THE global hunt for yields has seen Asian bond and equity markets rising more than 20% since the lows of January and February.

BlackRock Asset Management North Asia Ltd director and lead strategist Jonathan Reoch, who actively manages US$8 billion worth of Asian funds, believes that a benign policy environment and repricing of risks in the developed markets will give Asian equities a better second half.

“We reached an important tipping point in January and February this year, where faith in policymakers and global growth was probably at a five-year low. However, there was an important coming together when the G20 finance ministers and central bank governors met in Shanghai in February and we have seen more alignment and proactive stances in the major central banks and governments,” he tells The Edge.

“Investors went through the transition post the global financial crisis, when quantitative easing (QE) had been the biggest driver of returns in the developed markets. Asia has not really benefited from that. In fact, it has been a victim of QE. Clearly, QE stabilised growth in the developed markets but it just led to more pressures on Asia, that is, elevated lending cycles and rising debt levels, as well as the need to defend [the] currency when [the] rate is raised in the US.

“But that period is over. We are now moving to a new policy environment that combines fiscal and monetary policies, in which Asia will be a relative beneficiary. We think this policy environment is fantastic for Asia — you see an end in the strengthening of the US dollar, which means investors are embracing Asian equities again. We at BlackRock certainly think Asian equities are undervalued and under-owned,” says Reoch.

Dovish Fed to dominate

“While the US rate hike was a massive destabiliser for Asia, we think that slow-rising US rates is likely the base case. The expectations on the US Fed rate hike are changing on a monthly basis and we have seen massive oscillation and volatility in terms of the market-implied probabilities of a US rate hike. But our view is that the US Federal Reserve (Fed) is in no hurry to raise rates. While the US is moving towards full employment, I think the Fed is more than happy to let inflation move closer to its target before it starts to raise rates, says Reoch. (See Chart 1.)

“Asia has, for two years now, had this black cloud hanging over it. We had one last December when the US Fed tested the waters. Asia survived that. I think from here, the key thing to watch is the US dollar rather than the threat of rising US rates (see Chart 2). Our view at BlackRock is that the US Fed will take its time to raise interest rates. As long as the US is raising rates for the right reason and economic growth is expanding, that does not mean Asian markets are derailing.”

European banks are key risks

“When we look at the risks out there, I think the key ones are the eurozone’s political and banking system risks. The political temperature is rising and Brexit is a perfect example of that. More volatility from the upcoming US election is expected and needs to be closely watched. How Europe deals with the fallout post-Brexit is certainly an event to monitor. That could lead to increased tensions, which could have a spillover effect on not just the eurozone economy but the financial system as well,” says Reoch.

“Italian banks are seen as one of the weakest links in the chain (see Chart 3). You can see that around Brexit. It wasn’t the UK stocks that suffered the biggest decline. It’s more about the eurozone financial system, which remains a contagion risk for global financial markets. Although the European Central Bank has conducted more stress tests and the Italian banks have raised capital, it’s a risk that investors need to be aware of.”

Asia — a safe haven

“Ironically, Asia has become the safe haven in this environment. If you look at what happened in the past three or four months, Asian markets have gone up 23% from the low in January. That, in technical terms, is a bull market. I think that reflects not just the recognition that Asia has been ignored for a while but you are seeing a repricing of political risks in the developed markets — whereas in Asia, political risks have already been priced in,” Reoch says.

“There have been some spillover effects on Asian equities as well (see Chart 4). In some equity markets, you’ve still got dividend yields that are well above the prevailing risk-free rates. Asian companies are also embracing in this hunt for yields and actively promoting their abilities to pay dividends. For any global investors, Asia — from both the credit and equity perspectives — is a great place to look for yields.

“For the rally to continue, Asia needs to generate some growth. We think Asia is definitely capable of posting economic growth — double that of developed markets — in the next five to ten years. You’ve still got economies that are at very early stages of development. You see reforms come through in some of the important markets such as India, Indonesia and China,” he adds.

Overweight materials, energy and banks

“For us at BlackRock, even though the macro drivers are important, we are very much a bottom-up stock picker. From this perspective, we are beginning to look more at opportunities in sectors that have been out of favour, such as materials, energy and, potentially, financials as well, especially if we get some inflation back into the system.

“For bottom-up investors, it’s about relative valuation and whether companies can meet earnings forecasts. And we would say that there are more risks with defensive companies not meeting their forecasts vis-à-vis cyclicals failing to meet very low expectations. That’s very much where our focus has been on,” says Reoch.

“In the past five years, a lot of investors in Asia just gravitated towards the highest-quality exposure they could find in defensives. That’s why you see defensive stocks in Asia trading at massive premiums to the more cyclical stocks. I think the new policy environment is causing investors to question that. That’s why you saw cyclicals outperforming defensives in the past few months.” (see Charts 5 and 6.)

“The last five years have been a very difficult time for cyclicals with persistent downgrades in both earnings and valuation. Some of these stocks are trading below the lows seen during the global financial crisis, whereas defensives are trading at a massive premium to their historical valuations. That’s a massive stretch that we at BlackRock have identified for the past six or nine months, which guides our way of investing.

“And we see good opportunities in some of these cyclicals. But they have got to come with catalysts — it can’t be just cheap cyclicals. In China, we have seen some supply-side reforms that triggered certain cyclical sectors coming back into favour, such as paper and steel. We spent a lot of time looking at Indonesian banks as well because we think the non-performing loan cycle there is beginning to fade, which is generally the perfect time to invest in banks.

“There are also signs that non-performing loan ratios are beginning to peak in Thailand and Indonesia. The banking sector across Asean — [comprising] mainly private banks with professional management — is well managed and has a lower debt level compared with the Indian and Chinese state-owned banks. Moreover, default rates in Asia are actually dropping compared with those of developed markets, which are rising. This is one of the key factors to back up our thesis that Asia has become the safe haven.”

Malaysia not attractive enough

“Malaysia has a story of resilience and the government has been proactive in terms of balancing monetary and fiscal policies. Bank Negara (Malaysia) has steered the economy through some difficult times in the past year. I think it did a very good job, not panicking at that time. And investors were probably looking to see what Malaysia would do in that environment. From a macro perspective, we still see Malaysia growing at around 4%, which is pretty good in a global context.

“However, as an investor, we sometimes find it quite hard to see how that growth translate into good company earnings in the stock market. In terms of valuation, we find it [Malaysia] quite an expensive market relative to the other regional markets, probably reflecting its strong pension system and strong ownership of the stock market. That does tend to mean that you don’t get the big opportunities as you do in Indonesia, which relies much more on foreign fund flows,” says Reoch.

“When we go stock by stock and sector by sector, we find that certain stocks in sectors — such as telecommunications and healthcare — just can’t justify their valuations. But there are pockets of opportunities. We certainly think that the infrastructure story here is quite attractive and financials at certain points look attractive as well. We always have a keen eye on Malaysia, but for the moment, we think Indonesia and Thailand offer better opportunities,” he concludes.

With assets under management of US$4.9 trillion, US-listed BlackRock is the largest asset management firm in the world. In Malaysia, BlackRock is the target fund manager of AmInvestment Services Bhd, with feeder fund AmAsia Pacific Equity Income fund vested in BlackRock funds. 

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