APAC Issue 10 2018

18 APAC / Issue 10 2018 , 1. Chinese stocks, (A-shares in particular) have been weak since January with CSI Index down 18% The weakness of Chinese stocks since January can be explained in large part by three factors: first, escalation of the US-China trade conflict. While the market initially tended to believe the conflict would be resolved through negotiation, the confirmation of the first wave of tariffs on imports from China on 7th June came as a negative surprise and dragged the market down. Second, continued financial tightening. China has engaged in financial deleveraging since late 2016, notably reducing the volume of “shadow” credit. This deleveraging has impacted liquidity, which in turn has depressed domestic A-shares. Third, signs of growth slowdown, with macro data showing signs of slowdown from May onwards. The financial deleveraging mentioned above also impacted infrastructure investment; mid/ small cap companies’ spending was most seriously affected. 2.The MSCI Asia ex Japan Index is down 15% from its high in January. Do we see the beginning of a bear market in the entire region? Nomura’s Min Feng on The Asian Ex Japan Market The falls in the index seem even steeper when seen in the context of a strong start to the year – in January the index was up 8%! Looking forward, we feel that some caution is warranted. Trade tensions remain a headwind, and the strong USD and possibility of a further slowdown in China are risks that cannot be entirely discounted. Whilst we are cautious, we are not bearish. Earnings growth in the region remains solid with about 10% growth expected for this year. Governments in the region have plenty of room for policy adjustment to support their economies if required and the Chinese government has recently announced policy easing. Valuations have improved with the correction – the price to book ratio of 1.5 on average across the region represents a 20% discount relative to the MSCI World Index. On balance, we would say that we are at an attractive entry point for long term investors. 3. Recently there has also been a strong outflow of funds from emerging markets. How sustainable is this trend? Some emerging markets have been heavily sold this year, with rising financing costs and the strong US dollar sparking investor concern. Argentina and Turkey have been two countries badly hit. Again, the key risks of further trade tension, US dollar strength and further rate hikes could cause this trend to continue. However, the consensus amongst global portfolios has been to underweight emerging markets as a whole. With valuations so compelling relative to other markets, there is room for investors to add. It is worth adding that, within emerging markets, the relatively solid macroeconomic fundamentals of Asian countries, combined with a lower vulnerability to external financial conditions, make us more positive for Asian emerging markets than other emerging regions. 4.The Nomura Asia High Conviction Fund overweights the IT and financial services sectors at present. Financials remains our key overweight sector primarily because it is one of the few beneficiaries of increasing interest rates. We overweight selected bank and insurance names across different countries. We also like the Indian private bank sector, which has continuously expanded its reach and delivered high profitability as well as earnings growth over years. Min Feng, CIIA, CEFA, Senior Investment Specialist, Nomura AssetManagement Deutschland talks us through the Asianmarketplace currently. Within the IT sector the portfolio is focused in selected internet companies that display high earnings growth. The technology hardware sector is another focus for investment; we find names with very strong cash flow generation in addition to healthy earnings growth. 5. Other sectors are heavily underweighted (e.g. consumer staples, energy, utilities, telecoms).What are the weaknesses of these sectors? We have underweight traditionally defensive sectors such as telecoms, utilities and consumer staples. The key reason is their relatively low earnings growth. The healthcare sector is another underweight. That sector does display high earnings growth but valuations became stretched after a good run in 2017. After the recent market correction, we are re-examining a number of names in the sector. The energy sector includes a number of large state owned enterprises which are strong influenced by government policy. These are companies we choose to underweight. 6.What is currently dominant in the Asia-Pacific region: opportunities or risks?