Knowledge. Shared Blog

September 2019

Don’t Let the Trade Wars Detract from Asia’s Structural Growth Story

  • Andrew Gillan Andrew Gillan
    Head of Asia ex Japan Equities | Portfolio Manager

Andrew Gillan, Head of Asia ex Japan Equities and Co-Manager of the Asian Growth Strategy, discusses the reasons why investors should be less preoccupied by the machinations of the trade war and instead focus on Asia’s long-term structural growth story, strong fundamentals and the diversification benefits that the region can add to a balanced portfolio.

Key Takeaways

  • While Asian equities are trading at a reasonable discount, investors may question if this is justified given the historical corporate fundamentals and longer-term outperformance of the region.
  • Furthermore, while corporate earnings growth remains subdued, the longer-term picture is much more positive ‒ Asian earnings growth has outpaced that of both global and U.S. equities over the past 20 years.
  • Investing in Asia comes with higher volatility, but this has been compensated for to some extent by higher returns over the longer term. We believe adding exposure to Asia within a balanced portfolio can potentially offer benefits both from a risk and return perspective.

Given the backdrop of the trade wars that have dominated headlines in 2019, we think it is important to take a step back and look at where Asia stands from a long-term investment perspective.

First, let’s acknowledge the near-term headwinds. President Trump’s trade policies are undoubtedly having a negative effective on fundamentals across the region, causing companies to defer capital expenditure decisions or allocate costs to relocations and weakening growth and consumer sentiment. China is being affected at a time when growth is already slowing down because of the government’s deleveraging efforts. The most open trading economies, such as South Korea and Singapore, have posted lower economic growth as a result. Corporate earnings growth remains lackluster in Asia, and expectations at this stage are for very little earnings growth for 2019.

But will that be the case in the future? Asia Pacific ex Japan already accounts for 27% of global gross domestic product (GDP) as of the end of 2018, up from a mere 10% at the turn of the century (see chart below). This growth was driven by superior economic growth from countries like China, India and Indonesia and looks set to continue in the years ahead.

Asia ex Japan is Under-represented in Global Indices

[caption id=”attachment_223767″ align=”alignnone” width=”913″] Source: FactSet, Worldbank data, Asia Pacific ex Japan share of GDP vs weight in MSCI World Index, as of December 2018[/caption]

How Have Asian Equities Performed over the Longer Term?

Through June 2019, the U.S. stock market has experienced an unprecedented bull market generating a 14.7% annualized return. Asia Pacific ex Japan has delivered positive returns of 8.3% per year over the same period. It is easy to see why Asia and emerging markets have been more broadly out of favor given the superior returns available in the U.S., which have been buoyed by corporate earnings as well as share buybacks and a market multiple re-rating since the Global Financial Crisis.

Asia’s relative underperformance means that the region offers a reasonable discount from a valuation perspective. But investors should question whether this is justified given the historical corporate fundamentals and longer-term outperformance of the region. It is important to note that the returns highlighted in the chart below are in U.S. dollars, which is likely to mask stronger underlying equity market performance, as Asian currencies have weakened relative to the U.S. dollar in recent years.

Regional Comparison: Returns and Fundamentals

[caption id=”attachment_223778″ align=”alignnone” width=”934″] Source: FactSet, data as of June 28, 2019. Note: Annualized compounded returns are presented gross in U.S. dollars. Includes reinvestment of dividends. P/E= price-to-earnings ratio. Past performance is not a guide to future performance.[/caption]

How Have Underlying Company Fundamentals in Asia Fared over the Longer Term?

While corporate earnings growth remains subdued in Asia, the longer-term picture is much more positive. This is because Asian earnings growth has outpaced that of both global and U.S. equities (MSCI World Index, S&P 500® Index) over the past 20 years through June 30, 2019 (see chart below). Given the fact that the long-term drivers of Asian growth remain intact ‒ e.g., higher GDP growth, a rising middle class and the transition from lower stages of economic development – we believe it is reasonable to expect competitive earnings growth from Asian companies in the years ahead.

Regional Comparison: Earnings Growth

[caption id=”attachment_223789″ align=”alignnone” width=”935″] Source: FactSet, data as of June 28, 2019. Note: CAGR = compound annual growth rate. MSCI China data presented from December 2000 to June 2019. Other indices from December 1999 to June 2019. Past performance is not a guide to future performance.[/caption]

As illustrated in the chart below, Asia also holds its own, relative to other regions, in terms of compounded growth of company book values over the same longer period.

Regional Comparison: Book Value and Dividends

[caption id=”attachment_223800″ align=”alignnone” width=”945″] Source: FactSet, data as June 28, 2019. Note: CAGR=compound annual growth rate. Book value per share + cumulative dividend per share. MSCI China, data presented from December 2000 to June 2019. Other indices from December 1999 to June 2019. Past performance is not a guide to future performance.[/caption]

But Doesn’t Investing in Asia Involve Higher Risk?

It is true that we have seen higher volatility from Asia ex Japan equities over the last 20 years, but this has been compensated for to some extent by higher returns, as shown in the following chart:

Regional Comparison: Returns vs. Risk

[caption id=”attachment_223811″ align=”alignnone” width=”890″] Source: FactSet, data as of June 28, 2019. Note: 20-year gross monthly returns and monthly volatility annualized in USD. Past performance is not a guide to future performance.[/caption]

Investing in Asia and emerging markets more broadly will generally come with more political and economic risk than developed markets; however, it also provides opportunities to buy into quality businesses at attractive prices. Concerns remain over the state of the Chinese economy and the historical reliance on debt to assist growth, but this has been the case throughout this century. The overall economy has continued to move forward while many companies have produced healthy financial and share price returns.

More recently, there have been increased concerns about the indebtedness of many corporates in India. While this is justified in some instances, there are also some fantastic success stories across sectors in India at the individual company level. It is worth highlighting that in terms of monetary policy across Asia Pacific ex Japan, unlike many other development regions today there is ample room to cut interest rates if needed to stimulate economic growth. Those Asian economies with budget deficits have been under pressure to raise rates in recent years to defend their currencies against the strong U.S. dollar. However, there are already signs of that changing with expectations of lower U.S. interest rates or, at the very least, a pause in rate rises.

Last but Not Least, the Benefits of Diversification

Individual investor needs and targets vary, and an allocation to Asia ex Japan equities will not be for everyone. However, we believe that adding exposure to Asia within a balanced portfolio can potentially offer benefits both from a risk and return perspective (see chart below).

Allocating to Asia ex Japan within a Balanced Portfolio

[caption id=”attachment_223822″ align=”alignnone” width=”863″] Source: FactSet, data as of June 28, 2019. Note: For illustrative purposes only. Reference to any specific index or asset class is for informational purposes only and should not be construed as a recommendation to buy or sell. Hypothetical portfolio allocations based on monthly returns for the period 20 years to June 28, 2019. Past performance is not a guide to future performance.[/caption]

In conclusion, while it is reasonable to expect more negative news around the trade wars and the impact on the region’s short-term growth is uncertain, we are confident that the long-term growth drivers will keep Asia ex Japan very relevant to investors through the rest of this century.

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