Friday 29 Mar 2024
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This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on August 8 - 14, 2016.
 


ASIAN stocks fell out of favour in the last two years, owing to plunging commodity prices, weakening currencies and expectations that the US Federal Reserve would raise interest rates. 

But stocks in the region are starting to look attractive again because of their low valuations, according to Vasu Menon, vice-president and senior investment strategist at OCBC Singapore.

“A lot of fund managers have ignored Asia and not put money in the region. Its valuations are now the cheapest among all the regions. Just compare the MSCI Asia Pacific ex-Japan Index with the MSCI World Index. There is a big divergence,” he says.

The low valuations are due in part to market players being overly concerned about China’s private sector debt, which amounted to 210% of the country’s gross domestic product (GDP), according to Menon. Worries abound over whether its high debt level could lead to a collapse in the Chinese economy and cause a domino effect across Asian markets. 

However, Menon says things are starting to turn around as the Chinese government has taken action to tackle its debt issue by allowing shell companies to default. “The Chinese government recognised the debt problem and is dealing with it. We have seen about 

30 companies default this year, which is unprecedented. A couple of years ago, there was no default at all. [By allowing the defaults to happen] it is getting rid of the zombies and shell companies,” he adds.

The Asian stock markets have benefited from the stabilisation of commodity prices and weaker currencies, which will boost trade and export, says Menon. He also expects the Fed to hike the interest rate by 25 basis points at the end of this year, which will keep Asian currencies stable and prevent capital outflow. 

Gary Lim, regional fund manager at Apex Investment Services Bhd, says Asian equities are the only bright spot in all the regions. “Asian central banks have room to cut rates further, unlike those in Europe and Japan, which have turned to negative rates. They have room to cut rates further because the US dollar remained rangebound after the Fed raised the interest rate [last year]. For instance, Indonesia has cut rates four times this year and its currency has not weakened much,” he adds. 

Lim says that going forward, he is “slightly positive” on the Chinese economy, which is one of the major risks that could impact Asian stock markets. Despite China’s high debt level, the key issue is whether the funds provided by its government are flowing into the right sectors, he adds.

“The key issue is whether government funding is being channelled into the right companies rather than shell companies. China’s economy is transitioning from a manufacturing-based one to a service-based one, and it is still growing. The services and higher value-added sector would need money to grow. And if the government is putting money in the right sectors and companies, it does not really matter if the debt is high,” says Lim. 

Within the Asian equity space, he is bullish on Indonesia’s property sector. He says Indonesian President Joko Widodo (better known as Jokowi) has made advancements in implementing the country’s infrastructure projects. Under his leadership, the government passed its new Tax Amnesty Bill on June 28, aimed at repatriating overseas money to fund the country’s infrastructure projects while keeping the budget deficit under 3% of GDP. 

The bill is expected to bring IDR560 trillion (RM173.5 billion) of undeclared income from abroad, with 30% or IDR165 trillion going to the government’s coffers, according to a Bloomberg report. After the bill was passed, the rupiah strengthened and the Jakarta Composite Index rallied.

Lim says Indonesia’s property sector is expected to benefit from the bill as the wealthy who come clean with their income are expected to diversify their investments and put their money into properties. This also means banks will have more liquidity, which could lead to lower mortgage rates and give its property market a boost. “But this is a multi-year trend that will need time to take off,” he adds.

Pacific Mutual Fund Bhd CEO and executive director Teh Chi-cheun says fund managers also like Chinese technology and insurance companies as they are good proxy for the growing private wealth and consumption of consumers in the country. 

“Tech companies have been doing well in recent years. However, those focusing on software that interacts with consumers tend to perform better than companies focusing on hardware, such as smartphones. 

Teh says the second-quarter results of Facebook Inc and Apple Inc released last month are an example. Facebook’s earnings surged to more than US$2 billion, up 186% from the same period last year. Apple, on the other hand, saw its earnings fall 15% on the back of iPhone sales in China dropping 26%.

China’s insurance sector is expected to ride the increasing affluence of consumers, says Teh. “Chinese wealth is growing. Due to the previous one-child policy, Chinese parents would insure their only child to make sure he was protected. And when grown up, their child would insure his parents as he would be the only one to take care of their medical expenses. The insured amount increases as the wealth of the Chinese people grows. We will also see more insurance policies purchased by parents as China has implemented a two-child policy.” 

Meanwhile, Lim says the Philippine property sector looks attractive under the leadership of newly elected President Rodrigo Duterte. Infrastructure spending, which was key to boosting its economy under the previous government, is expected to be increased and implemented more thoroughly under Duterte, says Lim. 

“[Benigno] Aquino had fallen substantially behind in terms of infrastructure spending in the last two years of his tenure as president. Duterte is believed to have a higher chance of success,” he adds. 

Last month, Duterte’s administration announced that it would hike infrastructure expenditure to 7% of the country’s GDP over the next six years, up 2% from the previous administration under Aquino.

Lim says real estate companies will be beneficiaries as infrastructure will increase land values as more townships are built. The strong consumption of the Philippines, contributed by money remitted from overseas, will see property sales increase steadily in the long run.

 

Bullish on US equities and Asian high-yield bonds

US equities, despite their valuations looking quite stretched at the moment, remain one of Menon’s favourites. He says this is because they have outperformed equities in Europe, Japan and Asia ex-Japan year to date. And they are expected to continue outperforming the equities of other regions as the country’s economic fundamentals remain intact. 

Also, the US unemployment rate is still below 5%, wages are rising, consumer spending is growing stronger and banks’ lending is at healthy levels. As at Aug 1, US stocks were trading at a price-earnings ratio of about 20 times.

“PE ratios are still quite high. But if you look globally, US [equities] are the only good house in the neighbourhood. They are doing relatively well despite being expensive. And investment is all about relativity,” says Menon.

He also says US equities act as the safe haven for the global stock market. Investors tend to flock to the US stock markets in search of a certain degree of safety, which will drive up US share prices. “If you take the view that in the next six to nine months, there will be uncertainties in the global economy, the US stock market will hold up well,” he adds.

Menon says that in general, growth stocks will have limited upside under a low growth, low interest rate environment. Investors should enhance their returns by allocating more money to dividend-yielding stocks and bonds.

Within the bond universe, investors can consider Asian high-yield bonds because they provide investors with higher returns and have a shorter maturity date of four to five years. Investors can hold on to the bonds until they mature and receive their face value while enjoying steady returns over the years.

“Asian high-yield bonds will continue to be sought after around the globe as investors are looking for ways to put their money to work,” says Menon, adding that those who invest in these bonds have to be very careful when assessing the issuers’ financial status and not be carried away by the higher yield rates.

“Investors should not just look at the 6% to 7% yield and buy into them. It is more important to look into the company, the industry it is in and the risks involved. There are also financial parameters that investors should look at, such as interest coverage ratio and cash flow,” he says. 

 

‘Monitor Europe’s politics over the next 12 months’

Vasu Menon, vice-president and senior investment strategist at OCBC Singapore, says the bank underweights European equities owing to the political risks that have yet to unfold. 

Since the Brexit vote in June, there have been serious concerns in the market about whether the fallout will turn out to be politically contagious and cause the European Union to crumble and send the global economy into turmoil. Menon says investors should keep a close watch on political events in the EU over the next 12 months.

“The biggest concern is the political risks Brexit poses to the EU rather than financial risks. Theresa May has just become prime minister of the UK. This is chapter one of the whole [EU] saga. There are many chapters ahead,” he points out.

“The future of the EU is the main concern of the markets. On the surface, all EU leaders are very united. But if you look at the underlying sentiment of the people, you do not get a sense of unity.”

Menon says the impact of this event on the global economy is going to be gradual, unlike the Lehman Brothers collapse in 2008, which sent shockwaves across the global economy. “It is going to be a slow process. I think investors should keep an eye on what is happening in the EU, especially the political contagion from Brexit,” he adds. 

According to Menon, the “EU saga” will start in Hungary in October as its government has issues with the EU over refugees. “The Hungarian government sealed its borders when refugees [from war-torn countries] flooded into Eastern Europe last year. This is despite the EU urging them to take in refugees,” he says. 

The EU later proposed to implement a quota system so that Hungary would accept migrants. In response, the Hungarian government initiated a referendum which will be held in October.

The Italians are also unhappy with the EU and a constitutional referendum is expected to be held in November. Prime Minister Matteo Renzi has announced that he will step down if the referendum does not go through. Italians who vote against the referendum could then vote for the anti-establishment “Eurosceptic” Five Star Movement in the next general election, giving the party a chance to rise. 

Menon says the aim of the constitutional referendum is to get the consent of the Italian people to streamline its political system. But the voters may not take it as it is. Italians might vote against the referendum to express their unhappiness with the EU. 

“The general feeling is that the Italians will vote against the reform and its president will have to step down as he announced. It is not so much because they oppose the reform, but rather they want to vote against the EU. This is because the EU has stopped the Italian government from bailing out their debt-laden banks, which would impact many of the banks’ bondholders if the banks go bust. And many of the bondholders are the Italian people,” he says. 

Menon says general elections in the Netherlands and France next year will cast more uncertainties on the stability of the EU. Anti-establishment parties in both countries — Party for Freedom in the Netherlands and National Front Party in France — are already creating headwinds in their respective countries, he adds.

“The French election in April next year is the big one. Marine Le Pen — the leader of the National Front Party, a right winger and an anti-EU representative — says she will call for a referendum to vote against the EU if her party wins the election,” says Menon.

The National Front Party surprised the world in December last year by garnering 27.73% of votes in the country’s regional elections. This compares with the 9.17% the party received during the elections in 2010, according to Le Pen’s announcement after the election in 2013. 

Germany’s general election in September next year will also be the focus of the market as Angela Merkel is not only the chancellor of Germany but also the de facto leader of the EU. Menon says any changes to her position would change the face of the EU.

“She is a major driving force. She is like the EU itself. There is less risk in Germany, but the market will still be a worry if her party loses the election,” he adds.

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