Credit: JPM Asian Credit Index; Global IG Corp: Barclays Global Corporates (USD Hedged); EM Credit: JPMorgan Emerging Market Bond Global Diversified Index; Global HY Corp: Barclays High Yield Corporates (USD Hedged). Index performance is shown for illustrative purposes only. You cannot invest directly in an index.

Asian fixed income opportunities

Again, like equities, Asian companies offer a good hunting ground for corporate debt. Many Asian companies are well managed and have relatively low default rates.

Supply and demand dynamics are also favourable. While gross supply remains strong, this is offset by the increasing number of maturing bonds. The more limited net supply will be in high demand from investors.

Reflation resilience

Reflation is a virtuous cycle. Wage rises boost consumer spending; this leads to price increases that, in turn, feed into higher profits, giving businesses the confidence to invest, leading to steady economic expansion. It all creates a self-sustaining recovery.

That inflationary outlook, however, can create challenges for income investors. But by diversifying across different income-producing solutions, investors can find investments that generate solid income and provide protection against the impact of inflation.