NEWS ANALYSIS

Risks abound, but have opportunities also emerged in Asia?

China's rallying property market, as it slowly emerges from a year-long slump, makes the country's high-yield property bonds, attractive.
China's rallying property market, as it slowly emerges from a year-long slump, makes the country's high-yield property bonds, attractive. PHOTO: REUTERS

Prospects in Asian quality stocks, Japan's equity markets and China's property bonds

Halloween decorations are no match for financial market uncertainty: Plunging currencies and equity routs in Asia have frightened the most risk-ready investors.

Market sentiment remains fragile, with worsening macro conditions foretold in the continued loosening of monetary policy by Asia's central banks.

Emerging market instability even spooked the US Federal Reserve from raising interest rates in September. In snuffing out the added risk to the global economy, the Fed provided a reprieve, but only temporarily, to Asian currency markets - a reminder of the current macro-economic environment's fragility.

So where does this leave investors? And importantly: How has this turbulence influenced valuations in Asian equities? We believe markets are sturdier than valuations reflect, and selective investment opportunities are emerging as a result.

Asia's potential to bounce back has much to do with the region's tenuous valuations. Asia ex-Japan markets have tumbled nearly 25 per cent since April.

The region now trades at price-to-book of almost 30 per cent below the historical average, approaching valuations last seen during the 2008 financial crisis. Yet, today's 12 per cent return on equity is much higher than the near 8 per cent in 2008.

Closer to home, Singapore equities are trading near a 10-year low; banks in particular, are trading close to past recession levels. Meanwhile, Asian earnings - expected to rise by high single digits in the next 12 months - have remained resilient despite the equity selloff. This contrasts with the 50 per cent slump in Asian earnings during 2008 which suggests current markets have priced in significant pessimism.

A SLOWDOWN YES, BUT A CRISIS NO

In China, the harbinger of Asia's economic prowess, the central government is diligently endeavouring to cushion the impact of decelerating growth while continuing down the path of reform.

Despite a troublesome equity market, consumption has held steady reflecting a resilient job market and limited exposure of household financial wealth to equities. With intensifying fiscal and monetary policy support, we believe China remains on a path of controlled growth deceleration. Robust home sales are a telling indicator of China's pliability: The all-important property sector has rebounded for four consecutive months, with sales rising 16 per cent year-on-year in August.

Furthermore, while purchasing managers indices (PMI) across most of Asia are below 50, or contracting, they remain well above past crises lows. China's latest reading, for example, is now 49.8 versus the 38.8 low of the 2008 crisis. The United States ISM manufacturing index also remains healthy at above 50, in stark contrast to the 2001 and 2008 recessions.

In short, there is little evidence of an impending economic crisis which recent Asia ex-Japan valuations would imply.

CURRENCY VALUATIONS ARE NOT YET COMPELLING

Nascent investment prospects aside, we remain cognisant of near-term uncertainties. The foremost threat to stability is the looming US rate hike cycle and its impact on regional currencies.

We expect the Fed to first hike in December and continue at a moderate pace thereafter. Already battered Asian currencies may be in for more weakness of up to 5 per cent versus the US dollar in the next six months as the Fed returns to normalcy.

What's more, headwinds from the Chinese yuan could further exacerbate downbeat expectations.

As China restructures and its growth slows, a more market-driven exchange rate regime means the yuan could increasingly fall against the dollar over time, the impact of which would cascade through the entire Asian currency complex.

The Singapore dollar is not spared either - it could head toward 1.45 versus the US dollar over the next six months.

BUT VALUE EMERGING AMONG QUALITY STOCKS AND BONDS

Fear of a return to recession has adversely influenced current asset prices, constructing a reality not fully grounded in tangibles. It is worth noting that Asian equity markets have in the past risen as much as 20 per cent following an initial US fed hike. We see notable opportunities in holding equity exposure in India and Singapore.

For longer-term investors, the turmoil also presents opportunities to upgrade portfolio quality - Asian stocks with high and sustainable returns on equity, some of which are found in insurance, telecoms, and technology sectors. Within Singapore, we find banks attractive and favour companies with good earnings visibility and benefit from lower oil prices.

As for Japan, the Nikkei 225 nosedived almost 15 per cent from its August peak as global investors cut risks. Notwithstanding a worse-than-expected 2Q15 GDP and a sovereign credit rating downgrade, several positive catalysts are expected to support a rebound in Japan's equity markets: Additional fiscal stimulus, an expanded Japanese ETF-purchasing programme by the Bank of Japan, and solid earnings to name a few. As such, we think exposure to Japanese equities, especially the tourism sector, is a strong bet in the months to come.

Beyond equities, China's rallying property market makes Asian high-yield bonds, specifically China high-yield property bonds, attractive and recent spread widening offers an enticing entry level. Chinese bonds are also slated to benefit on the back of easing onshore liquidity. Within investment grade, BBB-rated China state-owned enterprise (SOE) bonds and bank subordinated

Tier 2 bonds are preferred. We remain cautious on issuers from Indonesia and Malaysia, and cyclical sectors such as oil and gas, and metals and mining.

In essence, naysayers of Asia's economic outlook ought to dig deeper. Growth is weak, but the risk of an economic hard-landing remains capped by intensified policy support. The key is in surveying the land and looking in the right places. Still, investors should not forget that elements of risk tolerance and patience are needed to venture forth and brave the uncertainty.


• Tan Min Lan is Head, Asia Pacific Investment Office, UBS CIO Wealth Management

A version of this article appeared in the print edition of The Straits Times on October 05, 2015, with the headline 'News analysis Risks abound, but have opportunities also emerged in Asia?'. Print Edition | Subscribe