Asian and Emerging Markets to Return 40% Over Next Two Years!

Transcription

1 Asian and Emerging Markets to Return 40% Over Next Two Years! In this article, we discuss why emerging markets, including Asia, are at an inflexion point for valuation re-rating and earnings upgrades. Based on this trend, we expect the PE of the Asian equity market to be re-rated to 16X over the next two years. We project Asian equities to offer a 40% upside by end of Asian And Emerging Markets Battered Over Past Few Years Asian and emerging markets saw de-ratings in terms of valuations over the past few years. This arose partly due to a downturn in commodity prices, including the collapse of international oil prices. The severe downturn, preceded by a decade-long commodities super-cycle, has hit emerging markets particularly hard. The S&P GSCI Index, which is a measure of commodity sector performance overtime, stood at USD 364 (as of 30 September 2016), down by -52% from its post-2008 global financial crisis peak at USD 760 in April 2011 (Chart 1). Copper, which peaked at USD 4.63 per pound in February 2011, is now trading at USD 2.21 per pound, while Brent crude oil, which peaked at USD 127 per barrel in April 2011, fell heftily to USD 49 per barrel. The collapse in commodity prices, including oil, has badly affected the terms of trade of resource-exporting emerging economies, as well as the earnings of emerging market producers. Chart 1: Commodities Prices Were Down 51% From Its Post-Crisis Peak

2 As of 30 September 2016, the PB ratio of emerging markets has contracted by about -26% since its post-2008 global financial crisis peak in May The main contributors to the overall PB compression in emerging markets were the valuation multiple contractions in some of the major countries within the emerging markets region. Commodity-driven markets, such as Russia and Brazil, were hit particularly hard. The PB ratios of the Russian and Brazilian equity markets have been down by -33% and -26% respectively from their post-crisis peak. 2. Poor Market Sentiment Due To Concerns Over China's Economy In addition, China's economic deceleration, as well as its transformation to a consumer-driven economy, pose major challenges to emerging and Asian markets. The economic slowdown has raised concerns that China's super-cycle may have come to an end; pessimists have even called for a hard-landing since years ago. Likewise, the anti-corruption drive, initiated by President Xi Jinping since , has also affected consumer consumption negatively. Emerging markets appeared to be highly exposed to the heightened volatility seen in China's stock markets during mid-2015 and early The CNY devaluation also shocked the already-fragile markets even further and sparked a widespread sell-off in emerging market assets. China's contribution to the market volatility and the downshift in global economic growth have fuelled pessimism in financial markets. The combination of these negative factors has caused investors' sentiment to be very negative over the past years. 3. Inflexion Point Reached As Commodity Prices Have Bottomed Out However, we believe that an inflexion point has been reached as the negative factors have begun to subside. This is because commodity prices seemed to have bottomed out at the beginning of this year, and have rebounded substantially since then. Commodity prices have been falling since 2011, but the pace of decline accelerated in 2014 due to the appreciation of hard currencies. Towards late-2015 and early-2016, commodity prices dipped further as market participants overreacted to the issues of disappointing global demand, high inventory levels and improved productive capacity that have created an imbalance between supply and demand in commodity markets. That said, we do not expect any further major downturns to take place in the near future. A stabilisation in commodity prices is highly beneficial to the countries that rely heavily on commodity exports. The earnings estimates of commodity-driven markets, especially EMEA (Europe, the Middle East and Africa) and Latin America, will be further revised upward, and these economies are likely to reap huge rewards from this trend. 4. No Hard-Landing As Worst Is Over For China's Economy China's economy has also felt the full negative impact of the downturn in commodity prices, together with a slowdown in consumer consumption. Recent economic indicators, however, have indicated some

3 stabilisation or even signs of improvement in the economy. While many foreign investors have been waiting for a meltdown of China's financial and property sector in the last few years, it did not materialise. It is noteworthy that the country's pursuit of a sustainable economic model may have contributed to a more volatile economic growth figure, especially on the manufacturing side. However, data related to domestic consumption remains robust, especially the contribution of the tertiary sector to economic growth, which has been gradually increasing after taking over the secondary sector as the biggest share of China's economy back in In addition, after contracting for fifty-five consecutive months, China's PPI (Producer Price Index) is expected to pick up by the end of this year. A negative PPI over prolonged periods will eat into industrial profits as profit margins come under sustained pressure. An easing of PPI deflation is a positive for corporate earnings, especially in the upstream sectors. In fact, profits of China's industrial corporations have regained momentum in the second half of this year, growing at its fastest pace in three years in August. These are evidence that the mainland's efforts to transform its economy towards a consumption-driven model is gathering steam, and that goes directly against the hard-landing call. 5. Asia And Emerging Markets To See Upward Re-Ratings In Valuations We believe emerging markets, including Asian markets, will see an upward re-rating in valuations over the next 1 2 years. Traditionally, emerging equity markets perform best as markets move from a period of substantial negative economic momentum to one whereby stock markets start to see some initial improvements in economic momentum. Over the past decade, emerging market equities have historically traded at 1.8X trailing book value. Today, they are trading at 1.5X PB. They were also trading close to a 35% discount relative to developed market equities in January this year, the largest since The discount has been narrowed to about 25% as of end-september Although the discount reflects the concerns and challenges faced by emerging markets, it is still way too excessive. Markets have not seemed to fully price in a reversal of the negative factors discussed above. As such, we believe that a buying opportunity is at hand as we see the potential for an upward re-rating in valuations of the region, which might still be overlooked by market participants. 6. Earnings Of Emerging Markets Poised For Upward Revisions Earnings revisions have also been on the downtrend over the last few years. Nevertheless, we believe that we are at an inflexion point, and earnings revisions will regain upward momentum over the next twelve months. Our bullish view for emerging markets is based on the base case that there will be a return of earnings growth in this region. Since peaking in 2011, the earnings of emerging markets have suffered from a five-year downgrade until June 2016, when we started to see upward revisions in earnings forecast. Improvements in earnings revision trends have been seen across emerging markets, with the earnings

4 revision ratios (upgrades minus downgrades divided by the total number of earnings estimates) of markets like Russia, Korea, Taiwan, Thailand and Indonesia turning positive over the past quarter. Emerging markets have underperformed developed markets by around 40% from its post-2008 global financial crisis peak in May The earnings of emerging markets have retreated after hitting the peak in 2011, while developed markets have delivered positive earnings growth since However, the situation is reversing as we have seen more upward revisions in earnings over in emerging markets than developed markets since June this year. 7. Huge Upside For Asian Equities By End-2018 We are bullish on the considerable upward re-rating potential of emerging markets, including Asia, over the next two years, which will lead to superior performance. Historically, low valuations (such as that of today) have generally been followed by strong positive returns over the subsequent 12 to 24-month period, triggered by a re-rating. In particular, we expect the PE ratio of Asian equity markets on aggregate (as represented by the MSCI Asia ex Japan Index) to be re-rated to 16X over the next two years. Coupled with reasonable levels of earnings forecast, we project Asian equities to offer a 40% upside by the end of Chart 2: 40% Upside In Asian Equities By End-2018

5 Table 1: PE And Earnings Growth Forecast For Asian Equities Index Estimated Earnings Growth Estimated PE MSCI Asia ex Japan -10.8% 12.2% 10.5% 14.3X 12.8X 11.6X Source: Bloomberg, ifast Compilations Data as of 6 October 2016 Chart 3: Potential Upside for Asia and Emerging Markets

6 Chart 4: Buying Asia and Emerging Markets at 14x PE or Less The Research Team is part of ifast Financial Pte Ltd. All materials and contents found in this Site are strictly for information purposes only and should not be considered as an offer, or solicitation, to deal in any of the funds or products found in this Site. While ifast Financial Pte Ltd ("IFPL") has tried to provide accurate and timely information, there may be inadvertent delays, omissions, technical or factual inaccuracies and typographical errors. Any opinion or estimate contained in this Site is made on a general basis and neither IFPL nor any of its servants or agents have given any consideration to nor have they or any of them made any investigation of the investment objective, financial situation or particular need of any user or reader, any specific person or group of persons. You should consider carefully if the products you are going to purchase into are suitable for your investment objective, investment experience, risk tolerance and other personal circumstances. If you are uncertain about the suitability of the investment product, please seek advice from a financial adviser, before making a decision to purchase the investment product. Past performance is not indicative of future performance. The prediction, projection or forecast is not necessarily indicative of the future or likely performance of the scheme. The value of the investment products and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice.