Welcome to Thoughts on the Market. I'm Jonathan Garner, Chief Asia and Emerging Markets Equity Strategist for Morgan Stanley Research. Along with my colleagues bringing you their perspectives, I'll be talking about Asian equities and why we continue to be more cautious than consensus. It's Thursday, July the 15th, at 7:30 AM here in Hong Kong.
At the end of last year, there was a high degree of investor optimism that 2021 could be a great year for Asia and emerging market equities. Indeed, at the back end of 2020 and into early this year, we tracked 24 straight weeks of inflows to dedicated Asia and EM equity products amounting to over $100 billion.
The idea was a strong recovery in the global economy, easy monetary conditions, a significant recovery in global trade and a weak US dollar would benefit these markets.
But year to date the broadest index of Asian equities, which we track is flat in US dollar terms versus a 15% gain for the S&P 500 and 8% for Eurostoxx. So what went wrong and where do we continue to differ from consensus on these markets?
We've had four key issues of concern which led us to downgrade our stance on Asia & EM in early February and which we think only one of which has partially adjusted more favorably in recent weeks.
Our initial concern was China's tightening cycle and its impact on economic growth. As far back as the fourth quarter of last year the growth rate of money supply began to peak as China's authorities removed stimulus given the strong recovery in exports and investment and concerns on leverage and property market overheating. We found that Asian equities tend to respond as much if not more to Chinese policy cycles than to those in the US given the higher degree of trade and investment linkages these days between Asia & China than between Asia & the US. The Chinese tightening has led the growth rate of M2 - a relatively broad measure of money supply in China - to fall from 11% year on year at the peak to 8% currently.
Our second concern is COVID-19. Early on in the pandemic, Asia led the world in controlling the spread of the virus through lockdowns, testing and contact tracing with innovative use of technology. Unfortunately, this year is very different, with Asia broadly lagging the US & Europe in vaccine deployment. Singapore, a market we continue to prefer, leads the region with 39% of the population fully vaccinated. But China's vaccination rate is 23%, Japan 15%, Korea 11%, and India and Thailand both currently below 5%. With the arrival of the Delta variant, this has posed a significant challenge both to governments and populations. As a result whilst activity in manufacturing and traded goods remains strong in Asia, the recovery and consumption generally and in particular in services in areas like travel, dining and eating out has broadly failed to meet bullish expectations. This in turn has fed through into a much more modest upward cycle of earnings estimates than we're seeing in the US & Europe.
Our third area of concern is China anti-trust, data security regulation and most recently, equity market listing and regulatory tightening.
Our fourth and final concern has been valuations and here there is better news. At the peak for Asian equities in late January we pointed out that - depending on the metric used - we had valuations that had already either reached or even exceeded those recorded at the top of the last three cycles in 2000, 2007 and 2017. Lackluster performance and a muted but positive earnings upgrade cycle mean that the valuation multiple for Asian equities has come back down now and is around 14 times consensus forward price to earnings currently, and that is close to where we see fair value.
But until we get better news on the first three issues of concern - that's China tightening and regulation and regional COVID vaccination - and given that the US dollar and Fed policy are now also shifting more to headwinds for the region than tailwinds - we think investors may want to consider staying on the sidelines in Asian equities this year.
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