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By Flavia Cheong, Head of Asia Pacific ex-Japan Equities, Aberdeen Standard Investments
Trade wars, US rate rises and China’s slowing growth all contributed to Asia’s surprise decline in 2018. Now, a focus on high-quality companies is critical to capturing value in the region, says Flavia Cheong, Head of Asia Pacific ex-Japan Equities, Aberdeen Standard Investments.
What a difference a year makes. This time last year I wrote: “Asia is sitting pretty. Things haven’t looked this good in years”. With hindsight, I may have been guilty of some hubris.
But in my defence, the outlook at the start of 2018 did look bright.
Following a blockbuster 2017 for markets, there were expectations of synchronised growth in the global economy and corporate profits. Analysts were forecasting the US dollar to weaken amid benign inflation. Liquidity was abundant. The reality was very different. The MSCI Asia Pacific ex-Japan suffered its worst year since 2011, falling by some 14% in US dollar terms. Almost all markets and sectors sank lower. So what went wrong?
US HIKES RATES
The US economy maintained its brisk growth last year, fuelled by President Donald Trump’s tax cuts. This coupled with the desire of policymakers to normalise monetary policy led the Federal Reserve to raise interest rates. Higher US rates are usually bad for emerging markets.
The Fed’s four hikes boosted the US dollar, along with demand for safe-haven assets driven by currency crises in some emerging markets. This sucked capital out of emerging markets, including Asia. In response, most Asian central banks raised interest rates to protect their own currencies and combat inflation. Unfortunately, higher rates can also be an obstacle to economic growth.
US-CHINA TRADE WAR
Another big factor weighing on Asia was of course, the trade war between the US and China as each country objected to tariffs imposed by the other. As US-China tensions worsened, investors worried about the likely impact on economic growth and corporate profits. This dragged on Chinese markets, along with those in Korea and Taiwan.
President Trump and Chinese leader Xi Jinping have agreed a temporary truce, but we’re sceptical of a resolution given the complexity of the issues and limited time in which to find a solution. We aim to invest in Chinese companies that depend on domestic demand, rather than overseas trade and exports. However, should tensions escalate again, even this more insulated part of the market won’t be spared.
SLOWING CHINA
Chinese growth was already slowing even before US-China trade ties soured. Policymakers had been trying to reduce the amount of debt that had built up since the global financial crisis. But as trade frictions escalated, the government partially reversed course. It cut taxes, lowered banks’ required reserve ratio, and increased infrastructure spending once again.
This policy relaxation helped to support the economy. For example, the property sector benefited when local governments were given more leeway to tweak restrictive policies. But in the long run, policymakers want more sustainable growth, rather than growth-at-all-costs. This is a structural shift that means slower growth is here to stay.
POOR TECH SENTIMENT
Technology stocks were the stars of 2017, but lost steam in 2018. Trade tensions weighed on consumer sentiment, hurting demand for smartphones and memory chips. This hampered shares of semiconductor and hardware-related companies, including Samsung Electronics.
Meanwhile, regulatory issues plagued Chinese internet firms such as Tencent. While these issues hurt its gaming revenues, we are confident that other revenue streams, such as payments and cloud-services, will continue to grow. There are also signs of easing regulatory pressures.
LOOKING AHEAD - END OF QE
This year promises to be just as eventful as 2018. The era of quantitative easing (QE) is ending as central bankers around the world seek to roll back the emergency stimulus measures that have helped the global economy recover from the global financial crisis of more than a decade ago.
The withdrawal of QE, with the Federal Reserve in the vanguard, will raise the cost of capital. Under normal circumstances, higher interest rates impede economic growth and undermine investor sentiment in equity markets. However, we have been arguing for some time that ending stimulus is a good thing because years of cheap money had indiscriminately boosted asset prices and created market distortions. We don’t know how this unwinding process will end, but it’s clear to us that doing nothing isn’t an option.
POLITICS TAKES CENTRE STAGE
Politics will be important too. While US-China trade tensions are often framed as an economic issue, what lies at the heart of the matter is geo-political. My colleague Devan Kaloo recently wrote about this in a letter to clients. “There has been a strategic shift in Washington’s attitude towards Beijing, moving from one of containment to confrontation,” he observed, “The US identifies China as a strategic rival, similar to how it viewed the former Soviet Union”.
“This potentially has longer-term implications for global capital flows, manufacturing supply chains and geopolitical alliances, as countries are increasingly pressed to take sides”.
This is a structural issue that will play out over years, if not decades. However, in the coming months, there will also be major elections in India and Indonesia. The outcome of those polls could decide whether economic and market reforms in those countries will proceed unimpeded. Thai voters are also scheduled to cast their ballots in general elections this year, although several recent attempts to elect a new government were cancelled.
OUR RESPONSE
On many fronts, financial markets are entering uncharted territory - and increased uncertainty often leads to greater volatility.
We started tweaking our Asia Pacific ex-Japan portfolios a couple of years ago, partly in recognition of these changes in the investment landscape. We pared our exposure to Singapore and Hong Kong in favour of markets with more attractive growth potential, such as China and south-east Asia. We also rebalanced our positioning towards the financial and technology sectors because of long-term structural trends we had identified. These changes, coupled with our continued focus on high-quality businesses, helped buffer our investments against last year’s big market declines.
FOCUSING ON ESG
In addition, we continue to invest much time and effort into corporate engagement on environmental, social and governance (ESG) matters. There’s a temptation to dismiss ESG as a fad for touchy-feely do-gooders. But ESG analysis isn’t simply driven by the desire to do the right thing. There is evidence of a link between good management of ESG risks and good management of the financial risks that determine corporate performance.
That’s why, for example, we wrote to all our investments listed on China’s two onshore stock exchanges in the so-called ‘A-share’ market. Our holdings in this market number more than 30 and we were encouraged by their response to our urgings for further improvements in corporate disclosure.
STAYING SELECTIVE
Challenging times lie ahead. Nevertheless, profit forecasts for many of our holdings are still decent, despite more cautious guidance. Lower energy prices should help ease cost pressures and improve margins. Although we are seeing substantial value emerging following 2018’s sell-offs, we still need to be selective.
Needless to say, we continue to focus on stocks with solid balance sheets, stable cash flows and pricing power. We think such companies will have the right stuff to withstand uncertainty.
Aberdeen Standard Investments’ Asian investment companies
Aberdeen Standard Investments manages seven investment companies in the Asia-Pacific region:
-Aberdeen Asian Income Fund Limited
-Aberdeen Japan Investment Trust PLC
-Aberdeen New Dawn Investment Trust PLC
-Aberdeen New India Investment Trust PLC
-Aberdeen New Thai Investment Trust PLC
-Aberdeen Standard Asia Focus Investment Trust PLC
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