While emerging economies such as Turkey, Brazil, Argentina and Ukraine are currently unattractive to investors, Jonathan Wu suggests investors look to the East.
The emerging markets debate is on once again, with Latin America starting the global rout of markets alongside Turkey and the Ukraine.
Coupled with this is the investment community’s continuing question over the fate of Chinese growth for 2014.
Lurking comments circulating include the infamous “is this a re-run of the 1997/98 Asian and Emerging Market Crisis all over again?” We certainly do not believe so.
In the case of Asia, it was in a much weaker position as the Asian Dragons of the 1990s were going broke for growth – and that’s exactly what ended up happening.
With reliance on foreign capital as well as low levels of foreign reserves, they didn’t have the power to hold the floor as the roof caved in, as we saw in 1997/98.
The Latin Americans do have it somewhat tougher this time around, as they don’t have the reserves to defend their currency and inflation has gone out of control.
So where to from here?
From the Asian perspective, markets are extremely attractive. Yes, liquidity concerns in China will be here for a fair while yet as they sort out the wealth management trusts out.
We believe that to speed up the clean-up, a few should default, to ensure others take note and start winding back these types of investment vehicles.
The mainland Chinese A share market has been in a secular bear market for four years and currently trades at 10 times historical price-to-earnings ratio (PE).
The Hang Seng is in similar territory at 10 times PE. H shares (which are those Chinese companies listing in Hong Kong) are trading at 7.3 times historical PE.
If we were to make an assumption that over the course of 2014 there will not be any price movements, with earnings still travelling on as well as they were in 2013 – which is quite a conservative assumption – the PEs start becoming somewhat ludicrous, with A shares at 8 times, H shares at 6.5 times and Hang Seng at 9.7 times, making them the cheapest market anywhere in the world.
But with the Chinese economy still confidently expected to churn out 7 per cent growth, it does create buying opportunities for active managers who are selectively picking stocks where many are not even index constituents.
From a sector perspective, there are many areas we are focusing on, including:
- Healthcare: The Chinese government has been focusing a lot of resources to roll out universal healthcare. Many of these companies enjoy stable growth with limited economic risks.
- Property: 2013 was a great year for property companies, which registered a 30 per cent increase in contract sales, 10 per cent increase in price and 13 per cent growth in sales volume. Developers are trading at record lows (some at 4.5 times historical PE) due to a fear of new taxes being implemented, but which still haven’t come to light. To put it into perspective, the average discount to NAV is over 20 per cent.
- Banks: Again, due to shadow banking fears, these have suffered another round of PE contraction – but with a solid return on equity of 20 per cent, dividend yield of 5-6 per cent while still trading at a P/B <1 for 2014, the proposition is very attractive. Just take one look at our local big four banks.
So what's the catch?
This sounds all great, but are there any risks? There are three, which all provide hiccups to a recovery.
Firstly, no one knows when the bear market will finish for A shares. But on the balance of probabilities of whether the risk is of the up or downside form, upside is more probable.
Secondly, there’s the whole issue of US tapering. Logically, if an economy of the size of the US is weaning itself off morphine, it should be good for investment risk, but the reverse occurs, so this always appears as a red herring issue.
Finally, other emerging markets such as Argentina, Brazil, Turkey and the Ukraine are dealing with issues without the ammunition that Asian countries have.
Argentina, with a combination of record low reserves matched with 30 per cent inflation, or Turkey with corruption woes and government collapse risk looming, could also continue to derail emerging markets’ performance for 2014.
Jonathan Wu is the associate director/head of distribution and operations at Premium China Funds Management.
