What’s happening with Asian stocks?

David Urquhart explains why Asia has under-performed this year – but also why the outlook for Asian stocks is strong.

Why have Asian stock markets underperformed so far in 2013? 

Asia’s stock markets have struggled in 2013 largely because China’s economy is slowing and because investors think the tapering of asset-buying by the Federal Reserve will hamper emerging markets, including those in Asia. 

China’s economic growth is dropping from the double digits of recent years – the economy grew at an annual pace of 7.5 per cent in the second quarter – because the Government undertook steps in 2011 and 2012 to suppress growth. 

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Authorities wanted to control inflation, which is now down to 2 per cent, and curb the excessive lending that was tied to the stimulus package in response to the global financial crisis that amounts to 16 per cent of GDP. That’s big by any standards. 

The smaller ASEAN markets are still doing relatively well this year, after having outperformed in recent years. Why? 

The ASEAN countries Indonesia, Malaysia, the Philippines and Thailand have performed well in recent years largely because a decline in inflation allowed central banks to cut interest rates. 

Lower rates in these countries are allowing people to buy their first fridge or car.

On top of that, the Philippines and Indonesia received a boost after rating agencies upgraded their debt ratings because their Governments have their finances under better control. 

China and India, on the other hand, have seen authorities clamp down on growth in recent years to control inflation.

These efforts stifled their stock markets as well as their economies. 

Why are Asian equities cheap? 

Asian equities are cheap compared with their history and when set against other regions. Why is that? 

It’s certainly true that Asian equity markets are attractive on valuations at the moment. On a price-earnings basis, Asian stock markets are probably 5 per cent to 10 per cent cheaper than their long-term averages.

On a price-to-book basis, they are about 20 per cent cheaper than their long-term averages. On these measures, Asia is the best-priced region in the world today. 

The reason Asia is trading at attractive valuations is because investors are concerned about China. They are worried China’s economy will slow further and that a slower-growing China will hurt China’s neighbours.

We believe that because inflation has slowed China can now lighten the pressure on the brakes, which will allow for sustainable growth at around the 7 per cent level, which will support stocks. 

Long-term prospects 

Are you still optimistic about Asian shares over the long term? 

Several factors are set to support Asian equities for the foreseeable future. 

The first is that Asia is enjoying robust economic growth. The expectations are that government and consumer spending, business investment and exports will contribute strongly to GDP growth in coming years. 

The second reason is that Asia’s productivity is outstripping the developed world’s, even that of the US and Germany.

The main explanation for this is that China is investing heavily in technology because the cost of labour has increased strongly in the past decade.

The days of adding more cheap labour to boost production are fading in China. It’s now about investing in machinery. 

The third reason, and perhaps the most important from an investor’s point of view, is that Asian companies are creating world-class brands.

China’s Lenovo and Acer and ASUS from Taiwan are among the five leading brands in the global PC market. Lenovo has the second-highest market share at close to 16 per cent, just below Hewlett-Packard, which has a market share just above 16 per cent. 

According to Brandirectory, a US brand specialist, Samsung, thanks to its smartphones and its dominance of the memory-chip market, has the second-most valuable brand in the world, up from 43rd spot in 2008. 

While Samsung is behind Apple on this ranking, it places higher than Google, Microsoft, Walmart and IBM, the next four on the list.

Hyundai has rocketed from 340th place five years ago on this ranking to 30th spot thanks to big improvements in the quality of its cars. 

Brand strength is important because it gives companies pricing power. That allows companies to boost their earnings per share, which justifies higher share prices. 

Another reason why Asia has an optimistic future is that across the region spending on research and development is strong, having increased from US$17 billion (A$18 billion) to almost US$70 billion in the past eight years. 

Asian companies see that R&D is the way to gain a sustainable competitive advantage. Patent applications in Asia of more than 34,000 in 2011-12 now outstrip the number of patent applications across Europe. 

The last reason for optimism about Asia is that M&A activity is giving Asian companies access to western technology and management techniques.

Asian companies can go on buying sprees because the financial crisis has lowered the prices of many western companies. 

The purchase of Jaguar Land Rover by India’s Tata Motors, Geely’s swoop on Swedish carmaker Volvo and the tilt by Dusan of Korea at Bobcat are among the takeovers that have helped Asian companies take massive leaps in product quality and distribution prowess, among other things.

Asian risk factors

What are the biggest risks facing Asia at the moment? 

One of the challenges Asia always throws up for investors is that governments intervene and take policy decisions that change the outlook for affected stocks. 

Corporate governance is a perennial issue, though this is continually improving. Shorter-term risks include the chance that Asia’s robust growth could reignite inflation in some countries; it’s never gone away in India. 

Another is the likely end of the Federal Reserve’s quantitative-easing program could prompt investors to shun emerging markets for a while.  

Which stocks? 

What are your biggest holdings at the moment and why do you have faith in these stocks? 

Samsung Electronics is a big holding in the fund, given its dominance of the memory-chip market and how its smartphone is the one to own in emerging markets.

The company is thriving so much that a 50 per cent jump in net profit for the second quarter disappointed some investors. 

SK Hynix of Korea is another sizeable position, thanks to its success with computer-memory chips. Another big holding is Techtronic Industries, a company that is based in Hong Kong, has its plant in China and notches over 70 per cent of its sales in the US.

The company makes power tools and vacuum cleaners. The power tools brands are well-known brands including Ryobi, AEG and Milwaukee, while their vacuum cleaners are even more famous, being Hoover and Dirt Devil. 

Techtronic is doing well because it is reducing its cost base. It has some great technology in cordless power tools and cordless vacuum cleaners, which is helping them gain market share in the US. 

Sa Sa International of Hong Kong is also another key overweight.

It is a cosmetics retailer and also has some of its own cosmetics brands. Sa Sa’s key market has been Hong Kong but it is building sales and distribution in China, Taiwan and Singapore.

Sa Sa is getting over 18 per cent same-store sales growth in its Hong Kong stores and overall sales are growing at more than 21 per cent. Yet the stock is trading at just around 20-times earning, which we see as an attractive price in such a defensive sector.  

David Urquhart is the portfolio manager of the Fidelity Asia Fund at Fidelity Worldwide Investments.