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Regional Outlook – Asia Yoji Takeda Director & V.P. RBC Investment Management (Asia) Limited Following a market recovery in the first quarter of 2012, Asian investors are contending with mixed prospects for global growth. Valuations have recovered from the deeply discounted levels of last autumn, albeit based on relatively conservative estimates. Until there is more clarity in the outlook for Eurozone stability and Chinese growth, we would remain slightly defensive in terms of our portfolio posture. Three key factors have been weighing on Asian equity markets during the last few quarters: the sluggish U.S. economy, Chinese economic policy and Europe’s sovereign-debt problems. Further out, U.S. presidential elections in November may provide a positive catalyst, but economic growth will remain anemic and the issue of the “fiscal cliff” remains. In Europe, Germany and other continental exporters are exposed to the possibility of lower foreign demand while the peripheral countries try to stabilize their debt situations. Gradual policy easing in China and other Asian countries is probably the only nearterm potential positive. Following the relative calm of the past few months, market volatility may increase, and this heralds a slightly negative global backdrop for the next few quarters. In China, the slower-than-expected pace of policy easing continues to disappoint investors. So far this year, economic statistics have been weakening, with the latest data from April being the worst this year. Growth in industrial production slowed to 9.3% year over year from 11.9% in March. The direction of the slowdown was consistent with the government’s new official target of 7.5% and its plan to reduce inflationary expectations. Last year’s tight monetary policy successfully reduced the inflation rate, and the government is, therefore, easing gradually. As a result, new bank loans increased by $1 trillion in April, or 15% year over year, and in mid-May, Asia Recommended Sector Weights RBC Investment Strategy Committee May 2012 Benchmark MSCI Pacific May 2012 Energy 2.0% 2.8% Materials 10.5% 10.8% Industrials 16.0% 16.0% Consumer Discretionary 15.5% 14.3% Consumer Staples 7.5% 6.4% Health Care 4.8% 4.7% Financials 29.6% 29.8% Information Technology 8.6% 7.8% Telecommunication Services 3.0% 3.8% Utilities 2.5% 3.7% Source: RBC GAM Japan Datastream Index Equilibrium Normalized Earnings and Valuations 1000 717 514 368 264 189 136 Jun. '12 Range: 146 - 347 (Mid: 246) 97 Jun. '13 Range: 333 - 793 (Mid: 563) 70 Current (01-June-12): 224 50 1980 1985 1990 1995 2000 2005 2010 2015 SAMPLE Source: Datastream, Consensus Economics, RBC GAM the government cut the bank reserverequirement ratio to spur lending. The government is also starting to follow a slightly expansionary fiscal policy. Continued easing in monetary and fiscal policy will likely depend on macroeconomic data, as China moves toward a leadership change later this year. The risk of a hard landing or crisis stemming from local-government debt 60 I The global investment outlook RBC INVESTMENT Strategy coMMITTEE Summer 2012
Regional outlook – Asia • Yoji Takeda seems low, as the government’s deep pockets mean it is likely equipped to deal with either situation. Stock valuations are still below the historical average, and some moderate upside is expected as policy support builds confidence for sustained growth in the economy. Japanese markets caught up with their U.S. and Asian peers during the first quarter of this year, thanks to the Bank of Japan’s surprising step to ease monetary policy and the positive effect on exports of a weakening yen. However, the market continues to display a tendency to move with the yen and gave back a large portion of its recent gains when the currency strengthened. Corporate earnings in fiscal 2011 fell by about one-third due to the March 2011 earthquake and subsequent rise in the yen, as well as floods in Thailand and weakening global demand. Earnings in fiscal 2012 should snap back, with gains expected in both the current fiscal year and the next one. During the tough environment in place since the financial crisis, Japanese corporations have made significant progress in reducing costs to counter much lower yen-denominated revenues, supply-chain problems and higher raw-material costs. The lower cost base will boost profits as revenues normalize this year, resulting in stronger cash flows on top of already high cash balances. This will likely result in dividend hikes and increased share buybacks. With the support of a strong recovery in earnings, we anticipate modest gains in the second half of 2012, although the market will continue to be affected by currency shifts and global risk appetites. In addition, political turmoil could overshadow higher profits in the near term, as the government of Yoshihiko Noda may have to contest late-summer elections for the lower house of Parliament. With the global economy slowing, stock markets in both South Korea and Taiwan have failed to regain levels reached before the market downdraft that started in August 2011. That said, valuations are not deeply discounted. Moderate upside can be expected in the near term as long as export demand from China picks up and/or earnings from companies with a domestic focus improve with policy easing. The economies of both countries continue to benefit from robust overseas demand for high-end electronics such as smartphones and tablets. South Korea also enjoys strong auto-related exports, particularly to the U.S. On the flipside, domestic sectors and exporters of flat-panel displays and computers remain weak in both countries. Raw-material exports such as chemicals and steel products are also weaker. Inflationary pressures are easing and there is room for some monetary stimulus, as government-set interest rates in both countries have not been cut since they started rising in 2010. There are some policy risks, however. In South Korea, elections set for December suggest that economic policy will favour social welfare over the interests of the “chaebol” industrial groups that dominate the economy. In Taiwan, the government is preparing to introduce a capital-gains tax on equity investments starting next year, so any meaningful market gains will have to wait until better global demand produces a recovery in exports. The Australian market has performed in line with its peers so far this year, but with less volatility. The market is supported by high dividend yields, which are somewhat offset by recent weakness in the Australian dollar. The economy continues to diverge, with a strong mining sector contrasted with weak domestic sectors. But with Chinese demand growth moderating, even mining investments are likely to be hurt. Weak domestic growth and relatively benign inflation prompted the Reserve Bank of Australia to cut its benchmark interest rate in early May by a more-than-expected 0.5%, pushing the currency below parity with the U.S. dollar. Monetary easing is likely to continue to ensure the economy remains healthy. Although we do not expect much downside, equity valuations are closer to more normal ranges, and profit growth will be needed to justify higher P/E multiples. SAMPLE The global investment outlook RBC INVESTMENT Strategy coMMITTEE Summer 2012 I 61
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The Global Investment Outlook RBC I
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Contents Executive Summary 2 The Gl
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Executive summary • Sarah Riopell
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Recommended Asset Mix Asset mix - t
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Recommended Asset Mix Balanced Asse
Page 11 and 12: Capital markets performance • Mil
Page 13 and 14: Global Investment Outlook Eric Lasc
Page 15 and 16: Global Investment Outlook • Eric
Page 37 and 38: Global Fixed income markets • Soo
Page 45 and 46: Currency Markets Dagmara Fijalkowsk
Page 47 and 48: Currency markets • Dagmara Fijalk
Page 57 and 58: Regional outlook - U.S. • Ray Maw
Page 59 and 60: Regional outlook - CANADA • Stuar
Page 61: Regional outlook - Europe • Domin
Page 65 and 66: Regional outlook - emerging markets
Page 67 and 68: Eric Lascelles Chief Economist RBC
Page 69 and 70: This report has been provided by RB
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