Asian Equities: A Diverging Recovery

Following an uptick in volatility during the first quarter, Asian equities generated positive returns in the second—and in our view remain well-supported going forward, even as regional economies are starting to see desynchronized growth and headwinds.

In particular, the second quarter saw several risks unfold, including the emergence of new Covid-19 strains, China’s tightening regulation of tech giants, inflationary commodity prices, and the U.S. Federal Reserve’s (Fed) incrementally hawkish stance on interest rates. Moreover, the stylistic rotation between growth and value stocks developed further, although both styles ended the second quarter with similar performance. Going forward, we expect markets to focus more on stock-specific fundamental earnings drivers, rather than on stylistic positioning. This is primarily because value stocks—specifically, value cyclicals—have registered strong performance, and the valuation in discount no longer looks as compelling, in our view. This is especially true when compared to growth stocks, in particular Chinese internet companies, which suffered a valuation de-rating due to regulatory pressures and rising interest rate expectations.
 

An Uneven Recovery

Looking ahead, while we expect market volatility to continue in the region in the near term, it is likely to be increasingly subject to the idiosyncrasies of each market. For instance, investors are now considering the varying pace of Covid-19 controls and vaccination efforts in each country, versus focusing on the unified optimism of a recovery that prevailed during the first quarter. The emergence of the significantly more contagious Delta variant could also set back the pace of an economic recovery, especially in ASEAN and India, where Covid-19 controls seem more challenged and the economies are more domestic-oriented. Singapore leads the region with over 70% of the population with at least one dose of vaccine, followed by mainland China administering over 1.3 billion doses, or approximately 43% of its population.¹ Other jurisdictions within the region, however, are lagging in terms of vaccine roll-outs—and are therefore vulnerable to pre-emptively opening up economic activities. At the same time, there will likely be tailwinds from stronger economic activities in developed markets as herd immunity becomes closer to being achieved.

While Covid-19 and vaccination developments, along with expectations of policy direction from the Fed and the People’s Bank of China, could create near-term volatility, investors are likely to increasingly focus on a post Covid-19 growth recovery—especially as vaccinations move the global population closer to herd immunity. As a result, we believe that stock selection will play a bigger role in active return generation in the coming quarters. For instance, component shortages, supply chain dislocations, underinvestment in commodities, and weather-related events have all conspired to create a perfect storm of sharply rising input costs. While companies with dominant franchises in secular growth industries will likely have pricing power to mitigate the resulting cost pressures and look well-positioned to thrive, those with poor or weak franchises with little pricing power will likely suffer from margin contraction. 

Meanwhile, headwinds from Chinese internet companies through additional regulations will likely continue. The current regulatory approach seems to be to develop robust regulatory frameworks for long-term sustainable growth without significantly impeding a recovery from Covid-19. This is also consistent with China’s 14th five-year-plan. And on the geopolitical front, investors are cognizant of, and have mostly factored in, the tension between the U.S. and China returning to focus as economic activities return to normal. Issues such as national security, data ownership, and trade would likely have proliferating effects throughout Asia.
 

A Positive Outlook

Against this backdrop, we are constructive on Asian equities and expect returns in the second half of 2021 to be driven by a substantial recovery in corporate earnings as economies open up, revenues pick up, and margins expand. Going into 2022, we expect the economic recovery to be strong, and even normalize toward 2023. So far, industrial productivity seems have recovered well, especially in tech-heavy markets such as Taiwan, China and Korea. Moreover, external balances for South Asian economies are much healthier than before and are therefore less subjected to foreign exchange movements. At the same time, peak growth levels are due for economies that are just starting to recover from Covid-19 in the region. 

As we look across the markets today, we see particular value in companies that are exposed to key secular growth trends such as technological ubiquity (the 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). The recent share price corrections in some companies have made valuations more compelling, which at times has created opportunities to purchase good companies at attractive prices. 

At Barings, while the stylistic rotations have caused some recent volatility, our approach remains anchored in our Growth-at-a-Reasonable-Price (GARP) investment philosophy. At the stock selection level, this approach ensures that overpaying for a company’s growth is avoided, while at the portfolio construction level, it ensures that the strategy is not overly exposed to factor risks, like particular styles.
 

^{1. Source: Our World in Data. Singapore data as of July 19, 2021, China data as of June 10, 2021.}