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While the spillover effects and potential benefits from China’s reopening to the rest of the region are yet to really come through, where do the investment opportunities lie in Asia now? What effects does the global slowdown have on the region? Why is the Asia Investment case interesting right now? We talked about these and other questions with Chris Chan, Portfolio Manager, New Capital, in our latest video interview. Chan talks about China vs. India equity markets development, potential industries, and risks.
Transcript
Thomas Schalow: Chris, the drastic COVID lockdowns in China have been history for a few days now. So how does the research and recovery affect Asian equities in general?
Chris Chan: So, I think you know when you look at the year-to-date performance of the China stock market, it probably surprises a lot of investors, ourselves included. The China stock market is pretty flat, which of course like Europe and the S&P and of course the NASDAQ year to date. Now this is despite what we could argue has been a recovery. You know, there’s no question in our mind that directionally things are improving. But I think what’s taking a lot of investors by surprise is the magnitude of that recovery. And you can really see that coming through in certain select areas of the economy. You really had that first derivative of the recovery coming through very strongly in terms of the serve side. You saw the tourism numbers domestically and now internationally picking up very strongly. You know eat people are eating out much more. So that really has improved and is actually higher than pre-COVID levels already. But actually, where there’s been a disappointment is on the more consumer goods side. Basically, the high-ticket items, whether that remains to be smartphones, autos, PCs, sportswear, for example. A lot of these key areas are much weaker than people would have hoped, as of November, December last. And so I think when you look back in terms of you know what’s driving this still apparent caution when it comes to the consumer spending, and again, that that’s kind of shown by credit growth has started to taper off a little bit, deposit growth and savings rates remains pretty high and one explanation is you know you are seeing very high youth unemployment and which of course are a big source of this consumer goods spending. So that does remain to be a little bit of an overhang in terms of the overall sentiment. Therefore, that spillover effect and potential benefits to the rest of the region is yet to really come through. You are seeing tourism numbers improving and of course other areas, but not enough to really drive economies such as Thailand. And then imports still remain very weak, so not benefiting the more export orientated areas such as Taiwan and Korea.
Thomas Schalow: So where are the current investment opportunities in Asia when the majority of investors are talking about a global economic slowdown and eventually a recession in Western countries?
Chris Chan: I think this is actually where the Asia investment case perhaps looks a little bit more interesting from a relative basis compared to, you know, developed markets such as the US and Europe. And I think, we all know that the weaker dollar which you could argue potentially has the potential in terms of what’s going on in the Fed tapering side if you do get a weaker dollar that generally that is more positive for ASEAN markets or Asian markets. But I think the other point is behind that is when you look not just in China but you know every market whether it’s India, the Southeast Asian countries, but even Korea and Taiwan, they didn’t loosen monetary policy anywhere near to the same extent as developed markets during COVID. So, what that means is the inflation, as of course it did rise just like it did elsewhere in the world, inflation levels didn’t really reach that extreme level versus their targeted range compared to those level. And so therefore, they haven’t needed to tighten as much, which of course, is what typically drives the economic slowdown. So, you can see that in areas such as India and Indonesia, that inflation has come down quite nicely over the past few months to the point where already the central banks in those countries have paused rates. And so you could argue that they’re actually much better position monetary wise because they’re not had that aggressive tightening and therefore you know that offers a lot of upside potentially supported by the more beneficial monetary policy versus developed markets.
Thomas Schalow: International investors are spooked by China’s more assertive behaviour and its position in the Russia-Ukraine War, but also the Taiwan conflict. How do you respond to these investors? How do you deal with these political risks?
Chris Chan: So it’s obviously a very fair and very key concern that a lot of investors have. I think it’s not, of course, just the Russian Ukraine war, you you can kind of put it into, you know, three major buckets. You do have the Russian-Ukraine war and obviously China, you know, and their stance. And of course, Taiwan remains a huge concern and overhang for Asian markets as a whole. And of course, the underlying concerns in terms of the tensions between the US overall, particularly on an economic stance. And you know, first and foremost, we don’t believe geopolitics is going to go away anytime soon and it very much this is here to stay and unfortunately this is something that any Asian investor has to get used to. But I think when you kind of dissect those three buckets, if we look at the US economic tensions, really, I think what will drive the stock market up and down is actually the relative improvement or deterioration from where we are. And you know, you could argue that if you look over just the past few weeks, there’s been a marginal improvement. You know, Biden came out in just the last few days and him himself talked about he expected to see these so-called tensions, saw very shortly. They’ve clearly started high-level government official. A couple actually, over the past, just two weeks. So that communication has clearly started to pick up after many months of essentially no meetings. And you can see in smaller areas such as solar panels, there’s been a little bit of a compromise. Actually, Chinese solar cells can now be supplied to the US assuming that end modules are produced in the country. So that’s a marginal positive, putting it all together. On Taiwan, clearly this is always going to be an overhang for many years to come. But again, I would point to Biden. Even just last year, saying he didn’t even see himself the Taiwan invasion as being an immediate threat. And we do think that we don’t see any at risk of that for a good few years from everything that we’re seeing.
Thomas Schalow: After two years of losses, a question arises about a possible entry or re-entry. Are Chinese equities currently cheap and how do you assess the risks for Chinese equity?
Chris Chan: So, I think there’s no question that at least versus history and developed markets would be the US, it’s hard to say that China is not trading cheap. I think if you look back on a five or seven-year trading history, the MSCI China is trading on about 10 times forward per year. You know, typically that’s at the very low or avoid trust of that trading range. And again the same goes for you know plotting that the valuation against the S&P. It’s certainly at that trough level versus history. So clearly that suggests that there’s upside from a valuation point of view. But of course, that alone isn’t going to stimulate buying and interest. You really need that the second element of stock market returns, which is the fundamental earnings to really pick up. Much stronger than perhaps we’ve seen, you know, year to date. I’ll go back to what I said, that despite the recovery not being as strong as people expected it is fair to say, the direction across what we’re seeing – property, infrastructure and consumer – is still up. So, we believe that given how attractive valuations are, if the fundamental earnings trends continue to improve, continue to be in the right direction, particularly relative to for example, U.S. equity over the next 12 to 18 months, then clearly that’s going to give a lot of investors food for thought when it comes to re-entering the market.
Asia Investment Case – India a better choice than China?
Thomas Schalow: Indian equities were one of the few asset classes to perform positively in 2022. So, is India currently a better choice than China?
Chris Chan: Well, I guess it depends on the time frame you’re looking at. I think shorter term, there’s perhaps the argument that you know India still is looking very expensive. You know, we talked about how cheap China was looking. At the end of last year, India was trading at about two times above its standard, its average in terms of deviation. That’s moderated a little bit to 1,5, but again, still far above its historic norms. So, valuations are much less supportive in India. The other point is, whilst top down, clearly, inflation is a big risk for the Indian economy. But as we said before, that is starting to moderate. The Bank of India has paused rates which of course should be positive or supportive for the economy. So that’s clearly, you know a plus sign. And fundamentally the economy is still very robust, actually much stronger and more robust than you could argue in China across the board. So, we prefer it longer term than China for various reasons. In terms of the consumer statement, much more under-penetrated, much more supportive demographics. We like what we’re seeing in terms of the industrial side and very strong public and private CapEx cycle, very strong property cycle, but we think perhaps shorter term. Because it’s coming off a higher base compared to China, both fundamentally, but also valuation-wise. Perhaps in the shorter term six months, maybe China has a little bit more potential, but longer term we prefer India.
Thomas Schalow: That directly connects with the next questions. Or can Indian equities build on the momentum of 2022? And in which industries are you invested in in India and what are the risk and opportunities?
Chris Chan: Because the economy remains robust, it’s still a little bit of a mixed picture and which is great actually for so-called active stock pickers because there’s a lot of dispersion opening up in India for sure. You know, I think on the slightly more negative side, and I would say only slightly, you know, of course you have the IT services side which of course is more driven by US and European business confidence and budgets. That’s clearly suffering a little bit as you would imagine. The banking side was one of the strongest performing sectors last year in India, remained a long-term, very attractive investment case for us and many investors. But again, I think on a 12-month basis whilst trends remain strong, we think actually a lot of the upside perhaps has played out in terms of already maxed out in terms of credit growth, asset quality is about as good as it can get versus history. So actually, what we’ve been doing is rotating into other areas of the economy such as the industrial side. You know, we pointed out how strong the public CapEx cycle is driven by the government receiving much more tax collections as they changed. That’s feeding through into very strong construction projects, that’s also benefiting from a private CapEx in part because of this government scheme production linked incentives (PLI), which is attracting a lot of foreign investors and investment. So, you’re really seeing that twin engine of public and private CapEx which is driving very strong industrial demand for various components, whether it’s speciality steel wires, cables and the like.
Thomas Schalow: So we touched on the danger of a potential recession in developed economies. So, what impact would have us slowed down on the attractiveness of technology stocks, for example, semiconductor companies? Especially in China, South Korea or Taiwan.
Chris Chan: Korea and Taiwan is quite an interesting one because if you look at it, Taiwan and the South Korean market has been the strongest performing markets in Asia year to date. But when you actually look at the earnings revisions and the earnings trends, they’re still incredibly weak and you’re fully expecting, you know, double digits earning decline year on year, this year versus land year. When you look at the end demand you know particularly in areas such as PC and smartphone, it’s fair to say you haven’t really seen an improvement and that’s why there’s so-called IT recovery story has been pushed out from Q1 to Q2 and now Q3 but. Saying that, we do think there’s a lot of potential still because what we’re seeing is in select areas of the IT chain for example, the memory, which is typically an early cycle indicator of the overall IT cycle, you are seeing pricing in certain products bottoming out, you’re getting the starting to get the benefits of these so-called production cuts by the key players and we expect then that actually the earnings perhaps started to bottom. You can see that in the infantry levels of key hardware, again PC smartphones being the key once,. They’ve reached that historic normalized level of infantry, which allows them then to start restocking, which in theory should support the pricing of a lot of these semiconductors going forward. So, we do think we’re reaching the bottom there or be it part of this has been priced in given how strong the IT cycle, the sector has performed year to date.
