Assistant Fund Manager - Asia
A better than expected pickup in global trade dynamics and elevated confidence levels lifted world markets higher over the first half of 2017.
With a protectionist policy agenda emanating from the Trump White House yet to materialise along with a delay in an expected US fiscal stimulus there has been an easing in financial conditions and a softening of the USD. This environment bodes positively for Asian bourses. The MSCI Asia Ex Japan returned 21.6%, outpacing the MSCI World Index’s return of 9.4%.
While most of the aforementioned conditions remain, market headwinds sit on the periphery if unexpected geopolitical concerns become exacerbated and central banks take aggressive steps to unwind the crisis-era stimulus. The Federal Reserve looks set to maintain its gradual pace of interest rate hikes after two increases this year, while other major central banks prepare to normalise monetary policy. The tightening pace becomes the key focus, as central bank governors appear sanguine, pointing to synchronised growth across major economies amid signs that labour conditions are tightening. Optimism is further enhanced as the wave of anti-globalization that sparked the Brexit vote a year ago now appears to fade.
For Asian equity markets, we hold a constructive outlook for the second half of this year, as the political and economic environment is more conducive towards earnings growth and is generally less vulnerable to global volatility. Policies continue to coalesce around a pro-economic agenda, evident with supply side reforms in China, goods and service tax (GST) implementation in India, and improving corporate governance in South Korea. Similarly to developed market central banks, the focus on deleveraging and reducing systemic risk will be a major theme for the remainder of the year, in our view, particularly as the calendar reaches the 20th anniversary of the Asian Financial Crisis. Positive real interest rates, currency stabilization, and healthy current account levels suggest a reduced onus to shadow the Fed's movements, but other macro-prudential measures that buttress the medium and longer-term investment cycles will remain.
Our investment outlook is anchored around China due to better domestic economic data and RMB stabilization. This is likely to allow the People’s Bank of China to maintain interbank liquidity while reducing the use of irregular leverage and financial instruments. The A-share inclusion into the MSCI Emerging Market Index is not seen as being materially significantly in the near-term, but more symbolically critical in our view. The optimism lies in the potential medium and longer term given the potential size China would constitute in the benchmark index as well as greater alignment of China with international accessibility and trading standards. Key events later this year include the 19th Party Congress where President Xi looks to maintain leadership control, suggesting that many already implemented reform policies will remain unchanged.
India begins the second half with the implementation of its GST programme, which aims to replace a tangle of local duties and levies into a uniformed tax structure. Economic momentum is likely to remain on the soft side due to uncertainties over the new regime while the impact of demonetization from late 2016 is still being felt. Prime Minister Modi has been able to maintain strong approval ratings, as the general public acknowledges the perennial benefits over the temporary inconvenience. That patience will again be tested amid the GST rollout; however, any disruption is likely to be short-lived.
Strong trade tailwinds should continue to benefit the North Asian export markets of South Korea and Taiwan. The tech sector will see a renewed product launch cycle, including the iPhone 8, as well as extended semiconductor demand plus DRAM memory from smart initiatives including artificial intelligence and voice recognition technology. South Korean equities have been among the best performing in the region, with investors optimistic that newly elected President Moon and his administration will be able to improve corporate governance and push forward Chaebol reforms while also spurring fiscal spending.
A stable oil price environment supports ASEAN equities, alleviating pressure on fiscal deficits as many Southeast Asian economies look to withdraw legacy public subsidies. State funding reallocation becomes more critical as fading agriculture and commodity prices place the onus on public spending for much needed infrastructure projects. Rising disposable incomes and resilient domestic demand have offset the pullback in private investments, as political uneasiness such as the Jakarta gubernatorial race, the call for martial law in southern Philippines and ongoing constitutional revisions in Thailand have kept private investments on the sidelines. These trends should reverse amid better policy clarity into the second half amid pent up demand. Singapore experienced an unexpected pickup in trade and export data, supporting trend growth in ASEAN amid the slowdown elsewhere, demonstrating the economic diversity of the Southeast Asian nations.
In our judgment, the substantial unknown surrounds the Trump administration as the US President has quickly revealed a preference for taking unilateral agreements over multinational ones. The uncertainty stems when vacuous Twitter messages become protectionist policies, leading to a drop in confidence that tightens financial conditions. However, the risk of any meaningful trade protectionism that would derail world economic growth momentum remains low. In this author’s view, Trump’s rejection of the Paris Accord should be seen as harbinger for realistic action taken by the US President. Despite holding the party majority, Trump’s decision to abandon a nonbinding agreement demonstrates that the only conduit to achieve campaign promises are those that do not include any Congressional review. With many of these channels becoming less available and an upcoming election cycle in 2018, Trump may voice his agenda loudly but be unable to execute it in practice. The caveat to this assessment is if any bellicose tensions and concerns arise, giving way to national security responses, where a maritime confrontation in the South China Sea or agitation from North Korea are possible risks.
Looking into the second half of the year, Asian equities remain an attractive asset class given growth dynamics and relative valuations. Any near-term correction would be viewed as an attractive entry point given that the current implemented policies aim to support the medium and longer-term outlook. Benign market conditions hold supportive factors to balance volatility from central bank policies, demonstrated by stable economic expansion over the past year when populist and anti-trade rhetoric were at their peak. Foreign exchange reserves and capital adequacy ratios remain at healthy levels and provide sufficient liquidity, paring back actions taken by global central banks.
Source: All MSCI and Economic Data from Bloomberg unless otherwise stated.More about Emerging Markets
Assistant Fund Manager - Asia