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.