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Asia ex-Japan appears to be one of the few bright spots for growth. In a “slower growth” world, the region is still expected to maintain gross domestic product (GDP) growth at around 4–5% per year. However, with growth moderation being a global phenomenon, Asia, like many other parts of the world, is undergoing a gradual growth deceleration.
So how will Asian economies and corporates sustain their competitiveness, and what are the implications for Asian equity investors? We believe favourable cost structure for corporates, a synchronisation of Asian currencies and the transformation of economies by new governments will set a positive tone for Asia in 2015.
Asia ex-Japan is undergoing a normal business cycle adjustment. As general demand is gradually levelling off amidst decelerating global growth, input costs are adjusting in response: costs of materials - ranging from agricultural products to hard commodities - are the biggest cost reduction drivers.
Financing costs are coming down in selected markets, such as China and Korea, where we have seen interest rate cuts. Looking ahead, further interest rate cuts for Hong Kong, Singapore, Korea and Taiwan may be limited, as suggested by their low 10-year sovereign bond yields, which were below 3% following the year-to-date decline. In contrast, we see opportunities in countries with relatively high interest rates for further rate cuts to stimulate demand. These include highpopulation, net oil-importing countries like China, India and Indonesia, which should benefit from declining energy costs and a softer inflationary outlook.
Looking ahead, we believe a favourable cost structure for corporates will serve as a key catalyst for margin improvement.
Currency has been a swinging factor in determining returns of specific Asian markets for the last two years. The US is the only bright spot in the developed markets that offer strong fundamentals and healthy growth. As such, every Asian market is bidding to win business with the US and is willing to revalue its own currencies.
Foreign exchange adjustment is the quickest and most direct way to preserve competitiveness, and historically this approach has often moved ahead of policies that are normally dependent on economic data.
We expect the US dollar to continue to strengthen heading into 2015. With key markets depreciating for the past three months - Japanese yen are down -10.0% and Korean won are down -4.3% - we ponder how the other Asian currencies will react. Instead of currency divergence across the region, we are likely to see Asian currencies move in a more synchronised manner in 2015. In any case, a stronger US dollar would be positive for Asian exporters.
In the past two years, China, India and Indonesia have ushered in crucial new leaders. In particular, the recent elections in India and Indonesia marked the start of a new beginning for the Pacific Century and its nations, which account for about 20% of the world’s population.
Reforms were rolled out in earnest shortly after new leadership took the helm of governments in several countries. In a world of slower growth, we believe maintaining competitiveness is very important. As such, we believe a dedicated focus on competition and productivity are common goals of the reforms being launched by the various nations. For example: • In China, its reform focused on a nationwide anti-corruption movement and deregulation in the ownership structures of state-owned enterprises (SOEs) in an effort to grow the presence of the country’s private sector. This will likely improve efficiency and align the corporates’ interests with those of its shareholders. • India launched several measures to support economic development, including labour deregulation to provide a more flexible cost structure. For example, the government passed four important labour laws that made it easier for companies to hire, train and dismiss workers. The new laws also stiffened the rules for trade union registration. • In Indonesia, the first reform step for the new government was to improve fiscal deficit by carrying out difficult decisions, such as reducing energy subsidies, which helped gasoline prices in the country move closer to market-determined rates.
Each nation has its own priorities. As such, it is unlikely for us to see a harmonised effort to implement structural changes among the various Asian economies. Yet, given the diversity in Asia, we believe we will continue to see greater reform efforts from the various countries, albeit with different targets, and at the countries’ own pace.
With earnings on the MSCI AC Asia ex Japan Index expected to expand 9.6% in fiscal-year 2015, Asia ex-Japan is no longer the growth engine it once was, as world trade has been static over the last three years.
Instead of focusing on top-line earnings growth, we believe Asian equity investors should shift their focus to the search for quality stocks, as measured by their competitiveness, shareholder returns and corporate governance. More attention should be paid, we believe, to companies’ capital allocation discipline. Management incentive schemes are also becoming more popular in Asia to align managements’ and shareholders’ interests. This has resulted in an increasing divergence between company share prices and sector performance.
The difference in retaining the pricing power and margin will ultimately be reflected in share prices. We believe this should be a positive environment for active managers to add value over passive funds that aim to resemble index return as a whole, but neglect to differentiate the winners from the losers.