Better at pandemic management

Global coronavirus cases hit a new milestone on 27 January, going pass the 100 million mark, according to Johns Hopkins University. This grim milestone is yet another reminder as to how rampant the pandemic remains after more than a year, with new variants of the virus raising alarm despite vaccine roll-outs.

Countries that proved successful in taming the invisible enemy in the first half of 2020, such as Japan, Hong Kong and South Korea, have recently found themselves dealing with a more potent wave as the weather turns cold. The cold weather kept people indoors and in close proximity to each other, increasing the spread of the virus. There was a palpable sense of lockdown fatigue as well, causing people to be less cautious and more complacent than they were before.

Still, some countries are better equipped than others to deal with the resurgence in Covid-19 cases, in large part thanks to the resources already invested to ensure adequate manpower and infrastructure are in place to help contain spikes in infections. Many Asian countries are expected to handle the outbreak more efficiently, and this is borne out in Bloomberg’s Covid-19 Resilience country rankings. The report gives a snapshot of where the virus is being handled most effectively and with the least social and economic disruption. Although Japan and South Korea’s rankings have taken a tumble, they remain among the top twenty most effective countries in handling Covid-19.

What’s perhaps surprising (or not) is how lowly ranked the largest developed Western economies are in the list, with the US at 35 and the UK at 32. In a rare televised address in April last year, Queen Elizabeth had assured her subjects that “better days will return.” Yet eight months later, the idea still seems elusive as several parts of the UK remain in lockdown amid the emergence of a more contagious strain of the virus.

Meanwhile, countries like China, Taiwan and Singapore have been rather successful at keeping the virus contained, with mandatory mask wearing and strict social distancing policies. Admittedly, the current situation is still far from normal – it’s certainly not normal to have masks on as a piece of uniform – but it is still the preferred outcome to having blanket lockdowns for days on end.

Standard ingredients for success

Indeed, countries that took decisive, quick and forceful action to contain the spread of Covid-19 enjoyed better economic outcomes. In addition to implementing to tough containment policies to quickly stem the spread of the virus, monetary and fiscal policy support were also critical in promoting a speedy economic recovery.

Because Asian economies have managed to avoid the types of repeated lockdowns seen in the West, they have successfully mitigated the scale of economic disruption to their economies – of course some with more success than others. The upshot is a shallower contraction in 2020 versus developed markets.

China is the perfect example of a country that has turned adversity into advantage. As it stands, it remains the only major economy that has logged positive growth in 2020, its GDP expanding 2.3%. The country has already returned to its pre-crisis growth trend rate of around 6% per year. By contrast, the US economy is expected to remain well below its long-term annual growth rate of about 2.0%.

At the same time, projections of future growth appear much more sanguine for Asian economies versus their European and American peers. A key reason might be China, which has been a big demand guzzler of manufactured goods from the rest of Asia ex-Japan. Growth in China’s domestic economy tends to pull the rest of Asia along with it. China may continue to generate positive spill overs with its 'dual circulation’ initiative, where it is expected to focus efforts on shoring up domestic demand and consumption. Asia ex-Japan is well placed geographically to meet such growing demand.

In addition, countries in Asia have ample policy space to respond to potential economic shocks, be it through monetary or fiscal policies, versus their Western peers. As it stands, Asian economies have been more prudent in exercising its fiscal powers whereas its developed market peers have been quick to pass expansionary fiscal policies with price tags of over 10% of GDP.

In terms of monetary policy, interest rates in the developed world including the US, Eurozone, the UK and Japan are already close to or below zero. By contrast, with interest rates relatively further away from the zero-lower bound, Asian central banks still have some monetary policy space to manoeuvre should their economies require more stimulus support.

Beneficiaries of improving cyclical fortunes

Asia ex-Japan is also the beneficiary of improving cyclical fortunes. Sharp improvements in the manufacturing Purchasing Managers’ Indices (PMIs) offer reassuring signs that the manufacturing sector – a major contributor to Asia’s GDP – continues to be on the mend. The worst is likely behind us as manufacturing capabilities have continued to run mostly uninterrupted as governments deployed targeted restrictions, as opposed to blanket containment.

The steady global economic recovery has also translated into better export prints for almost every major economy in the Asia ex-Japan region, even besting market expectations. Asia’s reputation as the world’s export centre invariably means that its fortunes are closely tied to the state of the global economy. Hence, buoyant and better-than-expected export data from South Korea, Taiwan and Singapore – typically seen as weathervanes of the global economy – may portend better days ahead as such data typically indicate an improving outlook for global demand. Widespread vaccination and containment of the virus potentially later this year may help unleash pent-up demand in developed economies to the benefit of Asia’s manufacturing sector.

First in, first out advantage

Early containment of Covid-19, better economic fundamentals and ample policy space have buoyed the region’s equity market. In fact, the MSCI Asia ex-Japan index outperformed other regional indices including the US, Europe and Japan on a total return basis. Equity benchmarks for several Asian markets also ended in the green for the year, save for Hong Kong and Singapore.

And while valuations may look somewhat extended from a 5-, 7- and even 10-year perspective, other positives in the form of a recovering earnings picture, weaker US Dollar, higher commodity prices, a more stable and predictable geopolitical environment and brighter growth prospects as vaccine distribution kicks off in earnest, suggest possibly higher upside for Asian equities.

Also, with interest rates in developed countries wedged at near zero levels, the positive interest rate differentials between Asia ex-Japan and these developed economies, in addition to better economic fundamentals, may continue to attract global capital flows into Asia ex-Japan. This is best exemplified by the Chinese yuan. Positive interest rate differential between Chinese and US government bonds has and will likely continue to divert capital flows into the region, buoying asset prices (Chart 9).

Selective opportunities

While we remain broadly constructive about Asia ex-Japan equities overall, we believe there are selective opportunities within the region that merits greater attention, in part because they are attractively valued.

After all, investors did not spread the love equally during the market rally of 2020. The usual suspects, namely growth sectors like health care and information technology were the main beneficiaries of capital inflows.

Other sectors like real estate, energy and financials underperformed the broader index as investors shunned cyclicals for the perceived security of “stay-at-home” winners amid the global pandemic.

Financial and energy stocks have recovered some lost ground on the back of steepening yield curves and rising commodity prices but are still far from the highs of growth stocks. Meanwhile, the real estate sector has underperformed its peers. Yet, this itself presents an opportunity.

The case for Asia real estate

From the outset, the real estate sector is attractively valued, with the MSCI Asia ex-Japan Real Estate Index trading close to 1 standard deviation below its past 10-year average, both on a 12-month forward Price-to-Earnings (P/E) and Price-to-Book (P/B) basis. Versus the broader index that is trading at historic highs, we would regard this as a potential bargain.

Second, dividends tend to account for a large proportion of total returns when investing in Asia ex-Japan equity markets. Over a 10-year time horizon, on a cumulative basis, dividends account for close to 50% of total returns of the MSCI Asia ex-Japan index, as can be gleaned from Chart 12. Hence, a dividend-focused equity strategy might be a more nuanced way of engaging opportunities in this region. In this regard, the real estate sector stands out for its attractive dividend yield versus the broader index, as shown in Chart 13.

Of course, dividends are not sacrosanct – they are as much a victim of adverse economic winds as anything else. Here, it pays to note that we are in the early innings of the expansionary cycle which tends to conducive for businesses, and therefore income generation.

In addition, even under the most rosy of economic conditions, we should still be judicious about our investments and adopt a strict and selective bottom-up stock picking strategy that sieves out the roses from the thorns in sub-sectors like real estate investment trusts (REITs), property developers and property management companies. The reliability of dividend payments should be a key consideration. Generally, we believe amid a lower for longer interest rate environment, the hunt for yield will be an added structural market driver for Asian real estate stocks, especially as the sector continues to pay attractive dividend yields versus its regional peers and other equity sectors.

Third, after a bruising year for global demand which precipitated the flood of liquidity into markets by central banks and massive deficit spending by governments around the world, concerns about potential inflation risks have surfaced. This is reflected in the sharp increase of long-term breakeven rates – market-based measures of long-term inflation expectations – to or above pre-pandemic levels. Amid such concerns, inflation hedges like real estate might be particularly useful. Numerous academic studies have shown that property prices and rental income tend to rise with inflation, thereby protecting the real value of an investor’s portfolio.

Fourth, investing in the real estate sector is one way to ride long-term secular growth trends playing out in the Asia ex-Japan region. We should recognise that Asia ex-Japan is more than just the world’s export centre or factory and not lose sight of the region’s overarching development story.

For example, while China has made much economic progress, it is still developing. It was not too long ago that a concerted push to rapidly urbanise and industrialise the country led to a sustained increase in real wages and uplifted hundreds of millions of rural people out of poverty. As incomes grow, needs and demands will change and much of this will be reflected in the real estate landscape. People will increasingly migrate to centres of economic activity in response to better income prospects, spurring demand for housing, amenities and recreational facilities. The advent of 5G technologies and the acceleration of digitalisation trends due to Covid-19 will also spur investments in infrastructure to widen internet connectivity.

India is poised to follow China’s example, with the current government likely to support programmes that will accelerate urbanisation and industrialisation efforts. As it stands, Prime Minister Narendra Modi’s government plans to raise funds and invest in areas such as urban technology and transport and also modernise India’s urban centres to make cities more liveable for people. These two growth behemoths will likely lead Asia’s urbanisation trend, a long-term process which will invariably lead to plenty of investible opportunities.

More generally, Asia, as a region, has experienced tremendous growth over the years. Income levels have steadily risen over time as countries continue to liberalise their economies and open their doors to foreign direct investments and trade. Moreover, better economic and social policies have improved social stability and have also led to a rise in educational attainment. These promising developments are instrumental in attracting businesses and encouraging the growth of higher skilled jobs.

The upshot of rising affluence and higher education is an expanding middle class. By some estimates, the Asia Pacific region is expected to account for 64% of the global middle-class population by 2030. Naturally, demand for real estate has and will continue to increase with rising affluence. This has already prompted governments in Asia to greenlight extensive urban restructuring and real estate development plans. Indeed, the real estate landscape will continue to be shaped by changing population dynamics and shifting economic prospects.

Ultimately, these structural and long-term demand drivers will continue to buoy the growth of the real estate sector. Investors may express a positive view on the long-term growth prospects of this sector through positions in REITs and stocks of property developers and property management companies with robust fundamentals.

Engaging opportunities in real estate via an actively managed portfolio might be a useful approach to mitigate downside risks especially when seeking meaningful exposure to just one sector. Investors should also be aware of idiosyncratic risks like sudden changes to a country’s macroprudential policies or the effects of structural shifts in behaviour as it relates to e-commerce penetration and work-from home trends, as these could potentially impact the performance of the sector.