Outlook 2018: Stars align for Asian markets
Asian markets have had a very strong year, up 29% year to date in 2017 (in AUD terms). This performance has been driven by a combination of strong earnings growth and moderate multiple expansion. Outstanding market performance in China and India and strong sector performance in the Asian mega-cap technology stocks (Samsung, Tencent, Alibaba and TSMC) have led the way.
GDP growth for the Asian region as a whole is forecast to be over 5% in 2018, with the two largest economies, China and India, growing at 6.5% and 7% respectively. Given this macro backdrop, earnings growth will continue to be strong next year at over 10%. The forward PE multiple for the Asian Index is still inexpensive at only 12.5x, so there is scope for further multiple expansion as well. As a result, we are very constructive on the outlook for Asian markets in 2018.
Key events across the major regions in Asia, China, India, North Asia (Korea and Taiwan) and ASEAN, are as follows:
China: The twice a decade 19th Party Congress meetings concluded in November 2017 and President Xi has cemented his control of the Chinese political apparatus. As such, 2018 could see a stronger focus on supply side reforms.
In May 2018, A shares (Chinese shares that trade in Shanghai or Shenzhen rather than H shares that trade in Hong Kong), will be admitted to MSCI Indicies in a staged manner. We think this could be a strong catalyst for the A share market which has massively lagged other Asian and developed markets since the end of the GFC.
India: The details of the Indian state bank recapitalization will be revealed in late 2017 or early 2018 and this will pave the way for a healthier banking sector overall. We also have an eye on the Gujarat State elections in December 2017, as these will be an important litmus test for Prime Minister Modi’s popularity going into the 2019 general election.
North Asia: There are two key trends to watch in Korea and Taiwan. The first is the situation with North Korea. Our base case remains that there is no attack by either side, but intermittent bouts of escalation. There could be a few quiet months with respect to North Korea, as December to February have historically had fewer missile launches. However, tensions could re-escalate by in mid-2018. If Rex Tillerson is replaced as Secretary of State, this would be a negative for the North Korea situation as he has favoured a negotiation approach more so than others in the Trump administration.
The other key issue in North Asia is the semi-conductor cycle and the potential for rotation out of technology stocks into old economy sectors. Samsung and SK Hynix together make up almost 37% of MSCI Korea and technology makes up 63% of MSCI Taiwan, so a sell down in tech is particularly detrimental to these markets.
ASEAN: South East Asian markets are relatively small and illiquid. If you add up the weights of the 159 stocks in Singapore, Thailand, Malaysia, Indonesia and the Philippines that are included in the Asia benchmark, they equal less than the combined weight of Tencent, Samsung and Alibaba. So are fund managers going for focus on 159 stocks in 5 different markets when they can generate more alpha by getting the big 3 right? We think not. So the risk is that ASEAN becomes a rounding error in Asian portfolios. On the political calendar, the election in Thailand after years of military rule will be an important event, as will elections in Malaysia.
Most Compelling Sectors
Financials and technology continue to be the most compelling sectors in Asia. We have also added some materials stocks in India and China going into 2018.
Financials are the stand out sector for Asia in 2018 because they are high growth and inexpensive. Many Asian financials are beneficiaries of rising rates in the US (Singapore banks, insurers) and the sectors is under-owned versus large cap tech.
Technology is the largest sector weight in Asia and one that offers Australian investors significant diversification opportunities given the lack of tech stocks domestically. We break the sector into 3 groups: mega cap tech (Samsung, Tencent, Alibaba and TSMC), supply chain stocks and disruptive technologies. Mega caps and supply chain companies have sold off sharply in December, while disruptive technology stocks like Airtac (industrial automation) and BYD (New Energy Vehicles) have fared much better.
Much of this sell off is a spill over effect from a correction in US tech, as investors simultaneously book profits on 2017’s winners and switch into sectors that will benefit from the Trump tax cuts. This sector rotation is playing out in Asia as well. A few months ago we began to add some materials and industrial names to the portfolio to benefit from the rotation trade. Specifically, we like cement, construction and infrastructure in China and India.
What is the market ignoring?
Asian markets are largely ignoring North Korea risk, trade policy risk and key man risk in India and China.
North Korea: The 3 best performing markets in Asia year to date in 2017 are Korea, China and India. The fact that the KOSPI is up 30% in AUD terms despite the situation in North Korea is surprising. We would feel more comfortable if the market was pricing in at least some Kim Jong Un risk.
Trade Risk: Asian market participants are largely ignoring the implications of the NAFTA renegotiations. Why should Asian investors care about Canada and Mexico? Because Asia could be next. During his election campaign, Trump was very critical of trade with both Mexico and China and vowed to label China a currency manipulator on “Day 1” of his administration. However, since the inauguration in January 2017, Trump’s attitude towards Asian trade has been decidedly benign.
This begs the question: Has the situation in North Korea fundamentally changed Trump’s attitude towards China (i.e. the US needs a friend in the region) to the extent that punitive trade policies are off the table? Or is Trump just biding his time and will turn his attention to Asian trade after dealing with NAFTA?
Key Man Risk: Lastly, we think the market is ignoring key man risk in the 2 largest economies in Asia. We remain staunch supporters of Prime Minister Modi and his reform agenda, but the more successful he is in devising and executing transformational policies, the higher the key man risk. Similarly in China, one notable outcome of the 19th Party Congress meetings was that President Xi did not identify a successor. This leaves China in unchartered territory in terms of future leadership.
High Conviction Stock Pick
Ping An Insurance is one of Ellerston Asia Investments’ (EAI) top picks and is a stock that has been in the fund since inception in 2015. With a market cap of over A$240 billion, Ping An is the largest insurance company in China and is the second largest insurance company in the world after Warren Buffet’s Berkshire Hathaway.
Ping An is a diversified financial institution with operations in life insurance, P&C insurance, banking, trust and securities and health care. All of these businesses are underpinned by cutting edge technologies. The stock is trading at only 13x PE with expected EPS growth of over 18%. The PEG ratio for Ping An (PE divided by the growth rate) is therefore far below 1x. The stock also has a high and rising ROE at 18% and is trading at only 2.2x Price to Book value.
Ping An’s core businesses are justification enough for holding the stock, however the real upside comes in the form of unlocking the hidden value in its technology facing businesses. Ping An has over 430 million internet users and over 300 million app users and all its businesses are linked via technology. In the next 2 years, Ping An is expected to IPO two of its technology assets: Lufax and Good Doctor. Our Sum of the Parts Analysis, where each individual business unit is valued separately and then added up, gives a price target for Ping An of HKD 100. That is 25% upside from the current price.
About Ellerston Asian Investments (ASX:EAI)
Ellerston Asian Investments (ASX:EAI) is a concentrated large cap portfolio based on high conviction best ideas which is benchmark independent. Providing investors access to high growth opportunities throughout Asia via a highly experienced and specialised team.
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Mary is a Portfolio Manager for the Alphinity Global Fund and Alphinity Global Sustainable Fund. She has been investing in global markets for over 20 years previously working for Ellerston Capital, Oaktree Capital and Soros Fund Management. Mary...