4newsletter Q1 2016

13
have a hard landing. The recent rapid growth in Chinese money
supply suggests that Chinese growth is unlikely to collapse in the
near future and could even surprise to the upside in the short
term. That said, support from authorities via cheap credit, strong
investment and a loose monetary policy has the potential to
exacerbate economic imbalances in the medium and long term.
We are neutral on Chinese equities
EMERGING ASIAN MARKETS (ASEAN)
In August of 2015 we saw Asian equity markets fall despite
many countries having strong economic fundamentals. A
number of Association of Southeast Asian Nations (ASEAN)
have built up large foreign exchange reserves and have adopted
flexible exchange rates to protect themselves from a repeat
of the balance of payments crisis that they experienced in the
late 1990s. We therefore believe that the long-term potential
for ASEAN equities remains high, especially now that equity
valuations are low.
Growth in the ASEAN inched up in the final quarter of 2015. The
associations economies accelerated from a 4.5% expansion in
Q3 to a 4.6% increase in Q4. The pick-up partly reflected strong
momentum in Indonesia fueled by government stimulus, as well
as solid expansions in the Philippines and Vietnam.
Despite the slight acceleration in Q4, growth in the ASEAN region
stalled in 2015 at the lowest level since 2009. The economic story
was dominated by external headwinds, especially weak demand
from China and the low-commodity-price environment. At the
outset of 2016, these factors look likely to linger and weigh on
growth prospects again this year.
To boost growth, some governments in the region have turned
to stimulus, such as Indonesia and Thailand. However, in
Thailand, although the government’s measures seem promising,
implementation has been slow. In Indonesia, the low-oil-price
environments, along with a delay in an important tax bill, are
squeezing the government’s revenues, which could affect
stimulus measures going forward. The government is set to
review the budget in May and these realities will likely be taken
into account.
We are overweight ASEAN
EMERGING MARKETS EX – ASIA (EM)
EM’s markets have performed badly in the past two quarters
as many macro and micro issues have led to unfavourable
conditions in many EM countries. The start of US Federal Reserve
interest rate hikes, the changing growth picture in China, falling
commodity prices, and political instability in some of the major
economies, including Brazil, Turkey and Russia have affected the
markets. It’s should come of no surprise that the MSCI Emerging
Markets Index has lost 12.5% since the start of 2015, compared
with a 3.6% fall for the MSCI World (DM) index. Many of these
problems are not actually dissipating but current EM equity
prices meanings that they should not be ignored.
EM equity outperformance has historically moved in tandem
with EM GDP growth expectations and the EM equity index has
underperformed over the last two years. The fall in EM earnings
expectation began in 2011, when the commodity cycle peaked.
Companies in Latin America have seen falling earnings estimates
since then, while emerging Europe (mostly comprised of Russia,
on a market-cap basis) held on to earnings expectations until
the oil price drop in mid-2014. The key catalyst for EM equities
to pick up again is when we see earnings estimates increase. It
is worth noting that the MSCI EM price-to-book ratio (P/B) is at
1.25x, the lowest level since November 2001. Within the index,
P/B valuations vary widely, with India and Indonesia at 2.6x,
Brazil at 1.0x and Russia the cheapest at 0.5x.
Valuations vary dramatically across countries, with India and
Mexico trading at much higher valuations than Russia and
Brazil. Furthermore, current valuations in some countries are
high relative to their own history, while others can be bought at
cheaper valuations than in the past. While valuation alone should
never be the only investment consideration, present valuations
and the underweight position of many investors suggest a
rethink on an emerging market position is warranted. However,
the diversity of the asset class means active management is
crucial.
Weak commodity prices have led to very poor company earnings,
particularly in Latin America and Russia. If EM growth can
stabilise and commodity prices stabilise, investors could turn
again to EM equities, where there are more companies offering
attractive income yields than in any other region. Whilst we
have seen large falls in a number of markets we still may have
further downside movement, so timing is important. There are
however opportunities available with valuations at historically
low levels from an equity and currency perspective, as at these
levels positive returns have historically been seen over the next
12 months.
There are selective opportunities in EM equities
US - We are overweight U.S. large cap equity and
underweight small cap
Europe ex-UK equities - We are overweight - SME’s
being more favoured
UK - We are neutral
Japan - Underweight with a bias for SME’s
China - We are Neutral
ASEAN - We are overweight
Emerging Market ex-Asia - Underweight with selective
opportunities