The backdrop for global equity markets remains grim, with rising inflation prompting steep interest rate hikes in the US, an energy crisis and recession in Europe, and a stumbling property market in Covid-impacted China.
As a result of this combination of factors and general risk aversion the US dollar reached two-decade highs in early September 2022.
Valuation gap is unjustified and will close
This has left the valuation gap between Asia-Pacific equities and US equities at extreme levels not seen since the late 1990s when the region was in a debt crisis. We believe fundamentals do not justify this valuation divergence and this represents an opportunity for investors looking to diversify from Europe or the US, or deploy some cash.
Our medium-term conviction is that this valuation gap will close over the next five years and Asian value stocks will outperform. Timing is difficult, but the opportunity is clear from a historical perspective.
Economic fundamentals across ASEAN1 are much stronger than in previous crisis periods after a further two decades of economic development. Fiscal and monetary policy was more restrained in the region through Covid than in Europe or the US, and real interest rates avoided going deeply negative, giving policymakers room for maneuver should global economic conditions materially worsen.
ASEAN is well placed in general but within the region our favored countries are Vietnam and Indonesia, with a combined population of 681 million and healthy demographics promoting a high propensity to consume. Vietnam and Indonesia are benefiting from the continued trend for supply chain diversification away from China, and Indonesia also benefits from an inflation hedge as a significant producer of commodities.
Japan unlocking hidden value
We are also constructive on some Japan equities where corporate governance reforms are seeing value unlocked in a market that has spent a long period in the doldrums. Since 2016, Japan corporates have been directed to aim for an 8% return on equity (ROE) ratio, with shareholders encouraged to vote against the reinstatement of boards which fail to reach this target three years in a row. The subsequent focus on profitability and balance sheet efficiency has seen an uptrend in profit margins.
With the yen at record lows against the dollar, inflation expectations anchored, Japanese monetary policy completely untethered from the Fed, and the ‘self help’ outlined above, this is could be an opportune time to enter or increase exposure.
Even in China, which has remained hamstrung by its Covid-zero policy, we believe valuations already reflect the negative outlook.
Within the vast Asia Pacific equities universe we believe there are companies whose share prices do not reflect the company’s true potential that will rerate to a higher level, and these are where the investment focus should be, rather than on names with valuations comparable to peers in the US.
There are financials that will benefit from higher interest rates, unfashionable technology hardware names, and some companies positioned to contribute to the energy transition, that fit into this category. Navigating the current environment is challenging so the process should begin where clear value exists.