2021: Dispersion in Asian equity valuations gives rise to attractive opportunities

The year 2020 has been a challenging one for the Asian equity market. The Covid-19 pandemic has led to a significant contraction in economic activity and considerable uncertainty over the timing and pace of recovery. The V-shaped recovery we have seen in the market suggests that the region has fared relatively well compared to others. This may ring true for North Asian economies such as Taiwan, Korea and China given their lower infection rates, fewer deaths and less economic damage, but other countries elsewhere in the region have had less success in containing the virus.

Against this backdrop, the equity market has seen a 47% bounce back since its trough at the end of March, hence it is possible that we have seen most (or all) of the rebound at the index level. However there has been a significant divergence in performance between sectors, with internet and technology companies faring far better than financials, energy and travel-related companies. Looking forward to next year, we believe this offers a notable amount of scope to drive outperformance by capitalising on valuation discrepancies within different areas of the market.

Opportunities among cyclical stocks

There are deep discounts available in more cyclical sectors where there is less confidence in the pace of recovery, such as in the auto and energy sectors. We believe the pandemic is unlikely to structurally change fundamentals in these areas, and there is potential for earnings to recover quicker than the market expects. Although there are valid concerns about the demand outlook for conventional autos as electric vehicles become more popular, some auto stock multiples are close to their 10-year lows. Within energy, our focus is on gas companies with oil-linked pricing that would be profitable even if the oil price remains at its current depressed level. We believe, however, that the current low price environment and the growth of renewables are discouraging new investment in the sector which is likely to lead to a shortage of supply. The market appears to be underappreciating this dynamic in some cases.

Attractive good quality businesses in India

We are particularly positive about the prospects for businesses in India. Although the initial lockdown harmed its large informal economy, the infection rate is declining, and the death rate is relatively low. The government is focusing its efforts on supporting the economy which is close to pre-Covid levels of activity. We believe this country offers one of the best structural growth stories in Asia, supported by a government that is bringing about tangible structural change. It is one of the only large economies to have kept credit to GDP levels almost unchanged since the Global Financial Crisis, providing scope for credit growth and business expansion. At the same time, the banks have been cleaning up their balance sheets for several years while it is likely that the strong reform momentum will bear fruit within our investment horizon. We have identified some well-managed companies, such as conglomerates and auto companies, which at purchase were trading at  significant discounts to our estimates of fair value. Also, we favour the private banks which are taking market share from the less well-run state-owned banks.

Tech companies capitalising on the new tech cycle and trends in consumer behaviour 

Among the technology and internet companies, we see companies emerging stronger, particularly those that continue to invest and innovate. Chinese internet companies have benefited from an acceleration in the trend towards online shopping, social connectivity and gaming, while demonstrating a willingness to focus on core profitability. Elsewhere, the rollout of 5G and the growth of artificial intelligence and the ‘internet of things’ have only been temporarily interrupted by the Covid-19 outbreak while, at the same time, working from home has increased demand for PC-related equipment and cloud capacity. We continue to be attracted to companies benefiting from these enduring themes and will remain so for as long as valuation levels permit.

The comfort of a clean balance sheet

We prefer companies which possess strong balance sheets which can be deployed to strengthen businesses either organically, or through mergers and acquisitions. We see many such companies among the conglomerates and auto and tech sectors. Even among the financials, despite low interest rates and some asset quality concerns within the industry, we are favourably disposed towards a selection of banks across the region which are well-capitalised and have strong core profitability.

Turning to the US-China trade war, the relationship between the US and China is likely to remain tense for the foreseeable future. While we need to consider the potential impact of trends such as tech decoupling and de-globalisation, as companies seek to ensure that their supply-chains are less reliant on China, we are also aware that there is likely to be a greater level of government investment in technology development by both countries and a desire for self-sufficiency. While this may create uncertainty within supply chains we believe that innovative companies stand to benefit.

Finally, the V-shaped recovery in the Asian equity market has seen valuations recover from oversold to average levels. The MSCI AC Asia Pacific ex Japan index is currently on a forward P/E of around 18x on depressed 2020 earnings, which optically no longer appears attractive, but should become more so as earnings growth picks up moving into next year. Most Asian countries went into the Covid-19 crisis with relatively low levels of government debt, which has enabled them to loosen fiscal policy and means they may not need to revert to austerity once the crisis is over. As the outlook for earnings improves, this should support Asian equity returns going forward, particularly the value/cyclical elements of the market which have valuation support and scope to beat expectations.

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