Why Southeast Asia is rewarding investors

Southeast Asian nations’ superior growth rates, lower leverage and huge infrastructure spending are looking increasingly attractive, according to Fidelity’s Gareth Nicholson.

Investors became more ‘risk-on’ early in 2013 and the Association of Southeast Asian Nations (ASEAN) equity markets have been among the biggest beneficiaries. 

This should come as no surprise to those investors familiar with the region’s obvious attractions, such as superior growth rates, lower leverage, huge infrastructure spending and the potential for currency appreciation relative to developed western markets. 

Many ASEAN markets remain within a dividend sweet-spot since cash flows are growing together with falling capital expenditure and gearing levels. ASEAN is also expected to benefit from increased economic integration with the full implementation of a free trade agreement in 2015. 

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Amid the positive backdrop, however, some headwinds have appeared in the form of heightened political risk and pockets of overheating.   

Thailand’s building boom  

Thailand is Asia’s second best performing stock market year-to-date (ex-Japan), driven by continued infrastructure expenditure and Prime Minister Yingluck Shinawatra’s consumption-friendly policies of lifting wages and cutting taxes. 

Labour shortages, higher wages, and targeted tax rebates have strengthened domestic demand and helped fuel a consumer credit boom. Consumer credit grew 21.6 per cent year-on-year in 2012. 

The country attracts strong foreign direct investment flows, particularly from Japan, and this has continued despite a weaker yen.     

In terms of infrastructure spending, the Government’s focus is on modernising its rail network, improving water management systems and expansion of the capital’s main Suvarnabhumi airport. 

Analysts are sanguine on the prospects for an infrastructure boom in Thailand, saying development of the economy is essential if the government wants the country to be at the epicentre of ASEAN trade integration, set for 2015. 

A more stable political situation, and the inclusion of the long-awaited flood management system in the Public Debt Management Office borrowing plan, augur well for more government expenditure in this area.  

Thailand enjoyed a strong fourth-quarter earnings season, with many companies surprising on the upside.

However, some brokerages note that equity valuations – particularly for small cap stocks – are now looking expensive on a historical basis, so careful stock selection and a disciplined buy and sell strategy are recommended.  

Indonesia can ride currency headwinds 

Indonesia has been one of ASEAN’s star stock market performers since the 2008/9 financial crisis, supported by a commodities boom, rising consumption, favourable demographics and supportive government policy (including large government-driven infrastructure projects). 

However, as the 2014 presidential election draws near, there are some signs of increased political risk and rising investor uncertainty. 

Indonesia’s Government has hinted at curtailing exports of coal to conserve supplies for future domestic demand – this at a time when the voracious resources appetite of China has cooled in line with its new policy focus on quality of growth over quantity.  

The Government signalled in 2012 it might boost the average minimum wage by as much as 50 per cent in 2013 amid rising economic growth, inflation pressures and labour protests. 

However, it subsequently backed down, implementing smaller wage increases and allowing about two-thirds of employers to postpone salary hikes until next year. 

CLSA analysts argue that potential wage increases in future (and the likely impact on company profits) are more of a concern that the incremental increases of the past year. 

In addition, a weaker rupiah has compounded inflationary dangers for the economy, and there is little sign that the Indonesian central bank will tighten policy. Given the current account deficit, we expect the Indonesia rupiah to remain volatile in 2013.    

All in all, however, there continues to be a strong secular growth story in Indonesia, driven by an increasingly affluent middle class. 

A positive consequence of increased wages is increased consumption, and as such consumption-related stocks, in addition to infrastructure moves linked to the Government’s spending projects and ongoing land reforms, remain attractive.  

Philippines on a tear – but expensive 

ASEAN’s star performer this year has been the Philippines, buoyed by GDP growth of at least 6 per cent, overseas worker remittance growth of about 5 per cent and President Benigno Aquino’s wider policy efforts to boost spending on government projects and tackle corruption. 

According to Bloomberg data , the Philippine Stock Exchange has climbed almost 14 per cent year-to-date, and over a third since May 2012. 

Political risk has dropped significantly - one example being the removal in June 2012 of Renato Corona, the Philippines former Chief Justice, for masking millions of dollars in assets. 

Ratings agencies have raised their outlook on the country to positive, citing political stability and economic growth, and central bank governor Amando Tetangco has indicated an investment grade rating could come in the first half this year.

Despite this, the market represents only 6-6.5 per cent of the MSCI All Countries South East Asia Blend benchmark index and valuations currently look expensive on a historical basis.  

Malaysia – a relative under-performer 

This year’s general election has seen an increase in political and market uncertainty in Malaysia although economic growth remains resilient, running at an above-forecast 5.6 per cent in 2012. 

Exports of commodities and manufactured products have weakened but this has been offset by government investment in the form of the Economic Transformation Programme (ETP), which is aimed at growing incomes and moving the country up the value chain. The construction-related projects have boosted both private and public investment. 

Nonetheless, Malaysian equities have under-performed their ASEAN peers and relative valuations now look inexpensive on a historical basis, with stocks trading below their 12-year mean average. With inflation pressures benign, current valuations could offer some buying opportunities given the ongoing ETP. 

Singapore balancing act 

Singapore has implemented a series of tightening measures to cool property market prices while at the same time attempting to rebalance growth in the city state across wider swathes of economic activity. 

GDP growth in 2012 fell to +1.3 per cent year-on-year compared with +5.2 per cent in 2011, according to official statistics.  

On the downside, stricter immigration policies and an ageing population are likely to act as dampeners on Singapore’s economic growth.

Business costs are expected to increase, specifically for industries which are labour-intensive and rely heavily on foreign labour.

On the positive side, and from an equity dividend perspective, the REIT sector still offers yields of around 6 per cent, given prevailing low interest rates. Select telecoms stocks also offer high dividend yields. 

ASEAN an all-round performer 

ASEAN remains an attractive all-round performer for stock-pickers, whether they’re looking for attractive growth prospects or simply a good dividend yield.   

David Urqhuart, portfolio manager of the Fidelity Asia Fund, concludes: “Investment opportunities continue to be healthy for ASEAN even after strong market performance. ASEAN countries like Indonesia, the Philippines and Thailand are now expected to deliver earnings per share (EPS) growth that is comfortably ahead of that being achieved by the region as a whole over the next two years. 

“Valuations for Thailand and Indonesia remain attractive given the growth expected, while the Philippines is now looking expensive on both earnings-based valuations and versus book value.”  

Gareth Nicholson is the senior investment writer at Fidelity Worldwide Investment.