The Asian equity market continues to rise, exceeding by over 50% the lows it touched in 2016. So far this year, the MSCI Asia Pacific Ex Japan index surpasses the S & P 500 by more than 21%, while the renminbi appreciated 6% against the dollar, is it still a good time to enter this asset class if you missed the rally? Josh Crabb, Head of Asian equities for Old Mutual Global Investors, thinks so.
During the OMGI Global Markets Forum in Boston, the Lead Manager for the Old Mutual Asian Equity Income and Old Mutual Pacific Equity funds reviewed potential threats to this asset class, their valuations, and the likelihood of a positive return in the next 12 months, along with the issues that are the main alpha generators in their portfolios.
What should concern the Asian equity investor?
In recent weeks, rising tensions between the United States and North Korea have created a lot of noise in the markets. According to Crabb, it should not be something that worries investors too much, because it estimates a 99% probability that nothing happens and only 1% that something truly bad happens that entails a 100% drop in the markets. Multiplying probabilities, this only represents a 1% impact on the markets.
“If we look back in history and review other events which were much more extreme, such as the Cuban missile crisis, with two powers which were more equipped and with a much worse possible final result, we can see that the market only moved between 3 % and 4%. If, as investors, this issue genuinely concerns us, and without this comment being meant as advice, the solution would be to buy put options on the Kospi (Korea Stock Exchange Index) index, which are “out of the money” and whose expiration date is long-term, this strategy will pay better than leaving some extra cash in the portfolio.”
The spectacular rally experienced by this asset class since last year to date has made some investors think that they are late for the party, but it’s still a good time to enter if you take into account the valuations in terms of the price /book value rate: “If investors had entered to buy in February 2016, when the price / book rate was 1.2 times, they would have obtained, with 100% probability, a positive return in the next 12 months, according to historical data of this asset class for the last 20 years. At present, the market stands at a rate of 1.7 times, at some distance from the lows, but still with a very favorable outlook, with a probability of obtaining positive returns around 70% to 80%. Right now it’s one of the cheapest asset classes and it’s still a good time to invest, with a good chance of making a profit.”
Another common concern is how Asian equities will react to potential interest rate hikes by the US Federal Reserve. The base scenario many investors anticipate is that if there is a new rate hike due to rising inflationary pressures, the dollar will appreciate, impacting negatively on commodity prices, emerging markets and in particular in Asia. Which is something that, according to Crabb, should not necessarily occur. To explain his vision, the Old Mutual manager goes back to the period between 2003 and 2007 to contrast the behavior of the dollar, as measured by the DXY (US Dollar Index), and the Asian equities under a restrictive cycle by the Fed : “While the American market was recovering from the technological bubble, Asian market rates were at low levels for a number of reasons: qualitative easing measures in Thailand, terrorist attacks on Indonesian discos, SARS disease, prices of real estate in Hong Kong were at half their current value and the economy was weak. When the Federal Reserve began to raise rates, the dollar began to appreciate at first to then depreciate, but the stock market continued to rise throughout the cycle. It is not until the Federal Reserve begins to lower rates that the MSCI Asia ex Japan index begins to fall. If we go back to the current cycle and review what happened so far, we can see that the dollar started its rally in anticipation of the Fed rate hike and Asian equities began to get better returns. The dollar has already begun to depreciate, but Asian markets continue to rise.”
Crabb also argues that now that global conditions seem to improve, with China and Europe offering attractive valuations and greater economic strength, investors will begin to allocate more resources to these asset classes.
What is the correct approach to positioning in Asian equities?
When investors think of the next economic crisis, they refer back to the 2009 crisis. Although, according to Josh Crabb, the next crisis is likely to look more like the 2000 crisis, in spite of the fact that the S&P 500 fell quite a lot, many value stocks rose in absolute terms. In this way, the asset manager seeks exposure to companies expected to have a great growth because their market is going to have great growth. At present, there are five trends that the manager is considering as the main alpha drivers of the portfolio: Indian infrastructure, frontier markets, pollution in China, the Internet of Things (IOT) and artificial intelligence (AI).
Beginning with companies linked to the internet of things and artificial intelligence, Crabb emphasizes the irruption in homes of new products that will represent a revolution in the same scale that the mobile phone represented in its day. “Most of those present will have heard of Amazon Echo and Google Home. The previous week I was in Europe and basically nobody knew these products, or the fact that Microsoft, Alibaba, Samsung and a good number of companies are in the process of launching their own versions of these products that will completely change the way in which people interact. These devices allow you to connect every household appliance in the house using voice as a command. This will lead to a cycle of mass product proliferation that we can benefit from by participating in companies of a relatively small size in terms of market capitalization today.”
As an example, the asset manager mentions Primax Electronics, a Thai company that specializes in manufacturing microphones that are able to identify voices, used by Google home and Amazon Echo. While the valuation of the company measured as a P/E ratio is about 10.5 times, that of Alibaba is around 50 times. “When we think that this product has not yet reached Latin America, Asia or Europe and how many people will have it in a short period of time. We can see it’s a fantastic opportunity. In addition, this technology will be integrated into televisions, light systems, door bells and sprinklers. This reasoning can also extend to manufacturers of sensors, camera lenses and other products whose companies show cheap valuations and massive potential growth.”
Finally, Crabb mentions the issue of pollution in China, noting that those highly polluting companies, such as steel manufacturers that are not complying with environmental regulation or paying their taxes, will have to close in the not very distant future, deriving their production to those companies which are complying. “The population in China has reached a socioeconomic level which is high enough to start worrying about pollution. This is why the creation of job positions is no longer a priority, and they are beginning to give more importance to steel manufacturing companies that respect the rules, that create quality standards and that in the future will gain the extra volume lost by companies which fail to comply “.