Chief Investment Officer Mike Shiao analyzes how Asian equities could benefit from pro-growth policies.

Nov 19, 2019 | Mike Shiao

 Key takeaways

• Economic growth in Asia ex-Japan will maintain its pace. There is ample room for continued policy support. 
• Trade tension will benefit lower value-added production outside China. Improving domestic business environment will be policy focus. 
• Favorable election results in 2019 pave the way for pro-growth policies in India, Indonesia and Thailand.
• Corporate health remains sound as competitive companies benefit from positive structural trends.

Asia ex Japan equities performed well in 2019. They rose 6.0% year-to-date as of end September and, except for South Korea and Malaysia, all other countries ended in positive territories during the period. Investors are however not complacent. Trade tensions have escalated since May, leading to rising uncertainties that have started to have real repercussions for the economy. Responding to the challenging outlook, policy makers across the region have embarked a renewed easing cycle (Figure 1). Looking to 2020, trade tensions are likely here to stay, causing supply chain to shift. However, we think policy actions will help offset growth pressure. We believe favouarble election outcomes pave the way for pro-growth policies and earnings growth in Asia will remain healthy despite the challenging macro outlook.

Policy support to restore growth in 2020
 

When we wrote our investment outlook for 2019 last year, we expect economies in Asia ex-Japan region to expand +5.9%. The actual number was much lower: real GDP rose +5.4% and +5.2% respectively in the first two quarters of 2019 and the consensus now expects growth to be at 5.4% for the full year¹. 

The escalating trade tension between China and the US is a key variable that has casted downside pressure to our more sanguine view. It has broadly affected manufacturing and trade activities globally and led to declining business and consumer confidence. However, what is changing as well are policy reactions to counter the trade headwinds. We have seen a clear shift in policy stance from a tightening to an easing bias over the past few months with central banks cutting policy rates and governments rolling out fiscal stimulus. As such we expect economic growth to stabilize in 2020 and maintain its current pace.

We expect monetary policies to be further loosened in 2020. The US Federal Reserve (Fed) has delivered three interest rate cuts as of October. We believe a less hawkish Fed offers a favourable external environment that is conducive for further monetary operations in Asia. Meanwhile, policy rate in Asia ex-Japan has fallen only by 40bps since the beginning of 2019, compared with 160bps implemented in the 2015 easing cycle and 270bps done in the 2009 easing cycle. We believe there remains scope for further cuts in policy rates². 

We also expect governments in the region to step up fiscal policies should growth outlook deteriorate. In China, the government has delivered cuts in tax and social security contribution amounting to RMB2trillion in 2019 and we expect more direct policies in 2020 to improve the execution of infrastructure projects and target consumer demands. In India, the government announced a large reduction in corporate tax that lowered effective tax rate to 25.2% from 34.9%. We believe more supportive policies will roll out in 2020 given India’s ambition to become a US$5trillion economy (currently at US$3trillion) by 2024-25.

A shifting supply chain amid trade tension

We believe trade tension will likely be with us in 2020 and remain a recurrent theme despite positive development since October. Overall, we expect the supply chain in Asia to remain in place rather than being moved elsewhere despite some relocation within the region. Long before the trade war, there has already been a gradual shift with low value-added exports moving out of China. We expect such a trend to accelerate in 2020 and countries with superior demographics and cost advantages to benefit the most. We have noticed ASEAN countries, particularly Vietnam, as major beneficiaries of the relocation trend. Wages there are still substantially low compared with China (Figure 2), but growth in working age population is generally more superior. With respect to higher value-added production such as capital machinery and electronics, there are companies moving production back home to Japan and Taiwan. That said, we believe China still holds key advantages in the higher value-added industries given its sustained efforts at growing R&D, improving human capital, raising the efficiency of the domestic supplier ecosystem and providing higher-quality infrastructure.

We believe countries outside China are eager to capitalize on the ongoing US-China trade tension.  For example, in Taiwan, a “Welcome Back” program was launched to lure Taiwanese manufacturers to return home; while in Indonesia, the government is cutting regulations to open up more domestic sectors and making it first priority to revamp labour rules that discourage foreign firms to expand operations. We believe improving foreign access and domestic business environment will be some of the key policy focuses for governments in the region in 2020.

Removal of election risk benefits pro-growth policies

We wrote last year that elections in India, Indonesia and Thailand would be key events to watch in 2019. Now with all elections over, we believe there will be a reduction in political uncertainty and the governments in those countries will be able to focus on implementing pro-growth policies in 2020.

In India, the election concluded with incumbent Prime Minister Narendra Modi re-elected. We believe initiatives focusing on boosting growth will continue. The meaningful corporate tax cuts announced post-election confirmed our view. We believe the cuts have long-term implications and will help corporate profitability and India’s competitive position globally. In Indonesia, incumbent President Joko Widodo was also re-elected. We believe policies in his next term will lead to a new infrastructure cycle. The government is expected to spend more than US$400billion on infrastructure projects from 2020 to 2024, compared with US$350billion announced when he first got elected four years ago. As we have discussed in the previous section, there will also be policies on improving ease of doing business to attract FDIs and grow the manufacturing sector. In Thailand, we have seen prompt policy responses as well. The government released a wide-ranging stimulus package of US$10bn in August and we expect more to be introduced to address growth weakness.

A disconnect between macro and micro

We believe there is a disconnect between healthy corporate fundamentals and moderating macro growth. Corporate health is sound in Asia despite the challenging outlook. In 2020, earnings growth is expected to reach 12%³ and led by key markets in China, India, South Korea and Taiwan. We think that information technology, healthcare and consumer discretionary will be the sectors that offer highest growth. This is encouraging news for bottom-up investors such as us.

We believe what underpins such a disconnect is the ability of competitive companies to capture structural trends and generate strong growth. In China, despite expecting macro growth to moderate to 5.9% in 2020, consensus expects consumer-related, healthcare and information technology sectors to offer more than 20% earnings growth⁴. Those sectors represent the future growth of China as the Chinese economy is rebalancing towards a consumption- and services-led growth model. In India, we see companies, particularly in the financials and consumer sectors, are thriving thanks to structural changes including financial inclusion, digitalization and formalization of the economy. We expect those forces to last in the medium to long term given policy clarity, proving continued support to earnings growth.

Conclusion

We believe economic growth in Asia ex-Japan in 2020 will remain stable. Governments in the region will step up to provide more supportive policies on both monetary and fiscal fronts to stabilize growth outlook. We believe trade tension will accelerate the relocation of lower value-added production, but we expect China to maintain its position as a major supplier of higher value-added products. Elections in 2019 in India, Indonesia and Thailand have removed political uncertainty, paving ways for further pro-growth policies. We expect earnings growth of Asian companies to remain strong given their abilities to tap into structural growth trends.  

We believe major risks deserving investors’ attention are trade tensions and policy implementation. We believe that due to the unpredictable nature of trade tensions, their development could move to either direction, posing positive or negative risks and leading to heightened market volatility in 2020. On policy implementation, we believe investors need closely monitor policy actions and assess reform efforts. Insufficient policy support or reform progress might drag down growth and hurt sentiments.

Mike Shiao is Chief Investment Officer, Asia ex-Japan at Invesco.

^1 Source: Bloomberg, Invesco. As of October 2019.

^2 Source: Bloomberg, CEIC, Morgan Stanley Research. As of October 2019.

^3 Source: FactSet, Invesco. As of October 2019.

^4 Source: Bloomberg, FactSet. As of October 2019.
 

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