It Could Be a Different Story for Asian Equities in the Second Half

Asian equities are set to get a leg up from some positive catalysts in the second half of the year. Possible easing of China’s zero-Covid strategy and the rollout of policy stimulus there, plus the US Federal Reserve turning less hawkish if growth slows and inflation moderates, will likely support Asian markets. Our base case target for the MSCI Asia ex-Japan index calls for mid-teens returns by end of 2022.

In the first half of 2022, Asian stocks came under selling pressure due to growing inflation risks, monetary policy tightening by the Fed, China’s efforts to rein in local Covid-19 outbreaks, and the Russia-Ukraine conflict. These concerns are likely to persist in the immediate near term as uncertainties remain over where global growth is headed.

While valuations have de-rated significantly reflecting these risks, there is a risk of earnings downgrades. The extent of these downgrades would depend on China’s approach to contain the pandemic, and whether there is a hard or soft landing in the US beyond 2022 – a question that is unlikely to be settled soon.

Asia will likely see some volatility if the US markets are weak because of concerns around high inflation and a hawkish Fed. But we expect Asian equities to be more immune in a scenario of continued weakness in US stocks.

There are several buffers. First, Asian equities’ valuations are modest in absolute and relative terms. Second, earnings in Asia will still grow in line with nominal GDP growth rates in 2022 and 2023. Third, Asian company balance sheets are generally healthy, and that gives them the ability to support share prices in the form of sustaining dividends and/or embarking on buybacks. Fourth, global investors’ allocations to emerging markets and Asian equities are generally low by historical standards.

The sectors we favor include emerging markets Asia financials (ex-China), companies with domestic Asia exposure, reopening plays, especially in ASEAN, and corporates with strong balance sheets – especially those that offer dividend growth and provide a good inflation-hedging strategy.

Risks from higher commodity prices such as energy and metals are already factored into stock prices. We’d be watching how higher prices of agricultural commodities and food security risks impact Asian stocks.

Some markets or economies will be more vulnerable to higher agricultural commodities and energy prices. India, Thailand and Philippines could be most affected, while Indonesia and Malaysia would be more immune, as they are net commodity exporters.

China

While investors are currently underweight China, precedent from other countries shows they are underestimating the scope for recovery into the second half and beyond. If we believe the current growth estimates, China is the cheapest market in the region on price-to-earnings growth ratio. Almost 100% of revenues from all companies in the MSCI China index are domestic. With economic growth slowing down in China, there isn’t much they can do about the domestic demand situation, but some of these companies have been embarking on share buybacks and announcing special dividends to alleviate some of the macro concerns. Unlike other markets in Asia, Chinese stocks are mainly held by local retail investors, so from a social cohesion standpoint, how these stocks perform is important to the Chinese authorities.

Japan

Despite the ongoing tug-of-war between rising costs and the recovery in demand, Japanese companies’ recurring profits are expected to rise by double digits this financial year, higher than the pre-pandemic five-year recurring profit CAGR of 4.7%. Key positives going for Japanese stocks are that company-issued forward guidance for earnings this financial year have come in looking more bullish than macro-level data had suggested. A string of share buybacks announced by companies is also indicative of corporate confidence in the outlook for earnings. Recovery in demand as the economy reopens, high commodity prices, the ability to withstand inflation, and new technologies and businesses as well as innovation will be key considerations in our analyses of each sector.

South Korea

Having declined by 20% from its peak in July 2021 despite strong 1Q earnings this year, the KOSPI will likely trade in a wide range over the next 12 months. We are relatively optimistic on sectors such as semiconductors, those with secular growth, such as renewable energy, and those recovering from supply disruptions, such as automobiles. However, there are sectors that reflect excessive optimism and are expensive, in our view, and sectors such as TV, large size display, internet and gaming that will likely be negatively impacted from the reopening.

India

We see downward pressure on earnings from slower top-line growth at companies due to slower demand as the Indian economy faces risks including higher oil prices and a global growth slowdown. But lower input costs and higher-than-estimated consensus refining margins could negate the impact to an extent. The Indian market has corrected 11.5% from its peak in Oct 2021 and currently trades at 18.4x one-year-forward earnings. A correction to 16-18x remains a possibility. We prefer stocks with relatively high earnings visibility and valuation comfort, and those with domestic exposure that are less impacted by slowing global growth. In terms of sectors, we are positive on financials, infrastructure/industrials, and pharma, while we are cautious on consumption, particularly discretionary consumption, metals and cement.

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Yunosuke Ikeda, Chief Equity Strategist & Head of Macro Strategy, Japan, CW Chung, Head of Research, Korea and Pan-Asia Tech / Semiconductors, and Saion Mukherjee, Head of Equity Research, India, contributed to this article