A first quarter cheer

Asia ex-Japan had a phenomenal January, enjoying high single digit price gains. These gains tapered off in February and March. While the index has not returned to the peaks of 2018, stocks have mostly clawed back losses incurred in the fourth quarter of last year. Overall, it is still a strong start to the year, with the MSCI Asia ex-Japan index clocking a 14.2% price gain as at 12 April 2019. On a total return basis, the index delivered a 11.4% return (US Dollar terms) in the first quarter (as at 31 March 2019).

Given the strong year-to-date rally, coupled with recent earnings downgrades on the back of a tepid macro environment, valuations have turned less attractive. The MSCI Asia ex-Japan index is currently trading at a 12-month blended forward Price-to-Earnings of 13.4 times (as at 12 April 2019), about 1.9 standard deviations above the past 7-year average and 1.7 standard deviations above the past 5-year average. Forward Earnings-per-Share (EPS) growth has turned negative as well.

Looking forward, extended valuations and weaker forward EPS growth might limit the scope for meaningful outperformance. With Asia ex-Japan having played catch-up, its best to turn our sights on other regions with more attractive valuations. As such, we have downgraded our view on Asia from positive to neutral. Nevertheless, we remain constructive on the outlook for Asia despite steep valuations for the region.

Economic outlook

Amid global pressures, Asia ex-Japan continues to be the face of economic resilience. Compared to January 2019 and October last year, the International Monetary Fund (IMF) revised down its 2019 growth forecasts for emerging markets by 0.1% and 0.3% respectively. Growth forecasts for advanced markets were marked down more significantly, as can be gleaned from the table below. However, the estimates for emerging Asia and ASEAN growth saw minimal revisions. This sustained strength of Asia – in terms of the overall growth rate and the minute scale of downward revision – stands out, especially amid current concerns about a synchronous growth slowdown in the developed world.

Indeed, given Asia’s reputation as an exports hub, the slowdown in developed economies is a clear concern. Weaker global demand necessarily slows down a key engine for growth in the region. For the most part, exports growth over the past three months have underperformed expectations for most key Asian countries. On the positive side, recent Chinese and Thai export data have surprised significantly on the upside. Whether this points to better trading days ahead, is yet unknown. After all, it’s difficult to draw conclusions from a single monthly data point.

Manufacturing Purchasing Manager Indices (PMIs) paint a more positive picture, as they broadly point to continued expansion in the manufacturing sector (most PMI figures hover above the 50-point threshold). But even the latest figures have slipped from recent 1-year highs, signalling a deterioration in growth momentum.

Insofar as Asia’s fortune is intertwined with the fate of the Chinese economy, the outlook for Asia ex-Japan may not seem so dour. Stimulus efforts by the Chinese government seems to be bearing fruit as evidenced by recent data.

We saw a sharp uptick in the Caixin manufacturing and non-manufacturing PMIs in March, which underscores an improvement in underlying business sentiment. Importantly, the manufacturing PMI finally entered expansionary territory, after languishing in contraction for three consecutive months.

Some would argue that China’s recent trade data provide another plus point for Asia. Exports surprised on the upside, growing a substantial 14% on the year in March, compared to the 20% slump seen a month earlier. Yet, imports declined 7.6% on the year, the fourth consecutive month of contraction, potentially signalling weak domestic demand.

Amid the broad slowdown in global growth, it seems wishful thinking to expect a V-shaped recovery in China. It’s important to note as well that the scale of the current stimulus effort is more measured compared to past episodes, where all levers of growth were pulled to support the economy as China seeks to prevent a worsening of domestic imbalances despite pursuing growth-supportive policies. Stabilisation is a more reasonable expectation. The recent ramp up of fiscal and monetary stimulus will likely deliver this outcome in the face of US-led protectionism. And, for the most part, recent data bear this out.

Meanwhile, the US Federal Reserve, the European Central Bank, the Bank of Japan, and the Bank of England have all shifted to a more accommodative stance. Also, the outlook for US–China trade tensions has improved as trade officials edge closer to an agreement. Dovish developed market central banks and receding US-China trade tensions alleviate somewhat external pressures on Asia ex-Japan, improving prospects in the region. The impact of these supportive policy responses is evident in buoyant financial markets but have been slow to materialize in the real economy. How the Asian economy evolves bears close monitoring.

Elections in focus

Beyond economic factors, politics is another key risk in Asia this year as voters in Indonesia and India go to the polls to elect their political representatives.

We do not expect these elections to throw up any major surprises and largely expect the incumbents to win another term in office. Policy continuity as opposed to political disruption is our base case.

Narendra Modi and Joko Widodo will likely continue to push forward their reform agenda should their political campaigns be successful in securing another term in office. Such an outcome would alleviate some near-term uncertainty for these economies.

In an environment where dramatic political changes have introduced a great deal of uncertainty, the prospect of two reform-minded leaders potentially winning a second term offers some much needed stability in an admittedly volatile political terrain.

Indonesia: A repeat showdown

On 17 April 2019, about 265 million people will go to the polls to vote for the country’s president and representatives in parliament and regional assemblies in what is expected to be the single largest day of voting in human history.

As expected, the presidential race has garnered the most attention. It’s a repeat showdown between the 57-year-old incumbent Joko Widodo and 67-year old retired general Prabowo Subianto. On the surface, it looks like a re-run of the 2014 presidential election.

As it stands, Jokowi is the hot favourite to win the presidency with polls showing him leading comfortably by double digits. Admittedly, the gap has narrowed closer to the election, but overall expectations are for Jokowi to sweep the election, much as he did in 2014.

In a calculated move, Mr Widodo had chosen as his running mate a Muslim cleric by the name of Ma’ruf Amin, who is the head of the Muslim Organisation Nahdlatul Ulama which boasts 50 million members. The choice of a deeply religious figure as a vice-presidential candidate could be viewed as a counter-balance to Mr Widodo’s secularist-bent as well as a not-so-subtle response to public criticisms about his seeming non-religiosity. In a country where political Islam is deeply entrenched, appealing to the 88% Muslim majority seems like a strategic political move by Mr Widodo. The admittedly controversial choice for a running mate may have provided Jokowi the insurance he needs to win this race: If all else fails in the campaign, he could always pivot to religion.

Promises are aplenty on both sides, as expected. Another term in office would mean the continuation of Jokowi’s reform agenda which broadly includes infrastructure development, cutting corporate taxes and easing regulations along with extending healthcare coverage to all Indonesians and providing price support to farmers.

Enacting these crucial reforms requires political will and parliamentary support. This will largely depend on the coalition make-up supporting Mr Widodo’s government and the number of seats they secure during the election. In the previous election, Jokowi’s coalition controlled more than 60% of the seats in the Dewan Perwakilan Rakyat or the country’s parliament. Whether these political parties will be able to retain these seats and/or win over new ones remains to be seen. The make-up of the new coalition will likely determine the type of reforms pursued. Their extent of control over parliament will determine the ease by which these reforms are carried out.

Regardless of the outcome, the incoming government will need to deal with the country’s twin deficit – current account and fiscal deficits – issue urgently so as to reduce the Rupiah’s vulnerability to external risks. With developed market central banks adopting a more dovish posture, now would be as good a time as any to correct these deficits through bold policy action. Over the longer term, building the economy’s capacity requires infrastructure improvements and investments into productive sectors.

[Unofficial quick counts indicate a win for Jokowi, although official results will only be released in a few days.]

Indian elections: The Modi effect

Over in India, 900 million-odd eligible voters are/will be exercising their civic duty by voting for the members of the 17th Lok Sabha (the lower house of India’s bicameral parliament). Given the scale of the national elections, the process is divided into seven phases and is spread over many weeks to make it more manageable. National elections began on 11 April 2019 and results are due on 23 May 2019.

Elections held in 2014 were notable for a couple of reasons, the first being the scale of voter turn-out. Roughly 66.4% of eligible voters turned up at the polls to choose the nation’s new leaders, significantly higher than previous elections.

2014 was particularly notable for the single party majority won by President Modi’s Bharatiya Janata Party (BJP) – a rare occurrence in an otherwise scattered parliament where coalition governments were the norm. The BJP won 282 out of the 543 seats in the lower house. In addition, there was no opposition leader in the Lok Sabha given that none of the other political parties could secure 55 seats, or 10% of the parliament.

Whether Mr Modi will be able to repeat his 2014 win remains to be seen, although political observers seem to think this to be rather likely. Leading up to the first phase of polling, an opinion poll by Times Now-VMR predicts that the BJP-led National Democratic Front will likely edge its way across the majority mark with 279 seats (or 51.4% of the total seats).

In contrast, other popularity surveys suggest that this will not be a straight-forward win especially considering Mr Modi’s declining popularity versus his main opponent Rahul Gandhi who is leading the Indian National Congress (INC).

Yet, an airstrike may have clinched Mr Modi the presidency. The deaths of 40 paramilitary police in a suicide bombing in Kashmir on 14 February 2019 triggerred a strong response from the Modi-led government after it was discovered that a terrorist group based in Pakistan had led the attack. The government retaliated swiftly by sending warplanes into Pakistani territory to bomb suspected Jaish-e-Muhammad terrorist cells. The move sparked harsh criticism for the government’s recklessness in potentially antagonising a fellow nuclear power. Yet, the optics of “strong man” defending Indian interests boosted patriotic fervour and was widely cheered by the electorate. Indeed, one could say that Mr Modi’s campaign has been Trump-esque, tugging on populist strings and appealing to nationalistic inclinations.

Meanwhile, Mr Modi’s economic policy report card seems patchy. On the upside, India’s economy remains the vanguard of growth in the emerging world, clocking in an average growth rate of about 7.5% since Mr Modi ascended to the top job in 2014. Yet, high growth was unacommpanied by job creation. Recent data shows unemployment rising to the highest level in over 40 years.

Mr Modi’s demonetisation movement in 2017, aimed at curbing corruption and preventing tax evasion, was a good move in theory. But in practice, it caused a great deal of disruption and disproportionately affected farmers and small business owners more, given that their transactions are often handled in cash.

The rise of Hindu nationalists and the alarming prevalence of political rhetoric verging on the extreme have led to rising concerns about Mr Modi’s leadership for a second term. The injection of Hindu-centric interests in policies and laws have also raised questions if secularism in India is being threatened.

Indeed, from an economic standpoint, a Modi-led victory would mean policy continuity and some sense of economic stability. The social and political ramifications appear more questionable.