Asian equity markets have yielded solid positive returns over 2019, led by China and Taiwan, and aided by a return of confidence to the information technology sector. Looser liquidity conditions and, towards year end, rising optimism over the global economy (and by inference trade) has added to a more positive tone. Politics remains the key area of uncertainty, most obviously the unrest in Hong Kong and the increased geo-political rivalry between China and the United States, of which the trade disputes are merely the most obvious symptom.
The recovery in markets in a year where there has been precious little earnings growth in aggregate means that regional valuations are back to slightly above their ten year averages. Consensus earnings growth of around 10% looks achievable but somewhat sensitive to hopes for the information technology sector being fulfilled on the back of demand for 5G handsets and infrastructure and recovery in server demand, along with the distinctly small green shoots of global growth proving sustainable.
We would prefer to err on the more conservative side. The known unknowns are political, and a number of long held assumptions underpinning our Asian investments such as the merits of free trade or the rule of law and stability of Hong Kong SAR are being seriously challenged. The other issue surrounds China, an increasingly important end market, but also rival, to the whole of Asia. The economy is likely to continue to expand at a gently decelerating pace. This may on the face of it seem bad news for regional earnings growth. However, we see this as a conscious multi-year shift by the Beijing authorities away from a credit intensive, investment heavy growth model which enhances the long-term sustainability of the economy and reduces its vulnerability to capital flight and debt led deflation.
Despite the generally lower growth in Asia that is in prospect over the next decade, as stock pickers we remain optimistic. Lower overall growth is less important to active investors than shifts in the contribution to growth. We continue to focus on finding companies and management capable of exploiting these faster growth pockets in areas such as e-commerce, digital media, IT hardware, consumer leisure, long-term savings demand, increased health care demand and spending, lifestyle changes, and consumer “upgrading”.
This is allied to some solid financial metrics in the region including generally strong national balance sheets, current account surpluses and a corporate sector with amongst the lowest financial leverage in the world. The more shareholder focused management which we favour have been disciplined in capital management and expansion spending, with the result that there is ample cash flow underpinning dividends that remain at attractive levels on a global basis.
Perhaps the last word should go to the rising profile being given to Environmental, Social and Governance (ESG) factors. These have always been important considerations for us as Asian investors – there have been many Asian companies (in some cases briefly the biggest companies in their market by capitalisation) which we have avoided investing in due to our doubts over the sustainability of their business models and/or doubts over governance and shareholder focus. What has changed is that the consideration of these issues has become a more explicit part of the process. It is also an important aspect of our dialogue with companies with continued focus on governance and stewardship, but also growing focus on how the region contributing most to global growth can palliate the inevitable impact on the environment. Asia’s innate creativity and growing strength in research and development can be as much part of the solution as the problem.
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