Asia’s new era of sustainable growth

As the 2018 Chinese New Year celebrations begin on 16 February and the Winter Olympics are under way in South Korea, Soo Nam NG, Head of Asian equities at Columbia Threadneedle Investments analyses the outlook for Asian markets.

The outlook for a multi-year rally in Asian equities is still very much intact. The correction we have seen has been driven by falls in the US market and, on the back of rising markets, there is of course a lot of profit to be taken. Long bond yields have risen, so it is understandable we have had some concern and repricing of risk.

But as far as the fundamental recovery is concerned, that remains very much intact. The multi-year uptrend is clear and the drivers of this are very grounded and not about to be shaken by an uptick in inflation.

Inflation is a positive force – it is an indicator of a strong global economy. Investors should expect inflation to pick up given the synchronised growth we have seen: the question is to what level. Inflation numbers should firm but still stay within benign levels, which will contribute to near-term volatility in the market; but longer-term, if inflation remains well controlled and within market expectations, I do not see it as something to be too concerned about.

The pace of Fed hikes is of course debatable. Even if there are one or two more hikes than are currently priced in, I still believe this will be part of the process of normalisation and will be sufficient to keep inflation in check. In which case, I do not see either the inflation trend or the interest policy rate trend derailing the multi-year recovery dynamic that is ongoing in Asia.

I believe sustainable growth, driven by policy and political stability, with strong momentum and positive sentiment, will lead to outperformance in the next couple of years. Investors should take this as an opportunity, because if the multi-year rally is intact, this is a good opportunity for active managers.

The huge Chinese economy is experiencing a ‘second awakening’ under President Xi Jinping, with a strong agenda for supply-side reforms and an emphasis on sustainable macroeconomic growth. Xi’s ambitious ‘One Belt One Road’ (OBOR) drive for geoeconomic integration also means the rest of Asia will rise with it, especially given the complementary strengths of the region’s different economies.

Across much of Asia, a new cycle of quality growth has already begun. In a break from the past, the pace will be moderately high yet sustainable, leading to a more robust environment for corporate profits to grow steadily and a positive backdrop for Asia’s stock markets.

In this context, we believe 2017 was a watershed year. The MSCI Asia ex-Japan Index made gains in every calendar quarter. As we write towards the year end, it has powered to returns of more than 30% in US dollar terms. Such a rally demonstrated what could happen to Asia’s stock markets as sustainable economic growth kicked in and fed through to corporate earnings.

By the end of the year, valuations were mixed. Stocks that led in the rally, such as the ‘new economy’ and technology names, are no longer cheap. But pockets of attractive valuations remain. The MSCI Asia Pacific ex-Japan Index trades at a forward priceearnings multiple of about 13x as we write, hardly presenting a threat to further market upside should the dynamics of 2017 sustain into the next few years.

Portending a quality growth cycle

Today’s emerging quality growth cycle has been at least five years in the making. Recounting the journey gives clues to the future.

China has led in engineering the current stability. In the aftermath of the Global Financial Crisis, the Hu Jintao administration injected a massive fiscal stimulus into the economy. This proved disastrous as it created excess capacity in various sectors, and was poorly executed in terms of making sure the money went into projects that were commercially viable, not to mention the leakages due to corruption. The fiscal intervention’s lack of sustainability eventually led to a rapid growth deceleration in 2010-2012.

This painful adjustment shaped a new mindset. Since becoming president in 2013, Xi has consistently emphasised sustainability of growth over the pace of growth. Supplyside reforms and a more balanced economy bode well for the future in terms of reducing vulnerability to economic shocks.

China’s pivotal event of 2017, the Communist Party of China’s 19th National Congress, affirmed the dominance of Xi’s political clout and the stronger discipline within the Party, boding well for an acceleration in supply-side reforms going forward. The persistence of Xi’s anti-corruption drive will also improve corporate governance in China’s vast stateowned enterprise sector, which should help elevate the standard for the overall market. The financial sector has weathered the challenges of rising debt and shadow lending, and been cleansed through proactive regulatory tightening. Admittedly, debt levels need watching but the probability of a systematic crisis has receded significantly.

Xi’s ambitious OBOR initiative aimed at geo-economic integration also means the rest of Asia will rise with it, especially given the different economies’ complementary strengths. Across the region, economic stability is twinned with political stability. New, strong leaders have emerged such as Xi, India’s Narendra Modi, Indonesia’s Joko Widodo (also known as Jokowi), Thailand’s Prayut Chan-o-cha and the Philippines’ Rodrigo Duterte. The Korean peninsula remains a geo-political hotspot but careful diplomacy should win the day, with the positive chemistry that emerged between Xi and President Trump being one of the major surprises in 2017.

Turning to India, the country should muddle through in 2018, although it seemed to be struggling to maintain its current growth momentum. India needs more fundamental reforms to address the underlying reasons why problems exist in the first place.

Recent headline-grabbing policies – 2016’s banknote de-monetisation, 2017’s introduction of a Goods and Services Tax, and the recapitalisation of state-owned banks – could be helpful for India without a doubt, but they are not silver bullets for India’s complex problems. For growth to be more sustainable in the medium to longer term, stronger action is needed to tackle a myriad of issues such as environmental pollution, corruption, income inequality and tax evasion.
Notwithstanding such challenges, Indian equities may still see upside in the near term if current earnings projections materialise.

Set for a multi-year rally

The 2010-2012 growth slowdown has steadfastly morphed into a solid trend of stable growth sustained at moderately high levels, with evident translation into corporate earnings expansion. From this perspective, we see the 2017 rally heralding the potential for a multi-year economic and equity upcycle.

China clearly has the resources, vision and leadership ambition to anchor this leg of the Asia Pacific century. Xi’s supply-side reforms and OBOR agenda are firmly secured at least for the next five years. Given the remaining terms of the political leadership in the rest of Asia, there should be enough stability for current growth dynamics to continue running their course. Consolidated industry structures, the return of pricing power, stronger consumer confidence, improving corporate governance as well as continued cost discipline should inject depth into the rally over the course of 2018, barring external events that may punctuate but are unlikely to derail the upward trend. High growth stocks in the ‘new economy’ and technology sectors should continue to do well but are unlikely to outperform in the manner which they did in 2017. Instead, we expect confidence in the profit recovery of the industrial and financial sectors to gather into more meaningful re-rating in stock valuations. The potential for a steepening of the yield curve may also spur upside for some banks and insurers.
From China to India and across Asia, the season is still ripe for the active stock picker.

Soo Nam NG – Head of Asian Equities, Asia – Columbia Threadneedle Investments