OCBC OneWealth App– Asia just keeps rolling along

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Asia just keeps rolling along

1 June 2017

A strong start to the year…

Asia’s reputation as the world’s export centre invariably means that its fortunes are closely tied to the state of the global economy. For the most part, global economic outlook has firmed prompting both the International Monetary Fund and the World Bank to revise global growth projections higher for the year. Looking at world industrial production and trade volume, we see the pace of economic activity picking up materially during 2H2016, which has carried through into 1Q2017.

Indeed, firming global demand has benefitted most major Asian economies with first quarter GDP growth largely besting consensus estimates. In this regard, Malaysia deserves a mention. At a 5.6 per cent year-on-year pace in the first three months of the year, Malaysia’s 1Q2017 GDP growth outperformed expectations by a solid 0.8 percentage points with the economy firing on all cylinders. In particular, its manufacturing and export sectors were among the top performers, clear beneficiaries of the stronger global economic momentum.

More generally, Asia’s manufacturing sector continues to look healthy with the latest Purchasing Manager Index (PMI) showing stark improvement from the lows of 2016, signalling buoyant manufacturing sentiment on the back of stronger global growth. Export growth in the first quarter has also continued to outperform expectations (with the exception of China), underscoring the robustness of global demand.

… but momentum will likely fade in the second quarter

Yet most crystal ball gazers would be quick to highlight that past performance is not necessarily indicative of future performance. So, while we should cheer robust first quarter data, it is still uncertain if the same economic momentum can carry through into the second quarter.

From the outset, economic momentum in developed economies is already showing signs of stalling as evidenced by the steady retreat in the Citi G10 economic surprise index, signalling that economic data releases are no longer coming in ahead of expectations. As growth momentum in developed markets fade, we should expect the same for Asia as well. That’s not to say that it’s all doom and gloom in this part of the world. It’s just making the point that while growth may remain satisfactory - good even – it is unlikely to repeat 1Q highs.

Such scepticism is warranted if one considers the reversal in policy stance among Chinese policymakers. China continues to be trapped in a “stop” and “go” policy cycle where stimulus is injected when the pace of economic growth is not fast enough (“go”) and is withdrawn once growth appears sufficiently stable for the government to deal with festering structural problems including the rapidly growing credit bubble (“stop”).

For most of 2H2016, the policy pendulum had swung decisively to “go” with government stimulus providing a shot in the arm of China’s old economy sectors (industrial and manufacturing), pushing industrial production measures and the Li Keqiang index – a measure of electricity use, rail cargo volume and bank loans – to three year highs. The material increase in China’s economic activity had pulled Asia up along with it.

With first quarter GDP up by 6.9 per cent and well within the 6.5 to 7.0 per cent target range, policymakers have swung back to the “stop” side of the pendulum to deal with the country’s debilitating debt condition. This is coming through a regulatory squeeze on grey areas of the financial sector as well as a tightening of liquidity to push up interest rates. Tighter financial conditions should temper the growth in debt, but will also lead to slower growth more broadly. In fact, we have seen early indications of this as April PMIs have slipped from the highs reached in prior months and industrial production have also ticked lower.

Nevertheless, Chinese authorities will likely be alert to the risk of growth slowing too much and will be ready to inject stimulus if need be, in line with the “stop” and “go” approach they seem to be favouring. Whether they will be able manage this transition smoothly will likely be the key challenge as each phase of policy tightening becomes progressively more dangerous in light of the rise in the debt service ratio.

Asia is bigger than just China: Focus on the long-term growth story

For the rest of Asia, a slowing China may be bad news, but not altogether terminal. Remember, China’s bumpy economic transition is not new and has played out for some years now. Yet, despite China’s slowing growth, we have not observed any marked deterioration in economic fundamentals of other Asian countries. Indeed, Asia has shown remarkable resilience during this period which could be attributed to better regional trade integration, diversification of export destinations to other regions like Europe, Australia and the U.S and a growing middle class supporting growth via domestic consumption. Yes, there are still dependencies on China, but it is certainly less extensive than previously anticipated. Hence, as we’ve mentioned earlier, while growth in subsequent quarters may not be Q1-spectacular, it is unlikely to be disastrous as well. As an adjective to describe the region’s growth outlook, “good” works just fine.

At the same time, economic reforms across most Asian economies should continue to pay dividends in the years ahead. For one, countries like Vietnam, the Philippines, India and Indonesia have continued to climb up the business competitiveness rankings in recent years and have also enjoyed higher foreign direct investment flows and economic growth as well.

More recently, after a long awaited upgrade by S&P, Indonesia’s sovereign credit has finally been conferred an investment grade rating by all three major rating agencies namely S&P, Moody’s and Fitch. In addition, Moody’s and Fitch have an active positive outlook in their assessment of Indonesia’s economy, opening up the possibility for more rating upgrades as well. The upgrade in credit rating could open up Indonesia to a broader – and stickier – base of investors, including funds that could not invest in the country before because of investment grade provisions in their mandates. It would also help to bolster the government’s efforts in improving the appeal of Indonesian assets to previously untapped groups of investors including retail investors in major developed markets. A vote of confidence by these rating agencies can only be a good thing for a country making some headway in reforms.

These factors remind us that there is much more to Asia than just China’s slowdown and that Asia’s longer-term growth story deserves some attention. Sure, there may be bumps along the way, but that’s unavoidable for countries in transition as most Asian economies are. So long as reforms continue apace, economic prosperity should not stay a farfetched proposition for too long.

Asia ex-Japan Stock valuations: Cheap but there are risks

Where investing in Asia is concerned, stocks elicit immediate interest. In terms of valuations, Asia ex-Japan stocks are selling for lower multiples of corporate earnings compared to other developed market stocks - especially relative to U.S. and European equities. In addition, price-to-earnings and price-to-book valuations are still undemanding relative to their own 10-year history.

On the earnings front, better economic conditions have filtered into companies’ bottom line, as can be gleaned from the rising trend in trailing earnings-per-share figures and more bullish forward earnings guidance.

However, cheap comes with a cost and for Asia ex-Japan stocks that usually takes the form of global and idiosyncratic risks. First, tighter global financial conditions arising from the withdrawal of monetary support by most major developed market central banks - chief among them being the Federal Reserve - could inject fresh doses of volatility into capital flows. In addition, a possible shift towards protectionism by major trade partners also represent a major downside risk to a region that largely depends on trade for growth on account of its significant participation in global supply chains. And last, but certainly not least, is China. As we’ve observed over the past few years, when China sneezes, Asia flinches. A bumpier-than-expected transition in China could have large spill-over effects on the rest of Asia, even if it were just a temporary shock.

Asia faces other idiosyncratic risks as well. The de-monetisation effort in India is a good example of region-specific risks that one may not necessarily encounter in other developed markets. And, given that analyst coverage of Asian stocks may not be as extensive and deep as its developed market peers, stock selection may require a more nuanced understanding of the business conditions in the region.

What can investors do?

As such, for investors looking to gain exposure to a region that seems pregnant with long-term promise yet troubled by near-term risks, investing in an actively managed, diversified portfolio of assets can be useful to mitigate potential downside risks relative to investing in a fully concentrated equities-only portfolio. Active management also becomes crucial to ensure agility during periods of heightened market volatility.

For this purpose, our top pick is the Lion-Bank of Singapore Asian Income Fund, a balanced multi-asset strategy fund.

The information below solely constitutes the views of OCBC Bank and does not consider the specific investment objectives, financial situation or needs of anyone. The Bank is therefore not responsible for any loss or damage arising from this information. Investment involves risks. If you wish to make an investment, you should first speak to your OCBC Relationship Manager or a Personal Financial Consultant.

Our top fund ideas

LION-BANK OF SINGAPORE ASIAN INCOME FD A DIS SGD-H

Suitable for Balanced/ Growth/ Aggressive

1-year performance

+ 8.65 ^%

LION-BANK OF SINGAPORE ASIAN INCOME FD A ACC SGD-H

Suitable for Balanced/ Growth

1-year performance

+ 8.66 ^%

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