Play­ing emerg­ing Asia’s new high

Financial Mirror (Cyprus) - - FRONT PAGE - Mar­cuard’s Mar­ket up­date by GaveKal Drago­nomics

Some 18 months af­ter US stocks re­gained the ground lost in the 2008-09 cri­sis, emerg­ing Asia has fi­nally made a new high. Last Thurs­day, the MSCI emerg­ing Asia US dol­lar to­tal re­turn in­dex closed above its 2007 peak for the first time, hav­ing risen 10% year-to-date. That makes emerg­ing Asia the best per­form­ing ma­jor re­gional mar­ket in the world so far in 2014. If you in­vest equally in the coun­tries in the in­dex’s uni­verse, your gains are even bet­ter: up 15%, with lit­tle volatil­ity. Af­ter such a stel­lar per­for­mance, it is time to step back and ask whether the rally is sus­tain­able.

Faced with such a ques­tion we al­ways re­turn to our con­tention that a bull mar­ket rests on three pil­lars: valu­a­tions, growth and mone­tary con­di­tions. So where does emerg­ing Asia sit?

Af­ter the re­cent rally, Asian valu­a­tions no longer scream “Buy!” but nei­ther are they ex­ces­sively stretched. The head­line in­dex val­u­a­tion is still below its long term mean, but on an equally-weighted ba­sis, mar­kets look fairly val­ued. The low head­line num­ber re­flects in­vestors’ skep­ti­cism to­wards Chi­nese banks, whose po­ten­tial prob­lems are no se­cret. If any­thing, the val­u­a­tion pic­ture in emerg­ing Asia is best char­ac­terised by its widen­ing dis­per­sion. Among the in­dus­try groups clas­si­fied by GICS, those with valu­a­tions in the low­est tenth per­centile are cheap by his­tor­i­cal stan­dards, while the top tenth per­centile are ap­proach­ing new highs.

The sec­ond pil­lar-growth-poses lit­tle threat to emerg­ing Asia. As we de­tailed in a pre­vi­ous ar­ti­cle “The Case For (Some) Emerg­ing Mar­kets”, although the ‘triple merit’ boom of the last decade will not be re­peated, the new nor­mal for emerg­ing mar­kets will still be nom­i­nal US dol­lar growth rates of 7-8%, and po­ten­tially even higher in Asia. In­deed, Asia’s earn­ings per share growth beats that of other emerg­ing re­gions over the past year and com­pares well with US EPS growth, de­spite the im­pact of ta­per­ing fears.

Even so, in­vestors re­main cau­tious about ac­knowl­edg­ing the earn­ings prospects of Asian com­pa­nies. Their con­cerns rest mainly on the sus­pi­cion that re­gional earn­ings are a mi­rage cre­ated by il­lu­sory Chi­nese bank prof­its. How­ever in re­al­ity, away from the fi­nan­cial sec­tor, EPS have grown de­cently in China over re­cent years.

In­vestors also fear that the earn­ings of non-Chi­nese com­pa­nies will be held down by dis­in­fla­tion­ary pres­sures em­a­nat­ing from China. This is a valid con­cern. Chi­nese pro­ducer prices have been in de­cline for more than two years, re­flect­ing com­pet­i­tive pric­ing by Chi­nese pro­duc­ers as ca­pac­ity util­i­sa­tion re­mains low, and China’s slug­gish de­mand growth. Against this back­drop, any­one who com­petes with or sells to China has lim­ited bar­gain­ing power. The good news is that our pre­ferred lead­ing in­di­ca­tor of China’s PPI, an equally-weighted in­dex of oil, metal and food prices, shows that prices should soon stop fall­ing and may pick up. In that case, the lon­gawaited bounce in Asian ex­ports promised by de­vel­oped world busi­ness sur­veys should start to ma­te­ri­alise. The mes­sage is sup­ported by Asian PMIs which in ag­gre­gate point to a brighter out­look for the com­ing months.

The great­est un­cer­tainty is the mone­tary pil­lar. On one hand, the Euro­pean Cen­tral Bank and the Bank of Ja­pan are bi­ased to­wards eas­ing. On the other, the Fed is mov­ing to­wards tight­en­ing, while prospects for do­mes­ti­cally-driven liq­uid­ity ex­pan­sion are lim­ited con­sid­er­ing emerg­ing Asia’s cor­po­rate debt load. With valu­a­tions in the sec­tors that ben­e­fited most from low global in­ter­est rates look­ing stretched, now may be an op­por­tune time to shift out of liq­uid­ity plays like the Philip­pines, Malaysia, util­i­ties and high yield stocks, and to­wards growth plays like Korean and Tai­wanese ex­porters and other cycli­cals.

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