Asia ex-Japan has been a major beneficiary of the ongoing global economic growth story, with the region outperforming all other major global equities markets over the past year or so.
Continuing global growth, improving business conditions, reform measures and consensus expectations for improved corporate earnings all suggest an upbeat outlook for Asia ex-Japan for the remainder of the year. However, there remain some risks.
Here are five influential themes for Asia ex-Japan equities investors will be focused on over the final three quarters of the year:
China’s ambitious reform agenda
With President Xi Jinping emerging from the recent Party conference with his power notably enhanced, the way now seems clear for him to press ahead with his ambitious reform agenda. Indeed, efforts aimed at deleveraging China’s corporate sector have been underway for some time – including shutting down inefficient producers, encouraging M&A and even allowing some companies to fail.
In terms of supply-side reform, progress is being made to remove excess capacity in the form of inefficient and unprofitable state-owned enterprises. Indeed, the improved discipline being shown by Chinese companies has created a new opportunity set for investors. We have increased our exposure to China – particularly more cyclical names and companies with industry-leading positions.
The Chinese government has made it clear pushing through potentially painful reform measures is a key priority. Accordingly, this could have negative implications for the economy in the near term – though growth will likely still be healthy. Indeed, if Xi can push through many of these painful reforms now, this should be positive for China’s longer-term economic prosperity and market value.
Ongoing rise of the Asian consumer
Unsurprisingly, the Asian consumer remains a major investment theme. In the past, China’s household sector has been characterised by relatively low levels of debt. However, this is changing, and the increase in the level of household debt over the past decade is a major shift, with significant knock-on implications for consumption.
What is more, despite the increase over the past decade, household debt is still at a relatively low level in China. We believe the Chinese consumer has the potential to drive the next phase of growth in Asia for years to come.
The consumer theme is central within our portfolio. China is now the largest online retail market globally, yet we believe there is still a long runway to growth. The adoption of online shopping, and the rise of electronic commerce companies such as Tencent and Alibaba, means Chinese consumers are increasingly turning to the Internet to purchase an ever-growing array of goods and services.
Capturing technological innovation
The rapid advancement and growth in new technologies is another pivotal theme, one we believe is set to run for many years. Where once the focus of technology consumers and investors was dominated by traditional computers, tablets and mobile phones – areas such as automation, augmented reality and artificial intelligence now represent the new frontier in advanced technology.
We look to capture this innovation in various ways. For example, the ‘Internet of Things’ is a central investment theme as we aim to capture the rapid growth in network connectivity.
Another way we look to capture the rapid growth in areas like artificial intelligence, augmented reality, automation, robotics and electric vehicles is to play these themes through our exposure to semiconductors. All technologies – from computers and mobile phones, through to the new wave of technological innovations, such as electric vehicles and robotics – require microchips to function.
Impact of US monetary policy
Another central theme for Asia in 2018 is the potential impact of rising US interest rates. Historically, a tightening US monetary policy environment has been negative for Asian economies. However, the landscape in Asia is very different today.
Driven by falling inflation, real interest rates in Asia are at relatively high levels compared with the US. Current account deficits of many Asian countries are also in surplus and currencies are broadly stable, providing a solid buffer against increases in US rates. As such, unlike in the past, Asian central banks will not necessarily be forced to respond with rate hikes, potentially choking off growth.
If the US rate cycle rises too steeply, or at a quicker pace than the market is expecting, Asian economies will come under pressure. However, our base-case scenario is for a more measured and gradual ‘normalisation’ of US rates. In this kind of environment, we see Asian economies and markets being minimally impacted. We have recently built our exposure to Asian banks, focusing on high-quality franchises.
The underappreciated Asian reformer
While China’s reform agenda might have captured more investor attention, it is not the only Asian country to be actively pushing through significant market reforms. India’s Prime Minister Narendra Modi has already delivered on several core objectives – including a demonetisation scheme designed to reduce corruption and the introduction of comprehensive GST, replacing the complex multiple indirect tax structure.
The government has also enacted a US$32bn recapitalisation of India’s state-controlled banks, many of which remain plagued by bad corporate loans. While this was not the major financial system overhaul some deemed necessary, it was certainly a step in the right direction.
We currently maintain an underweight position in India. With equity valuations that appear demanding in many sectors, we have been content to allocate selectively to the market. While our long-term positive outlook on the market remains intact, we are waiting for signs of revival in the capital expenditure cycle before we make a further allocation to the market.Anh Lu is portfolio manager of the T. Rowe Price Asian ex-Japan Equity Fund.
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