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Emerging markets and Asian equities outlook The cycle is favorable, we’ve only just begun

By Geoffrey Wong,
Head of Global Emerging Markets and Asia Pacific Equities, UBS Asset Management

Investors continue to watch US President Trump closely for how his campaign rhetoric around protectionism and antiglobalization will unfold. These policy uncertainties, including trade frictions and a stronger USD, pose risks to emerging markets (EM) assets. However, a policy mix favorable for global growth should not derail the momentum in EM. Meanwhile, we see increasing signs that the economic cycle is turning favorable for EM and Asia and we believe we’ve only just begun on this cycle as typical economic upswings and downturns last five to seven years (see Chart 1). Most major indicators suggest that EM and Asian economies have stabilized and bottomed including improving current account balances, increased competitiveness on the back of lower real wage growth, more sustainable credit growth in most countries except notably in China, and the bottoming out of commodity prices. This has led to some stabilization of earnings revisions.

Examining the countries, we believe the rapid increase of debt in China is a long-term risk and see low likelihood of a near-term crisis. China’s economy seems to have stabilized, as it rebalances from an investment-led to a services-led economy.

Geoffrey Wong

Geoffrey Wong is Head of Global Emerging Markets and Asia Pacific Equities with overall responsibility for all Asian, Japanese and Australian equity teams, strategies and research. Geoffrey joined UBS in 1997. He also served on the board of directors of the Singapore Exchange, the combined stock and futures exchange of Singapore between 2003 and 2006.

The quality of growth and cash flows should improve over time as China implements reforms to address issues such as problematic debt levels and overcapacity in state-owned enterprises. These significant changes in the economic structure are providing investment opportunities especially within the services sectors, such as e-commerce, social media, education and insurance.

In India, we believe that the Modi government will continue to focus on removing bottlenecks and pushing through calibrated reforms to revive investments for sustained growth in the medium term. India’s demonetization move now looks more like a ripple than a storm. During our team’s recent trip to India to assess the impact of demonetization, it seemed no longer as big an issue as the media had made it out to be. Consensus opinion seemed to confirm an immediate and significant hit to businesses (due to reduced cash based transactions) but also that this was rapidly normalizing to varying degrees across sectors. Although demonetization might not have fully achieved its stated objective of reducing corruption by squeezing the informal/black economy and moving much of this to the formal economy, it has had some success, especially when seen in conjunction with other inter-connected initiatives such as the implementation of GST, the move towards digitization of transactions and processes and a proactive IT enforcement of tax evaders.

Chart 1: Cycle is turning, should drive market returns

Typically each cycle lasts 5-7 years. Economics usually ”Trumps” politics

Chart 1: Emerging Markets vs Developed Markets
Bull

Bull

  • The economic cycle in EM has bottomed: Imbalances are generally being corrected, economic data is ticking up
  • EM and Asian equities are starting the cycle from reasonable valuations, particularly compared to other asset classes
Bear

Bear

  • If protectionist policies are overdone, the global economy and subsequently EM and Asian equities could be negatively affected
  • Continued rapid USD appreciation

South-East Asia has favorable secular domestic growth drivers and credit growth has moderated significantly in the region. While the Thai King’s death brought near term concerns about reduced consumption and infrastructure spending, sales appear to start normalizing. We continue to view Thailand as a low risk economy with a large current account surplus, low public debt, low inflation and a strong banking system.

In Korea, politics remain an overhang but our bottomup research finds several businesses with solid long-term growth prospects trading at attractive valuations.

We are still watching for more clarity about Trump’s policies or the extent to which they can be implemented. Meanwhile, the economic cycle is turning and earnings are improving. We expect fundamentals of this asset class to reassert themselves over time, and view EM and Asian equities as an attractive long term proposition at current valuations, with Asia ex Japan equities trading at 1.5x price-to book as of end- February, below their historical average, and below most developed markets (DM) (see Chart 2).

Chart 2: Valuations are attractive

Valuations in EM & Asia are below average and below valuations in DM

Index P/B (31 January 1997 – 28 February 2017)

Chart 2: Valuations in Emerging Markets and Asian equities