Asian Markets Update- Analyst visit
On our latest visit to Asia, Marcel Porcheron assessed the outlook for Asian equities and gathered the views of a broad spectrum of locally based fund managers. Traditionally Asian equities have been correlated to US equities and have fallen more aggressively in downturns. However, this time events in US credit markets and the resulting falls in Western listed equities have so far had a limited impact on South East Asia’s equities or growth estimates. Marcel visited two of Asia’s most developed locations: Hong Kong and Singapore.
How expensive are Asian markets?
Valuations are a key sticking point amongst a number of the Asian equity managers based in the region. This partly reflects the dispersion of valuations between the better performing markets like China and Hong Kong and the laggards like Korea and Taiwan. As Peter Hames Director of Asian Equities at Aberdeen noted, “broadly valuations are okay, although stretched in some places. In particular markets need to be reminded about risk in China and the broader region would benefit from a pull back, although we would see this as a buying opportunity”.
The Asia Pacific market (excluding Japan) is on a price/earnings ratio of 18 times current earnings*. That compares with about 17x for the US and 14x for the UK and Europe. Asian markets look about fairly valued relative to historic levels and many Asian companies are now valued more highly than their Western peers. However, earnings prospects are stronger and Asian regional growth is not only high but also expected to stay high for longer than in the past. So what is the level of risk associated with these forecasts?
Asian Economic Growth
On the ground Hong Kong and Singapore are booming. Local investor talk concerns rumours of labour shortages in China and the robust residential property market. In common with other metropolises new buildings are changing the skyline in South East Asia’s two regional hubs with construction work in full swing, for example, on Hong Kong’s giant new skyscraper, the 118 story International Commerce Centre in Kowloon which will have a floor area of about 450,000 ft². Global car manufactures are benefiting from rising volumes in Asia, whilst restaurants, night clubs and shops are full and appear to be doing brisk business. Lai Kwai Fong is as busy as ever and designer shops around the Peninsular Hotel in Kowloon are busily catering to Chinese mainlanders.
Hong Kong’s International Commercial Centre, under construction.
Singapore too has recovered from its over-dependence on tech at the turn of the millennium and like Hong Kong its people demonstrate plenty of local self-confidence. A walk around redeveloped Clarke Quay paints a picture of a vibrant economy and shopping districts in the country are bustling. The GDP per capita of Singapore exceeded $31,000 in 2006 in pricing power parity terms, whilst Hong Kong boasted a level in excess of the major western economies at above $37,000. Both countries have very visibility benefited from a robust global growth environment and regional development, where about 40% of Singapore’s population works in the service industry which generates more than 60% of the country’s gross domestic product. Hong Kong’s population is even more exposed to the broad service industry, accounting for about 90% of GDP.
Infrastructure spending continues to be a popular theme amongst the regions’ equity managers with Singapore’s expanding Changi Airport, for example, opening a gleaming new Terminal Three shortly. Because of local spending plans many fund managers see little impact to Asian economic growth from a US slowdown although plenty of economists and investors outside Asia don’t believe that Asia has successfully ‘decoupled’ from the global economy. Chris Weaver at City of London in Singapore noted “Chinese management of the macro economy has been good and Asia is much more dependent on China than it used to be”. Ronald Chan, manager of the Allianz RCM Asian Total Return fund, is more cognisant of the link to the US and other OECD economies as he is “cautious on the prospects of Asian exporters. Earnings may be revised down as there are signs of weakness in the major Western economies”.
View on the regions key markets
Martin Lau, who runs First State’s Chinese equity funds as well as a broader Asian equity mandate believes that “liquidity is high in Asia and that negative real interest rates are likely in parts of the region”. He and Terence Law, Senior Analyst at RCM, expect asset prices to benefit through rising property prices in Hong Kong and rising equity markets in the region. However, most Asian equity managers also agree that China’s domestic equity market is overvalued and perhaps approaching a bubble, with alarming anecdotal stories of highly leveraged Chinese investors. The risk to China’s stock market is compounded by the high proportion of profits coming from speculative equity investment by listed Chinese companies. However, they also agree that the weight of money waiting to be invested in China and other regional markets could drive them higher for some time.
Korea and Taiwan are the two largest Asian markets which have underperformed regional peers. Whilst there is an expectation that the political situation may improve in future in Taiwan, local fund managers are also finding some opportunities in terms of high yields and low valuations of some Taiwanese stocks. India, like China, is seen as a growth play. Jardine Fleming’s Ted Pulling was the most bullish manager met and his view is that “Asian growth looks self sustaining because Asian consumption has finally started to come through and Asian savings should also provide support to regional equity markets”. He sees India as a major beneficiary from regional fund flows and he dismissed the views of other managers who feel that valuations are too rich. Susie Rippingall, Asian small company specialist at First State, warns of significant risks: “On the one hand the US consumer is slowing down and on the other inflation is rising. Costs are rising for Asian corporates. There is also a lot of uncertainty over markets at the moment, although Asian equities have a tendency to run in the 4th quarter of the year”.
Summary
Our view is that Asian markets are about fair value with some markets in bubble territory and others looking cheap. Clearly there is a wide dispersion of manager views underlying this. Generally the managers with a focus on potential earnings growth expect further market gains driven by strong corporate earnings. Those who are traditionally more concerned with valuations are more cautious and in some cases nervous about markets at current levels. Almost everyone is extremely positive on the prospects for Asian economic growth over the longer term, although there is some concern over the extent to which China and the rest of Asia are exposed to trade with the US.
At current valuations there is little room for error in Asian earnings. The major risk now lies in companies meeting and exceeding their earnings targets. If they do not, some of the regions equity markets will look overvalued. Whilst economic growth is robust investors should remain vigilant of the political risks in a region which has not yet moved to a fully democratic model. Local capital markets are also less developed than Western peers and so arguably deserve a higher risk premium as a result. Emerging Asian economies also tend to be more exposed to oil and raw material prices than their western peers and Millicent Lai, fund manager at Schroders in Singapore, is typical in highlighting the risk to the region’s companies: “higher costs are causing inflationary pressures build”.
*2007 consensus earnings estimates