11 April 2016

Asia: bargain or value trap?

History shows that it pays to be brave during times of extreme pessimism.

It may feel counter-intuitive, but we think the time is ripe to buy Asian equities. A review of the past 40 years suggests that whenever Asia ex Japan markets trade between 0.9 and 1.4 times price-to-book, investors have subsequently benefited from strong markets for 80-90% of the following 12 or 36 months.

This trend can be identified through the various crashes and sell-offs that Asia has experienced over the past 40 years, not least the 1997 financial crisis. As Asia ex Japan markets are currently trading around 1.2 times price-to-book , starting to recover from January’s lows, we think there is a compelling case to invest now.

So how can you tell if Asian equities are a bargain or a value trap? Over the past three years, I would have suggested the latter. Asian stocks looked cheap, yet this proved illusory, as companies faced pressures on profits as a result of slowing nominal GDP growth and margin pressure. The region thus failed to meet expectations and developed markets have broadly outperformed Asia and emerging markets as a result.

What has changed? We are not expecting earnings to recover dramatically, but valuations at these levels suggest that stocks look oversold. We believe there is better alignment amongst central banks – following the Bank of Japan’s unsuccessful attempt to go it alone with the introduction of negative rates – can provide further support. Meanwhile, the recent weakening of the dollar gives Asia some breathing space to implement the right mix of monetary and fiscal policy and bolster growth.

We are still finding opportunities in China, ranging from growth companies in the e-commerce space through to value stocks that can benefit from supply-side reform. Energy companies, post the recent fall in the oil price, offer good value in our view.

Similarly, we believe fears in India have been overplayed. Although it is one of the more expensive markets and there is scepticism due to the political logjam, if you peel away the surface, you can see Narendra Modi is driving reform in certain sectors.

Positive initiatives are under way in the energy sector, for example. Around 300 million Indians still do not have access to electricity. So the authorities are removing the logjams to ensure there is enough coal supply to boost generation capacity. Elsewhere in the country’s stock market, we like autos and telecoms.

We are also positive on the Indonesian market, where we believe growth resilience and a renewed commitment to reform can help extend its recent recovery.

In our experience, the stocks that have been hit the hardest post a sharp sell-off tend to bounce the most in a recovery. Investors have crowded into defensive stocks over the last year – but we believe a change of tack is now necessary on valuation grounds. Our risk team have found that quality stocks are at 15-year valuation highs, while the reverse is true for value stocks.

Selectivity is crucial though – at both a stock and country level. We think Korea and Malaysia still have a number of structural issues to resolve.

So where to from here? Asia and especially China is at a crucial juncture. Growth expectations are slowing and the Chinese authorities face a challenging path ahead. What matters from here is the implementation of reforms and getting the currency under control in the short term. But, overall, we expect growth to pick up over the next six months, and hopefully this will surprise markets on the upside.

Most importantly, Asia as a whole needs a new growth model. It must become more self-reliant and develop its own engines of growth for the next decade.

This doesn’t necessarily spell a downturn as the doomsayers will have you believe. With valuations where they are, we expect to see further upside.

CARS ref: RSM-3740
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of 23/03/2016 and may change as subsequent conditions vary.

‘In our experience, the stocks that have been bit the hardest post a sharp sell-off tend to bounce the most in a recovery.’