December 2016 16 Navigating Asian equities in 2017 With Christmas around the corner, it s almost the end of 2016. How would investors depict 2016? Surprised? Startled? Shocked? Few would argue that Trump s victory and Brexit are two of the biggest challenges in recent years to the global economic status quo, reminding us just how much of a roller coaster 2016 was. In the midst of heightened political risks in Europe and US, we believe in 2017 Asia equities still provide relative value in uncertainty, especially the potential to offer diversification benefits for global portfolios throughout a challenging 2017 global landscape. We hope you enjoy this issue of Monthly Macro View. Global market review after Trump wins 1 Despite a volatile 2016, overall equities are on the track to end the year higher: The MSCI Asia (ex- Japan) index gained 5.32% thus far in 2016, which was marginally higher than the MSCI World index s gain of 5.20% but lower than the MSCI Emerging Market index s gain of 9.25%. Fixed income, or bonds, turned into one of the most volatile markets post-election. The 10-year Treasury rose 57 basis points (bps) in less than a month from 1.88% on the day of the election (8 November) to a post-election high of 2.45% (1 December) 2. The rise in yields was mirrored by that of the US dollar: The US dollar (as measured by US Dollar Index), which had a see-saw year, surged roughly 3% on a trade-weighted basis after the US election, while the Japanese yen, traditionally a safe haven, fell more than 8%. Finally, crude oil (measured by West Texas Intermediate futures), which had hit lows in February, rose 10% shortly after the announcement in late November about cutting back output starting in January 2017. 2016: Asia Year in Review Positive market performance in Asia was due to myriad factors. A stable regional macroeconomic environment was one factor. China s economy ended 2016 on a stable note. Economic growth averaged 6.7% over the first three quarters, and long-awaited reflation of the economy emerged: the producer price index (PPI) turned positive for the first time in 55 months in September, and further rose to 3.3% in November (the highest reading for over 5 years), while most recently the purchasing 1 Source: Bloomberg, 7 December 2016. 2 Source: US Treasury data, as of 1 December 2016. 1
manager index (PMI) went further into expansionary territory for both services and manufacturing. Southeast Asian countries also continued to post stable growth: Vietnam, Indonesia and the Philippines are all forecast to post economic growth exceeding 5% for 2016. 3 Earnings in Asia have also improved over the past year: a stable growth environment, a supportive fiscal and monetary policy, falling real interest rates, and a rebound in commodity prices all contributed. The earnings revisions ratio (number of stocks upgraded versus downgraded) for Asia (ex-japan) and China both notably increased in 2016, with the earnings revisions ratio for China surpassing 1 (meaning more upward than downward revisions) 4. 2017: Opportunities arise in Asia amidst risk Based on current valuations and the potential diversification benefits for global investors, we view Asian equities as an attractive relative value play in 2017, particularly compared to developed markets. We believe Asia continues to promise steady robust economic growth, with a similar steady rate of growth in 2017 expected. The policy road map is clearer in Asia: e.g. reform continues in India, China is on track to transition from traditional to new economies with increasing domestic consumption. Asia presents potential opportunities as the price to earnings ratio is lower compared to developed markets in 2016, as the chart below shows. Figure 1: Asian equities offer relative value compared to developed markets Estimated P/E Ratio (MSCI Asia) Estimated P/E Ratio (MSCI World) 17 16 15 14 13 12 11 10 9 8 3 Source: The World Bank, http://www.worldbank.org/en/region/eap/publication/east-asia-pacific-economic-update. 4 Source: BofA Merrill Lynch, as of November 2016 2
However, this assessment is based on several assumptions on how the substantial uncertainty in 2017 will be navigated. The main uncertainty surrounds which policies President-elect Trump will adopt once in office. Although markets have rallied due to his pro-growth economic policies, such as tax reform and fiscal stimulus, it is unclear whether he will implement more populist policies. Europe will also face a challenging year with elections in France and Germany potentially deciding the future of the European project. We view increased volatility from these political events. Both North and South Asia present values Based on those assumptions, our base case scenario sees continued growth in Asia as fiscal stimulus boosts economic growth in the US. This should benefit Asian companies that compose the supply chain related to industries that would see an uptick in orders, which should benefit North Asian markets. Additionally, exporters that were sold off due to potential trade friction after Trump s election may be attractive at current valuation levels. As the year progresses and rate rise momentum begins to plateau, Southeast Asia should do well as the US dollar stabilizes and as events surrounding European elections begin to subside. For sectors, banks and properties should do better as rates normalize over 2017. Asia will also present opportunities in infrastructure and a shifting trade configuration, which will not likely be affected by changing trade flows. Asia provides diversification benefits From a global portfolio perspective, we believe Asian equities are well positioned to potentially provide diversification benefits for investors. Indeed, Asian equity markets are increasingly correlated with developments in China, a market that is driven more by domestic factors than international ones. A recent International Monetary Fund (IMF) Working Paper 5 found that the average correlation between Chinese equities and Asian equity markets has almost doubled since the time period before the Global Financial Crisis (GFC) (2001-2007); Asian FX markets have also increased their correlation to movements in the renminbi over the same time period. Asian equities and currencies correlation have strengthened with the US, although it has not changed since after the end of the GFC (Figure 2). 5 IMF Working Paper: China s Growing Influence on Asian Financial Markets. WP/16/173, available at: https://www.imf.org/external/pubs/ft/wp/2016/wp16173.pdf 3
Figure 2: Increasing Asian equities and FX correlations with China 6 One important channel for the correlation is trade exposure with China 7. In our view, this correlation is likely to strengthen over time as intra-regional economic ties deepen. Indeed, after President-elect Trump s statement that the US will quit the Transpacific Pacific Partnership (TPP) on his first day of office 8, regional trade integration efforts may consolidate around the Regional Comprehensive Economic Partnership (RCEP, viewed as an alternative to the TPP agreement). The RCEP is a Chinese-led initiative that consists of ASEAN and six other regional countries with which ASEAN has trade agreements with (see map below). The One-Belt-One- Road initiative will also rise in prominence this year as the Asian Infrastructure Bank (AIIB) has signed co-funding agreements with the World Bank and Asian Development Bank in 2016. 6 Source: IMF, April 2016 Regional Economic Outlook 7 https://www.imf.org/external/pubs/ft/wp/2016/wp16173.pdf 8 http://www.bbc.com/news/world-us-canada-38059623 4
But still under-owned Despite potential diversification benefits, Asia continues to be under-owned by global institutional investors due to numerous reasons which include home bias, lack of breadth and depth in the Asian capital markets, asymmetrical information, as well as policy and corporate governance risks. However, progress is being made on a number of these issues. Capital markets are deepening in a number of important markets. The Shanghai-Hong Kong Connect and Shenzhen Hong-Kong Connect, both approved in 2016, allow foreigners investors to purchase individual stocks in the A- share market without needing a Qualified Foreign Institutional Investor (QFII) license. Currently, Korea is going through once in a generation change in ownership, which will result in a corporate restructuring that will align the interests of the new generation of family owners with minority shareholders. This includes increasing dividend payments and efforts that focus on generating cash. Vietnam has announced a second wave of State Owned Enterprise privatization, and perhaps most importantly, eliminated the foreign investment ceiling for a state-owned dairy producer, allowing 100% foreign ownership for the first time 9. This may serve as a template for future liberalization efforts. Although political risks have been a concern for investors in Asia, the region may be relatively more attractive as risks in developed markets have notably increased with the events of 2016 and upcoming events in 2017. There is still more work to be done but these are moves in the right direction that should provide investors greater confidence in the region. In looking at a rough estimate of Asian investments, the level of economic output and institutional investors holdings globally may be one way to assess it. Indeed, Asian economies (East and South) 9 Wall Street Journal, 20 July 2016. 5
composed roughly 40% of global gross domestic product (GDP, in purchasing power parity) in 2015 (Figure 3). At the same time, a sample of pension funds from OECD countries only invested 7% of total assets in the region (Figure 4). Although not all markets in Asia are accessible to foreign investors and have the liquidity needed for large investments, the gap between Asia s economic contribution and level of investment suggests possible area for improvement. Figure 3: 2015 Global GDP divided by region, 2015 10 Rest of the world 26% Asia (East and South) 40% North America 17% European Union 17% Figure 4: Pension fund investments by region, 2015 11 Rest of the world 20% Asia (East and South) 7% North America 60% Europe 13% 10 Source: World Bank, 2015 PPP data (http://data.worldbank.org/indicator/ny.gdp.mktp.pp.cd) 11 Source: OECD 2015 Pension markets in focus 2015 6
Conclusion 2017, much like the past year, promises to be a year of surprises and opportunities in Asian markets: a new president will be inaugurated in the United States; critical elections will decide the future of Europe; and China s long-term economic transition will continue. Before navigating and exploring a dynamic 2017, we wish you all a very merry Christmas and a prosperous investment year ahead. Disclaimer Manulife Asset Management is the asset management division of Manulife Financial. This material, intended for the exclusive use by the recipients who are allowable to receive this document under the applicable laws and regulations of the relevant jurisdictions, was produced by and the opinions expressed are those of Manulife Asset Management as of the date of writing and are subject to change. The information and/or analysis contained in this material have been compiled or arrived at from sources believed to be reliable but Manulife Asset Management does not make any representation as to their accuracy, correctness, usefulness or completeness and does not accept liability for any loss arising from the use hereof or the information and/or analysis contained herein. Information about the portfolio s holdings, asset allocation, or country diversification is historical and is not an indication of future portfolio composition, which will vary. Neither Manulife Asset Management or its affiliates, nor any of their directors, officers or employees shall assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained herein. The information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline or other expectations, and is only as current as of the date indicated. There is no assurance that such events will occur, and may be significantly different than that shown here. The information in this material including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. This material was prepared solely for informational purposes and does not constitute a recommendation, professional advice, an off er, solicitation or an invitation by or on behalf of Manulife Asset Management to any person to buy or sell any security. This material should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any investment products or to adopt any investment strategy. Nothing in this material constitutes investment, legal, accounting or tax advice, or a representation that any investment or strategy is suitable or appropriate to your individual circumstances, or otherwise constitutes a personal recommendation to you. Past performance is not an indication of future results. Investment involves risk. Investors should not base on this material alone to make investment decisions and should read the offering document (if applicable) for details, including the risk factors, charges and features of any investment products. Proprietary Information Please note that this material must not be wholly or partially reproduced, distributed, circulated, disseminated, published or disclosed, in any form and for any purpose, to any third party without prior approval from Manulife Asset Management. This material is issued by Manulife Asset Management (Asia), a division of Manulife Asset Management (Hong Kong) Limited. This material has not been reviewed by the Securities and Futures Commission (SFC). 7
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