Will Asia’s economic growth translate to growth in equity prices in the Chinese New Year of the Dragon? David Urquhart believes it will.
According to the Chinese zodiac, 2012 is the Year of the Dragon – an auspicious symbol of good fortune and power. Will it help turn around and boost Asian equity markets this year?
Asian markets have historically performed well once they dropped to the current inexpensive valuations of 10.3 times price-to-earnings ratio (P/E) and 1.5 times trailing book value.
Over the past 20 years when P/Es have been this low, we have seen rallies on average of 16 per cent or higher over 12 months, 92 per cent of the time, according to studies by Goldman Sachs and Citi.
Although Asia is not immune to the slowdown in the West, the region is proving more resilient to a global economic downturn than in the past.
One reason is that the region is significantly less reliant on the West than previously, with over half of its exports now being traded within the region.
The region’s demographics also continue to be very favourable for companies and investors.
The labour force is forecast to grow at 1.5 per cent a year for the next 10 years, compared to Europe and the US which are growing at just 0.3 per cent.
The region’s steadily rising labour force will provide a source of higher growth.
As people enter the labour market they become economically productive, rather than being a drain on an economy. More people will be able to earn and therefore spend, buying goods and services that companies provide.
The rising labour force is also adding to the growing middle class in Asia, which is expected to almost double to over a billion people in the next five years.
China is expected to report the biggest absolute increase, while India and Indonesia will have stronger percentage growth.
Another positive for the region is that while most Western economies have a negative current account balance, most Asian nations have a positive one (with the notable exception of India).
Policymakers in the region still have more growth-supportive options at their disposal than their developed market peers.
Asian economies still have the ability to use both monetary and fiscal policy to help stimulate domestic demand, while in the West high levels of government debt have made fiscal policy tools unavailable.
Most Asian central banks have been tightening their monetary policies in the past few quarters so they now have flexibility to relax interest rates and credit policy in case of a severe economic slowdown outside their borders.
It is similar, with foreign exchange (FX) reserves. Asia accounts for 63 per cent of global FX reserves, with China having accounted for half of these at the end of 2010.
Corporate debt levels are the lowest they have been since 1981 at 25.8 per cent debt/ equity.
They have been building increasingly large reserves of cash and significantly de-leveraging their balance sheets following the Asian Financial Crisis in 1997 and the Global Financial Crisis in 2008.
Strong balance sheets, cash flow and rates of return have put Asian companies in great shape, although some companies will do better than others in this kind of environment.
There are several other factors that will further contribute to Asia’s growth this Chinese New Year – including increasing participation rates in tertiary education, rising labour skills, increasing urbanisation, developing credit markets and so on.
All these should further underpin the growth opportunities of companies and their share prices in the region.
Overall, Asia’s healthy financial system, robust domestic demand, low debt levels, high savings rates and the emergence of China as an anchor of growth for the region will continue to be supportive of multi-year growth in the region.
Because they are in better economic shape, we expect Asian equity markets – which are currently following the lead of US markets – to have greater upside when global markets do improve.
What countries will provide the best market returns?
I have returned to a slight overweight to China, as the government in Beijing should start to loosen monetary and fiscal policy there as inflation concerns reduce and growth slows in response to the slowing global economy.
This should help the growth of local companies.
I also like Indonesia and Thailand, as we have identified some great businesses there with great growth potential.
This is key, as while the region as a whole is one of the strongest in the world, it is important to identify from the bottom-up those companies that are going to deliver earnings per share growth stronger than the market anticipates and currently at very attractive valuations.
These stocks should perform well over the next few years, even in the challenging macro environment.
David Urquhart is the portfolio manager of Fidelity Asia Fund.
