Investors in Asia equities are learning lessons that students of Newtonian gravity, statistical mean reversion and Buddhist karma have known for centuries: what goes up, eventually comes down; and what goes around, eventually comes around. Having enjoyed blockbuster returns of more than 25% in 2020 (via the MSCI Asia ex-Japan Index), investors in Asia have had to content themselves with returns of –1.2% this year.
Therefore, having significantly underperformed, are Asia’s equity markets poised to spring back in 2022, as they did in 2020? Unfortunately not, in our view. Asia is still consolidating, repairing and normalising; and underlying economic and market conditions indicate a muted, if not challenging, outlook for regional markets in the year ahead.
Weak earnings momentum
As discussed in the previous week’s macro outlook, economic momentum in Asia will likely remain below trend over the near-term, as decelerating growth in China exerts a gravitational drag on the region and reduces growth in Asia ex-Japan to 5.9% in 2022 from 7.3% in 2021.
Asia’s muted macro outlook is also reflected in company earnings. Decelerating growth in North Asia — finally — is being reflected in earnings following some 14 months of upgrades inspired by Fifo (first in, first out). In other words, the post-pandemic, V-shaped bounce in earnings is now dissipating, with analysts now revising down their earnings estimates over the past three months. I think this is realistic.
In fact, the market’s projected 9% earnings growth for the MSCI Asia ex-Japan Index in 2022, based heavily on expectations of 16% earnings growth in China, appears optimistic — even unlikely — given the Chinese economy’s multifaceted difficulties.
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Additionally, as supply chains gradually repair and the memory chip cycle peaks, DRAM prices are expected to decline in the next few quarters, which should lead to an earnings contraction for South Korea in 2022 and weigh on the region more broadly. This was one of the motivating factors behind our decision to reduce our overweight allocation to South Korea equities in October.
Valuations reasonable but not cheap
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On a positive note, Asian equity markets are no longer expensive; declines in price have seen to that. However, it would be a stretch to say Asian markets are cheap. On an absolute basis, the MSCI Asia ex-Japan index still trades at one standard deviation above its 10-year historical average. However, relative to global equities, the region is trading one standard deviation below its historical average.
Nevertheless, we believe Asian equities are not cheap enough to warrant an aggressively bullish stance, given the confluence of macro headwinds, earning downgrades and policy risks. As such, in our view, valuations are unlikely to represent a meaningful buy catalyst for now.
Bearish technical outlook for Asia and China
Asia’s bearish outlook is also reflected in its technical chart setup, which continues to point to an underweight MSCI China Index and MSCI Asia ex-Japan Index, both in absolute terms and relative to the MSCI EM Index.
For example, our technical analyst colleagues warn that the MSCI China Index is at risk of heading lower with a potential bear triangle shape forming. Meanwhile, the setup is a little more positive for the MSCI Asia ex-Japan, with key absolute supports still holding but with the broader underperformance trend remaining intact.
What would it take to turn positive on China equities?
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As Asia’s bellwether equity market, China’s fortunes matter. Right now, it would not be too much of an exaggeration to describe aspects of China’s market as being in crisis — particularly the property sector — but in crisis lies opportunity; so what should we be looking for in terms of signs and signals that sentiment may — or may not — be turning?
To organise the most relevant signals and determine what they are saying in aggregate, we have refreshed our China equity scorecard, originally introduced in July. We have taken snapshots of five key variables — growth, liquidity, earnings, valuations and cross-asset signals — at the five points in the last 12 years that were followed by returns in the following 12 months of 10% or greater on the MSCI China Index (see Figure 3).
Predictably — and not surprisingly — the combined and aggregate message communicated by this collection of signals suggests that underlying conditions are still not yet sufficient nor conducive to become bullish on China. Rather, the data cautions patience until economic momentum rebounds, liquidity conditions improve and earnings downgrades end. As such, we would advise discipline at this juncture.
2022 investment themes
While China’s purely directional outlook is clearly compromised, pockets of opportunities nevertheless abound. Below, we present our high conviction investment themes for 2022.
1. Sustainable China: Throughout 2022, it is likely that China equities will struggle amid regulatory uncertainty and shocks to the property sector. Thus, we continue to suggest focusing on sectors and themes that are aligned with the government’s objectives. Our Sustainable China theme fits this bill and continues to deliver healthy returns, rallying more than 50% year to date. The recent power cuts in China, which have been tied in part to the pursuit of carbon emission targets, is testament to China’s commitment to its 2060 carbon-neutral targets and supportive of the renewable energy space. We expect it to remain a key investment theme for 2022.
2. Beautiful Europe: Exposure to European luxury stocks is an indirect way to benefit from China’s new growth strategy under the “common prosperity” banner. While fears of increased taxation still remain, China’s government has flagged its support for its middle class, with consumption being led by Millennials. A recovery in discretionary consumer spending by China’s middle class is likely to have a meaningful spillover onto European luxury goods, in our view.
3. Return of the tourist: With the Covid-19 contagion decelerating in Asia and Southeast Asia especially, movement restrictions are being relaxed internally and, tentatively, even externally; this should pave the way for a rebound in tourism. The key change is the newly adopted approach of “living with Covid,” made possible by the vaccine rollout. Thailand, Malaysia and Singapore have fully vaccinated 60%–80% of their populations while the Philippines and Indonesia are also catching up. As such, Singapore, Malaysia, Thailand, Indonesia and Philippines have all partially relaxed movement restrictions and travel curbs. The key Southeast Asia holiday destinations of Phuket, Bali and Langkawi are in various stages of pilot programs to allow domestic and international visitors. The region is reopening and should continue to progress as vaccination rates climb.
4. Indonesia reopens: Several factors make Indonesian equities our preferred mode of gaining exposure to Southeast Asia’s reopening and economic recovery. First, economic activity has been accelerating as evident in the latest purchasing managers’ index (PMI) readings. Growth in exports and auto sales has improved and consumer confidence is on the rise. Second, the earnings outlook for banks, which account for 30% of Indonesia’s market capitalisation, have also been improving. Loan-loss provisions are decreasing thanks to a less severe economic fallout from the second wave of infections and credit growth should improve. Third, benign inflation should allow Bank Indonesia to delay policy tightening for some months at least. These factors have combined to push Indonesia’s 12-month forward earnings higher, giving Indonesia the second-highest revisions in Asia in November. Strong commodity prices and below mean composite equity valuations relative to emerging markets make a compelling case to turn positive on Indonesia at this time.
5. Japanese equities: We expect the global economy will continue to recover in 2022, supported by the 2H2022 normalisation in supply chains. Given that Japan’s exporters are mostly manufacturers — specifically of capital and production goods — we suspect they will likely be able to benefit from this recovery. Additionally, consumption might turn out to be a key support for a domestic economic recovery. The new government of Prime Minister Fumio Kishida has elevated income distribution and sustainable consumption as key policy priorities for growth. A stronger growth outlook should support a robust earnings recovery next year, which should in turn lead Japanese equities to outperform. As such, Japan is one of our key high conviction investment themes for 2022.
John Woods is Credit Suisse’s chief investment officer, APAC
Cover photo: Li Yang/Unsplash
