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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.
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The global investment outlook RBC INVESTMENT Strategy coMMITTEE Summer 2012 I 61