22nd November 2013
Equities investors have profited handsomely from the quantitative easing-driven flow of capital into markets. But once the taps are turned off will a more-sustainable period of economic growth become the next driver of equity markets?
Alastair Campbell, an international equity manager, with Kames Capital looks at the issue below.
In Asia we aim to exploit the theme of brighter global growth through opportunities in North Asia, especially smaller-cap and value stocks, where we can find them. The North Asian countries, such as China, Korea and Taiwan, have large industrial export sectors, some of which are listed on their respective stock-markets. The positive view on North Asia is predicated on the eventual ‘tapering’ of the US Federal Reserve’s bond-buying programme, which will begin when the Fed sees clear evidence of growth. To this end, Asian economic data has yet to show a consistent improvement in exports. Meanwhile, earnings revisions are weak and the third-quarter corporate results season has been fairly lacklustre.
At this point, Asian valuations are neither a support nor an obstacle to investing in equities: the critical factor is earnings momentum. Asia is currently the weakest global region in this regard. Merrill Lynch uses monthly consensus analysts’ figures to calculate a monthly earnings revision ratio – that is, the number of analyst upgrades to corporate earnings as a proportion of all revisions. For the Asia Pacific region the October ratio rose from 0.53 to 0.73, but that still means that there are only just over seven upgrades for every 10 downgrades. However, the earnings revision ratios of those countries in Asia that have seen most benefit from exceptionally low interest rates due to QE are now seeing deterioration. These countries are in South Asia, and the deterioration is most evident in Indonesia and Thailand. Meanwhile, the earnings revisions ratio in China has recently picked up, though Korea has yet to show signs of life. The North Asian countries are less reliant on foreign capital, with significant foreign exchange reserves supporting their currencies. In addition companies from the North Asian countries generally trade at discounts to those in South Asia and are less ‘loved’ than those from sunnier Southern climes.
While the US remains the key engine of global growth, the powerhouse of any Asian recovery will be China – still our favoured market in the region. Recent Chinese economic data, especially the encouraging 7.8% third-quarter GDP growth and October’s Purchasing Managers Index (‘PMI’) figure of 51.4, suggests that the economy is on the right track. The PMI is a forward indicator of economic strength which predicts that production growth in China will rise and that order momentum will remain robust. Policy making looks to be nudging the economy in the right direction, but of course long term structural weaknesses remain. Our Global Equity Fund is underweight the markets of South Asia that are vulnerable to ‘tapering’, but is overweight North Asia, mainly through China, which has positive domestic momentum and is exposed to accelerating global growth. The fund holds Industrial and Commercial Bank of China, Tencent, which is one of the world’s largest internet companies, and Vipshop, an online discount retailer for branded products.
From a global perspective, the postponement of tapering in the US has provided a brief fillip to the Asia Pacific region. But Asia will require a sustained improvement in earnings momentum to push its markets through the top of their current trading ranges. While international investors look forward to global liquidity developing into global growth, investors in Asia can also base their optimism over the tangible progress made in China and hope that the US recovery brings greater export demand.