Mike Kerley, Co-Manager of the Asian Dividend Income Strategy provides the reasons why he maintains an optimistic outlook for Asia and its prospects for delivering income to investors.

Key takeaways

• An improving outlook for China is likely to benefit the region
• The trend for corporate earnings upgrades in Asia looks positive moving into the new year
• Should the Asian economies improve, the drivers of performance should switch to more value orientated-sectors, which would better suit the team’s positioning.
• The team’s expectation for growth of dividends to exceed earnings remains

Despite Asia Pacific ex Japan markets rising almost 20% in US dollar terms in 2019¹ and geopolitical and trade risks still elevated, we believe there are reasons to be optimistic about the year ahead.

China may provide regional support

The optimism is based on improvements in China and the positive impact this will have on the rest of the region. Unlike previous cycles where the Chinese response to domestic or external challenges has resulted in a splurge on debt-funded spending leading to overcapacity, especially in the state sector and stressed balance sheets, the response though 2019 has been much more pragmatic. Cuts in interest rates and bank reserve requirements have increased liquidity and the access to credit, while tax cuts and state-owned enterprise reforms have stabilised consumption and increased the productivity of the most inefficient parts of the economy. These measures were deemed insufficient to offset the trade dispute with the US through most of 2019, but recent manufacturing and service PMIs (purchasing managers’ indices) are suggesting that the worst is now behind us and economic expansion is possible in the quarters ahead.

Expectations for strong earnings growth persist

The earnings outlook for the region is crucial as history suggests that Asia and emerging markets only tend to outperform developed markets when earnings growth is superior. (Expectations for 2019 were high but continual downgrades left earnings growth for the region up only 2% on a year earlier resulting in Asia lagging other regions and the US in particular. NEED BACKUP)The outlook for 2020, however, is more encouraging with earnings growth expected to be north of 10%, ahead of most other regions NEED BACKUP, and more importantly the trend is looking positive with upgrades through the last quarter of 2019. NEED BACKUP)

The strong price performance and weak earnings have left valuations above long-term averages at around 14x forward price-to-earnings.²  NEED BACKUP It is imperative that Asian companies deliver or beat analyst’s expectations to justify these valuations – they do however, remain attractive relative to other regions where price-to-earnings multiples are higher and growth expectations are lower.

How we are positioned for the year ahead

An improvement in economic prospects across the region could materially impact the drivers of stock market performance. Growth has outperformed value over the last ten years as a relatively weak global environment has led to investors paying more for quality growth stocks, while performance has been concentrated in sectors such as internet, consumer staples and healthcare.

If economic momentum improves we expect more cyclical sectors to perform better, which is why we have increased our exposure to materials, semiconductors, property and industrials. At the country level, this has led to a greater allocation to North Asia compared to South Asia with positions in China, Taiwan and Korea prominent while weightings in Australia are dominated by positions in select miners and other companies that may benefit from a pick up in the region.

BACKUP NEEDED FOR PORTFOLIO MOVES

While the earnings position in most of Asia appears to be improving this cannot be said of India where momentum continues to fade. The market underperformed the rest of the region in 2019 but not by enough to reflect the fundamental deterioration resulting in the market’s valuation premium to the rest of Asia expanding. The Indian market has never in its history posted a one-year positive return from this valuation point NEED BACKUPand we retain a zero weighting.

Banking on dividend growth to exceed earnings

With the tensions between the US and China running high there continues to be a risk of a deterioration in relations and the possibility of a resumption of the tariff war, which has proved damaging to both countries. Additionally, the volatile situation in the Middle East could have a material impact on the oil price, which would be detrimental to most Asian countries. With the exception of Malaysia, they are all net importers of oil.

That said, we believe the outlook for dividends in Asia Pacific remains robust as we anticipate dividend growth to exceed earnings growth in the coming years. Asian companies have the potential to produce ever increasing levels of cash flow and with dividend payouts still below 30% in some markets, there is ample room for dividend uplift or even special dividends. The share buyback culture, which is so prominent in the US has thankfully not made its way to Asia in any meaningful way, providing plenty of opportunities for dividend investors to reap the benefits in the years ahead.

 

 

 

 

¹ Source: Refinitiv Datastream. MSCI AC Asia Pacific ex Japan Index total returns in USD 12 months to 31 December 2019. Past performance is not a guide to future performance.

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