Bulls agree that a US-led global slowdown is underway and this is confirmed by a turn in global leading indicators. Profit growth is slowing and analysts are being forced to reduce their earnings expectations. After all, one cannot expect global leading indicators to rise indefinitely, right? A global soft-landing means that this should take place in a measured fashion. Bulls further argue that inflationary pressures are moderating which allows the Federal Reserve to be more accommodative from a monetary perspective. In this environment, equities tend to outperform due to multiple expansion.
The bears will argue that the slowdown in the US housing market and the problems brewing in the sub-prime sector will inevitably tip the US into a recession, which will be bad for emerging markets. However, we remain convinced Asian bulls, as the evidence seems to us to remain compelling for a positive outlook.
The arguments for the long-term re-rating of Asian equities are driven by a structural change in Asian growth. The trend towards global outsourcing is continuing and Asia is now moving to higher value-added products such as machinery and electronics. European companies lag their US peers in this regard and are accelerating their outsourcing programs to remain competitive. Asian investment spending is rising as infrastructure and capacity are in desperate need of upgrading. As the wealth effects of rising exports and investment filters down to individuals, consumption will gain a greater share of output. Long-term risk premiums should reduce as Asia’s macroeconomic balances look very healthy with current account surpluses, low inflation and pressure on currencies to appreciate.
Growth is surprising positively in Europe, Japan and Asia. We do not expect the weakness in the US sub-prime market to spread to the broader economy. Asian corporate earnings are still being revised upwards. Valuations look attractive not only because Asia trades at an 8 per cent discount to global equities (despite the superior earnings growth), but also as Asian valuations look cheap compared to historic valuations. From a quality perspective, Asian companies are reporting rising returns on equity through better profit margins and improving asset utilisation. There is further upside to returns through more efficient balance sheet gearing.
Greg Kuhnert, manager of Investec Asset Management’s Asian Equity Fund.
