Asia Equities: Trade war unlikely to derail the Asia growth story

Key points

  • Trade war will have limited medium- and long-term effect on Asian companies while it will remain to be the key risk factor in 2020
  • Asian growth story will continue to present attractive long-term investment opportunities backed by structural drivers
  • Asia ex. Japan firms’ valuations remain attractive with strong balance sheet
  • Chinese equities will continue to offer opportunities as more foreign investments set to flow in

Asian resilience building up amid trade tensions

Heading into 2020, global growth is likely to continue to moderate - and the key risk factor impacting investor sentiment will remain the ongoing US/China trade dispute. Throughout 2019 we have seen a pattern of escalation and de-escalation in trade tensions. Despite the positive prospect of a ‘phase one’ deal, our current base case remains that a meaningful and comprehensive trade resolution is unlikely to be agreed upon in the near term.

However, if there are concrete positive developments in negotiations, equity markets will likely see some relief rally, as much of the bad news has already been priced in, especially in Asia. Meanwhile, from a longer-term perspective, the trade war is unlikely to derail the secular growth story in Asia - supported by structural drivers including favourable demographics, the expanding middle class and greater urbanisation - which will continue to present attractive long-term investment opportunities.

Against this slowing global macro backdrop, real interest rates in Asian economies are generally higher compared to those in the developed markets. As such, there is more scope for Asian central banks to support growth through monetary policy. Indeed, India and Indonesia have already been on a rate cut cycle in 2019, while South Korea and China have also recently followed suit in loosening monetary policy. If more downside risks to growth emerge, central banks in Asia still have further latitude to lower interest rates - especially as fiscal positions in the region are generally healthy and overall better than they were in 2013 during the “Taper Tantrum”.

There is no doubt that the ongoing US/China trade issues have created some disruptions for supply chains across the region. However, in the medium term, potential shifts in supply chains should also offer opportunities. Countries such as India, Vietnam and Indonesia have already been attracting interest from multi-national corporations looking to shift manufacturing facilities outside China. Such shifts also reflect that wages in China have reached a level that have dented its attractiveness as a manufacturer. 

Therefore, while we expect such changes in supply chains to continue, much of the new investments are likely to remain within the region – in part reflecting that Asia has established its own growth dynamic in recent years. The significant expansion in intra-regional trade, as a result, makes Asia more resilient to the fallout from the US/China dispute.

A notable example of this is on the technology front, where Taiwanese component suppliers are benefiting from Chinese companies’ efforts to secure non-US alternatives for their production chains. TSMC, the world’s largest contract chip maker and supplier to both Apple and Huawei, has upped its capital expenditure in 2019 significantly, and well ahead of market expectations. This is set to continue in 2020 backed by strong demand as China rolls out its 5G plan.

In addition, many corporates in the region have already adjusted to the uncertain environment by containing inventory, costs and capex, which could benefit corporate profits and cashflows next year if growth prospects improve. (Exhibit 1) For the Asia Pacific ex. Japan region, we expect earnings growth to accelerate, with earnings per share reaching the high-single-digit end in 2020. Sectors such as semiconductors and technology - pressured in 2019 - could see earnings recovery as demand catches up with recent increases in supply, especially in memory, together with a broader increase in capex spend driven by the 5G rollout. This low base effect should play out particularly well for Korean technology, led by names such as Samsung Electronics and SK Hynix. We expect a significant boost in 2020.

Exhibit 1: Natural growth gravitates lower

Source: CEIC, AXA IM Research, as of Oct 2019. YoY = year-on-year

Asian equities are in good position with relative attractive valuation and abundant cash

In general, valuations for Asia ex. Japan equities still appear relatively attractive, particularly on a price-to-book basis, compared to both their own history and to the rest of the world. Furthermore, Asian corporates overall have strong balance sheets, positive cash flows and relatively low pay-out ratios. This means that despite the current high dividend yields that are already available in the region, the likelihood and ability of Asian companies to raise pay-outs or indulge shareholders in other forms of capital management is still high.

Data provided by Jefferies shows that about 22% of market cap in Asia ex. Japan is backed by cash (Exhibit 2), significantly above both Europe (at around 12.6%) and the US (about 7.5%). As such, we continue to see significant opportunity for investors to access income in Asia even as bond yields globally remain close to historical lows. Moreover, even if companies maintain their pay-out ratios at their current relatively subdued levels, Asian growth means that the region should be able to provide investors with a rising income stream over time.

Exhibit 2: MSCI regions (ex. Financials) – Cash to market cap

Source: Jefferies, Factset and AXA IM Research, as of Nov 2019. AC Europe = All Countries Europe. AsiaxJ = Asia excluding Japan

Chinese equities will continue to offer opportunities in 2020

Despite headline growth momentum slowing and trade uncertainties lingering, our view is that Chinese equities will continue to offer attractive opportunities in 2020. This is especially the case in the consumer and services-related sectors, given that income growth has remained solid at the mid-single-digit level, supported by cuts in personal tax, a government effort to ease the impact of tight monetary policy. More recently, the People’s Bank of China has made small cuts in policy interest rates which should also ensure that liquidity remains.

In addition, we expect China onshore equities (A-shares) to continue to attract more investor interest as the MSCI Index increased its A-share inclusion factor from 5% to 20% in 2019. Northbound flows investing through the Stock Connect programme have increased in 2019 compared to previous years and this trend should continue as Beijing looks to further open its capital markets - and foreign investments in A-shares remains low compared to other capital markets. Importantly, valuation of onshore equities remains attractive on long term basis. (Exhibit 3) Meanwhile, the recent launch of Alibaba’s initial public offering in Hong Kong successfully raised some $11bn, reconfirming the significance of Hong Kong as a source of funding for Chinese corporates.

Exhibit 3: CSI 300 Index historical P/E valuation

Source: Bloomberg, Citi Research, and AXA IM Research, as of Nov 2019
P/E = price to earnings ratio. Stdev = Standard deviation.