Asian Equities: A Constructive Outlook

By the end of the second quarter, the majority of the economies in Asia had reopened to quarantine-free travels. This provided, and will likely continue to provide, much-needed support to company fundamentals—suggesting COVID could potentially be less of an overhang on the economy in the coming months than previously. In China, in particular, the improving COVID situation is also supporting the recovery of the country’s local and export-driven activities. Although China’s quarantine requirements are expected to ease, its “zero tolerance” policy will likely be enforced until the effective roll-out of vaccines among its elderly age groups.

On the other hand, external demand, particularly from the U.S. and Europe, is expected to weaken on the back of inflationary pressure and hawkish central bank policies, which could create headwinds for export-driven manufacturing sectors. However, this could also provide some relief to commodity prices, which are expected to benefit most Asian economies. In addition, there are a number of other factors that could provide a positive surprise, including a reduction or removal of import tariffs by the U.S. on some Chinese goods, moderating of the hawkish U.S. monetary policy due to the slowing economy, or a de-escalation of the war in Ukraine.

Maintaining a Constructive Outlook
Although external macro headwinds exist, such as a possible recession in the U.S. and Europe, as well as ongoing energy security risks in Europe, we see sufficient mitigating factors to maintain a constructive view on Asian equities in the coming months. After one of worst first half of the year performances for Asia ex-Japan equities, we believe markets have discounted a fair bit of the earnings cuts to come, partly driven by the tech inventory de-stocking cycle in the coming months. At the same time, we believe the Chinese economy has likely recently bottomed-out, alongside corporate earnings, following the severe lockdown in Shanghai.

Going forward, we expect to see more stimulus measures to support the economy and markets. Although COVID remains a potential risk, supportive fiscal and monetary policies, such as an easing credit environment and accelerated deployment of infrastructure investments, are expected to support a sequential improvement of the macro economy. The reopening of the Chinese economy is also expected to support domestic consumption, while easing regulatory policies around internet companies and the real estate market may support China’s economy toward its tough growth target in 2022.

In ASEAN, the economic recovery is expected to continue. Quarantine-free travelers from developed markets are gradually returning, and domestic activities are also slowly returning to pre-COVID levels. Structural trends, such as diversification of certain supply chains from China, may continue or even accelerate due to the recent production disruptions from China’s COVID-related lockdowns. Key ASEAN markets may experience faster growth this year in light of improving fundamentals from depressed activity levels in 2021 due to the pandemic, leading to stronger earnings revisions relative to broader Asia in the coming months. Corporate earnings estimates for the region remain undemanding considering that they are below 2019 pre-pandemic levels for most ASEAN markets.

Finally, global funds are largely underweighting the Asian equities markets. In our view, improving fundamentals, more attractive valuations and relatively looser monetary conditions in Asia can help deliver relative equity outperformance for the region in the coming months.

Attractive Opportunities Remain
In this environment, we see opportunities in Asian corporates that have exposure to secular growth themes such as technological ubiquity (digitalization and connectivity of everything), evolving lifestyle and societal values (sustainability, millennial/Gen Z consumption trends, healthy living) and de-globalization (supply chain diversification/bifurcation and reshoring). We believe the recent share price corrections in some companies have made valuations more attractive, creating opportunities to build positions in strong companies at attractive prices.

At Barings, while stylistic rotations have caused some volatility across markets, our approach remains anchored in our Growth-at-a-Reasonable-Price (GARP) investment philosophy. At the stock selection level, this approach helps us to avoid overpaying for a company’s growth, while at the portfolio construction level, it helps limit exposure to unintended styles or risks.

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