Asian stock markets: looking ahead

5 min read 14 Nov 22

Asian markets have been volatile since the start of the year, but the region’s corporate sector is showing real resilience. There is a wealth of choice among businesses geared to long-term structural trends. M&G Equities investment director, Sunny Romo participated in a panel discussion with Jason Pidcock (Jupiter Asset Management) and hosted by Cherry Reynard (Adviser Hub) to discuss this further.

Sunny Romo,
Investment Director,
M&G Investments

Asian stock markets have not escaped the volatility seen in financial markets since the start of the year. Many of the patterns have been the same: a preference for value over growth, a focus on higher quality companies with defensive characteristics, but with the added drama of China’s ups and downs added in for good measure. What is next for the region’s stock markets?

Stock specific characteristics have been important. Companies that have balance sheet strength, that have the ability to pass on cost increases and can side-step regulatory and political risk have also been popular with investors. Sunny Romo, equities investment director at M&G Investments, says: “Where companies have been doing the right things, such as restructuring, it has been noted by the market. Overall, it has been individual stock stories that have driven markets.”

Winners and losers

From here, both Pidcock and Romo believe there are real opportunities despite a difficult economic backdrop. Romo says: “We’re seeing such amazing opportunities. Even in a falling market it is possible to make money, and we’ve managed to do that. It’s about picking the stocks that have the prospects of an outsized return and avoiding macro or factor risks that you don’t want to take on.”

Pidcock agrees that it’s still possible to make money, while acknowledging that it is very difficult to predict markets in the short-term. “I don’t think we have to be hugely positive for the year ahead, the key is to be positive for the long-term. I still think equities are the best place to put your money if you can handle any short-term volatility. The important thing is to avoid sectors in real difficulty such as the residential property market in China.”

Asian markets have started to anticipate a weaker time ahead for the consumer, even though inflationary pressures have not been as severe as in the West. Consumer staples stocks have held up well because they have pricing power. Pidcock says; “Businesses can pass on their cost increases but that squeezes the wallet of the consumer, which means they have less money to spend on discretionary items. That’s where there have been problems.” He believes any slowdown or recession will be tough for consumer discretionary businesses.

Romo is focusing on specific segments. She likes companies involved in IT services, for example, that are helping Japanese companies catch up on digitisation. She believes in-bound tourism and the cheaper exchange rate should help some domestic leisure companies. She adds: “There’s a lot of companies undiscovered compared to US peers, valued at extremely low multiples. While investors often worry about ‘Japanification’ – a developed country in decline and long deflation, they could ultimately start to look at Japan as an economy that actually provides solutions. Any companies that contribute to that have a long way to go.”

Dividends

The market is likely to be supported by dividends. Pidcock says that this year has already seen good dividend increases in Singapore, India, Taiwan and Australia. However, payouts may be less certain over the next 12 months. “There is a lag between profits and dividend payments, so it’s a bit early to predict dividend prospects for 2023. There will be pressures. Energy companies and financial companies have seen robust dividend payments.”

He believes technology company dividends could remain under pressure, along with payouts from more cyclical companies as well. However, he adds: “Dividend yields are pretty healthy. It is possible to put together a portfolio yielding above 4% quite easily. The long-term output for dividends remains good and is high compared to the 10 year government bond yield.”

Romo says: “In Japan, dividends have held up well, but more interesting have been buybacks, which have been used as a way to return excess capital to investors. By the end of August, buybacks were almost at the level of 2021, which was in itself a record. Add this to a 2.5% dividend yield and it looks pretty healthy.”

As with all markets, it is difficult to predict the outlook for Asian markets over the next 12 months. However, in the longer-term, valuations are low, dividends are robust and growth prospects are stronger than elsewhere. It is a fertile hunting ground for the investor who can look through short-term noise.

The views expressed in this document should not be taken as a recommendation, advice or forecast.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

Sunny Romo,
Investment Director,
M&G Investments

Growth is in short supply across the world as inflationary pressures weigh on spending. However, Asian economies are not experiencing the downturn in the same way: inflationary pressures are lower and the potential for long-term growth is stronger. Can they sidestep some of the economic problems that are bearing down on the rest of the world?

Jason Pidcock, manager of the Jupiter Asian Income fund, says that while the world’s economies are connected, inflation has been less of a problem across Asia, particularly in China. He adds: “These economies haven’t seen severe currency weakness against the Dollar. Typically, when the Dollar has been strong, Asian emerging markets have seen their currency weaken more, but that hasn’t happened this time. Asian economies also haven’t experienced the same supply squeezes, which has heightened the inflationary pressure elsewhere.”

For Japan, some inflation is welcome: Sunny Romo, equities investment director at M&G Investments says: “We’ve been in a deflationary environment for so long and finally we’re seeing pressure for companies to raise prices. Consumers are accepting those price rises and Prime Minister Kishida has talked about the need for higher wages. All of this is positive for Japan. There are higher costs as a result of rising energy prices, but we can absorb these pressures.”

There are worries. For Pidcock, these centre on China and, potentially, its weaker growth. He has sold out of all his direct China holdings, though still has some exposure indirectly through companies in Australia, South Korea and Singapore that sell into China.

He says: “There has been a slowdown in growth as a result of Covid lockdowns. There are also risks to growth from slowing exports as demand from other countries falls. We are still likely to see Covid lockdowns for a few months and geopolitical tensions are making investors in China more nervous, which means foreign direct investment won’t be the driving force it was in the past. India and Vietnam are benefiting from companies wanting to diversify their supply chains, just in case political tensions become even worse in the future.”

Long-term growth

However, Asia continues to offer better growth prospects than the indebted and fractured West. Tourism is returning in the wake of Covid and there is considerable innovation, creating technologies that may leapfrog those in more developed countries. Pidcock says: “At the moment, we favour India over China. In South East Asia, our preferred route is Singapore, where companies derive earnings from across the region. We also invest in Australia, which gives us access to the growth in the rest of the region. It’s a great growth story – a large population, very competitive with lots of skilled people and world-class companies.”

Romo says that investors need to revise their view of Japan’s prospects: “When you hear news about Japan, it’s tinted with a sense of doom. I’m excited about Japan as an asset class - so much has changed. It hasn’t happened fast enough for the Western viewer - that’s why the stock market has disappointed - but I think we’ve definitely reached an inflection point where things have changed for good.”

She believes the social contract has changed for Japanese companies. In the past, they thought of themselves as employment providers. Now, there’s an understanding that Japan has to be profitable to regain its economic standing.” She points to initiatives such as the stewardship code, rising merger and acquisition activity, industry consolidation and better scrutiny by investment managers.

From here, the key issues facing Asian economies are not very different for those in the West: how much further do interest rates rise? How quickly does inflation roll over? Pidcock says that while Asia can weather these issues better, it will not be plain-sailing: “The strong Dollar has sucked liquidity out of many markets. We have quantitative tightening ramping up. It remains to be seen what impact that has on markets. It is unlikely to be positive so it is reasonable to be cautious.”

He believes that by early next year, the bulk of interest rate rises may have happened and markets may start to look forward again: “If they start to anticipate a recovery by the end of 2023, particularly if high energy prices come off a little bit, then markets can be more optimistic. We can look through a period of lower corporate profitability if we believe the businesses we own can come through that…there will be ups and downs, but we are investing in businesses with strong balance sheets and pricing power that should be resilient through economic downturns.”

Romo says: “There’s so many factors in play, it’s difficult to navigate. The input cost push is obviously a concern for many companies. From a Japan point of view, a lot of companies can wear that. Prices have been kept low for a long time in Japan because of the deflationary mindset. There’s a lot of room for Japanese companies to pass through that cost. It comes down to stock specifics. Companies with unique intellectual property and a good business model can weather this period of volatility. That presents opportunities for stock pickers.”

The views expressed in this document should not be taken as a recommendation, advice or forecast.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

Sunny Romo,
Investment Director,
M&G Investments

In spite of a stronger economic outlook, Asian equities have tracked the ups and downs of global financial markets for the year to date. For fund managers, there has been a question of whether to stay put, or respond to a changed economic environment. Jason Pidcock, manager of the Jupiter Asian Income fund, and Sunny Romo, equities investment director at M&G Investments, describe how they are responding to market volatility and positioning their portfolios for the uncertainty ahead.

Despite volatility in stock markets, neither manager is frantically adjusting their portfolio. Pidcock, for example, has seen relatively little activity in the portfolio, having sold out of his last Chinese holdings early this year as part of a country allocation call. Nor does he foresee any major activity from here: “The portfolio is well-balanced. We have some big country bets versus the benchmark. We are very overweight Singapore and Australia, and have a zero weighting to China. Australia is one of the most underappreciated markets globally – for me, it’s like a small version of the US without the same political tension or government debt, plus some world class businesses.”

Romo has also made relatively few changes in the portfolio: “We are always on the look-out for new ideas and we always try to ensure competition for capital within the portfolio. There has been a few opportunities to add more capital to our existing holdings and that has been our main focus.”

Key themes

Pidcock has been looking again at some unloved sectors: “The world changed in February when Russia invaded Ukraine and we’re likely to be in a different world for some time. Defence spending has been ratcheted much lower for many years, now it’s going to rise. Defence companies have the highest barriers to entry of any sector in the world. It takes a long time to get a licence and then to get orders, so it’s the incumbents who benefit most from increased spending.

For Romo, the theme of “value-added share ownership” runs through the group’s holdings in Japan: “We want to be active investors. That means having a dialogue with investee companies and being one catalyst for change in companies. We want to be the shareholder of choice. That doesn’t mean we’re a pushover. We want to challenge management, and bring something to the table in company meetings.” She also sees an increasing receptiveness among Japanese companies to have these conversations.

The prospects for earnings

Earnings have been reasonably robust over the past few months, in spite of the difficulties facing the global economy. Jason believes there may be more pain to come, but it will depend on the sector.

However, he believes it will be important to look through shorter-term earnings problems: “One year of earnings decline doesn’t matter if the three to five year view is still good – particularly if the company has still got a good balance sheet.”

“The indebtedness of a company will make a difference as interest rates go up. Companies with strong balance sheets relative to their business model. The greater the visibility of earnings, the more comfortable we are with debt. Where earnings are variable, we like a rock-solid balance sheet and net cash.”

Romo says the market is looking beyond short-term bumps. While there is a dislocation between operational and share price performance, this is more because Japan itself is overlooked. She adds: “There are just so many undiscovered companies in Japan at the moment. Not enough people cover the market. So far earnings have held up well. We’ll probably see downward revisions, later in the year, but I don’t expect it to be severe.”

Nevertheless, both managers expect there to be significant differences between the winners and losers in tough market conditions. Finding resilient businesses that can grow their earnings in spite of rising inflation, interest rates and weaker growth will be vital in generating returns in this environment.

The views expressed in this document should not be taken as a recommendation, advice or forecast.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

By Sunny Romo

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

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