Asian Equities: A Positive Long-term Outlook, But Risks Remain

The decline in Asian equities so far this year sets up 2022 to be one of the worst annual performances since the Global Financial Crisis. However, despite this dismal market performance and the current downgrade cycle, market consensus continues to expect mid-single digit earnings growth for 2023. While this may be encouraging, recent macroeconomic developments and geopolitical movements—including the U.S. high-tech export restrictions to China—pose ongoing downside risks to earnings expectations.

Headwinds on the Horizon

The severe correction in equity markets this year was driven primarily by the confluence of unprecedented macroeconomic and earnings risks. Going forward, the aggressive pace of U.S. Federal Reserve (Fed) tightening, a global liquidity contraction and a strong U.S. dollar could further elevate risks. In addition to this, we believe the global economy lacks a growth engine heading into 2023. Global growth looks increasingly challenged, with inflation-busting interest rates and soaring energy costs threatening to send both the U.S. and EU into recessions. Meanwhile, China’s economic growth recovery is expected to remain tepid due to its reluctance to pivot away from the dynamic zero-COVID policy, at least until the second quarter of next year. And while inflation in emerging markets (EM) Asia is at reasonable levels, a number of countries (excluding China) are being forced to synchronize their monetary policies with the Fed to avoid a free fall in their local currencies. Further, geopolitical tensions between the U.S. and China and the resultant uncertainty could dampen near-term capital expenditure investments—which will likely accelerate the investment in supply chain bifurcation. 

A More Positive Long-Term Outlook

While the near-term fundamental outlook looks less positive, and markets are expected to remain volatile in the coming months as investors seek and price in the peak in interest rates, there are reasons to believe the long-term outlook is more constructive. For one, the Fed will likely be closer to the end of its tightening cycle by early to mid-next year, and that should help ease headwinds on Asian equities from a strong U.S. dollar. Secondly, in China, the 20th National Congress of the Chinese Communist Party is expected to confirm China’s senior leadership for the next five years. This should lead to better coordination of growth-oriented supportive policies and implementation of structural reforms. Further, a potential pivot away from China’s dynamic zero-COVID policy next year will likely improve growth momentum of the Chinese economy.

Select Opportunities Emerge

ASEAN companies have proven to be resilient in this year’s sell-off, and earnings revisions have been strong relative to broader Asia this year, in part supported by strong commodity prices. Current account balances for key ASEAN countries such as Singapore, Indonesia, Malaysia and Thailand are expected to improve on the back of commodity exports and a recovery in tourism, supporting their economic positioning and mitigating some of the impact from a strong U.S. dollar. Like ASEAN, India is expected to benefit from secular tailwinds including a large and youthful domestic population, and many Indian companies are beneficiaries of the supply chain diversification theme. While valuations in the Indian market appear to be expensive after solid relative outperformance, we continue to find interesting bottom-up opportunities where solid growth can potentially be sustained due to an under-penetration of certain goods and services.

In Korea and Taiwan specifically, current valuations of leading tech companies are depressed at cyclical downturns despite their compelling secular long-term growth outlook. The tech industry’s capital expenditure reductions planned for 2023 will likely set the stage for another supply-demand imbalance in time to come. We believe that the structural growth story in the tech sector remains solid despite near-term cyclical headwinds—and attractive opportunities are likely to emerge on a longer-term basis.

Against this backdrop, we see value in companies that are exposed 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). The recent share price corrections have made valuations more attractive, and we continue to look for opportunities to purchase good companies at attractive prices.

At Barings, while the stylistic rotations have caused some recent volatility across markets, 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.