Meeting the challenges: Investing in Asia Pacific (August edition)

A monthly guide to investing in Asia Pacific financial markets

China's property market challenges, a strong US dollar, recession risks in the US and Europe, and elevated energy prices have put Asia in an uncertain position. The region’s equity and high yield bond benchmarks are down nearly 19% and 22%, respectively, this year.

Asia, as a trade and industrial powerhouse, will have to grapple with slower global demand, in addition to the other headwinds. Local central banks are likely to continue tightening in order to prevent foreign exchange outflows and combat inflationary pressures.

But fundamentals, in terms of balance of payment positions, and real effective exchange rates are in decent shape for economies like Indonesia and Thailand—both of which are among our preferred markets in the region. China, meanwhile, should bounce back in the second half, helping the region grow above 4% for the year.

Given the downside risks, there is still a wide band of potential outcomes. This is therefore an environment to stay diversified with a focus on the opportunities we see in various areas.

First, we remain most preferred on China. We expect the property market crisis, while a risk to near-term sentiment, to be resolved over time. Beijing is acting decisively to bolster banks and support developers’ liquidity to help them resume work, and we think the potential rise in non-performing loans will be manageable for the financial sector.

We expect China’s equity market to rebound as evidence of government support materializes and as the housing uncertainty clears. Within China, we like leaders in the digital economy, consumer services and discretionary, auto, and greentech sectors.

Second, quality income strategies are becoming increasingly attractive. A basket of select Asian dividend stocks can offer a yield of around 7% with solid free cashflow dividend cover. Short-duration Asian investment grade bonds are also preferred; we recommend names with yields over 4% and durations below five years.

Third, the broad slump in stocks has seen valuations of many secular growth companies drop to lower levels. We think now is a good time to gain exposure to Asia’s electric vehicle value chain, as well as the region’s top renewable energy operators.

On the other hand, we would avoid Korean stocks and certain segments within Asia’s IT supply chain, because of the slowdown in global demand. Malaysia is least preferred due to its weak earnings momentum and political uncertainty. We also urge caution on Chinese property bonds and stocks.

Outside of stocks and bonds, we are long the AUD and the SGD—two currencies with hawkish central banks and robust domestic growth—versus the CNY, as well as the SGD versus the TWD. We think investors can also look to capitalize on the drop in oil prices and energy stocks, as constrained supply should push prices up despite the slowdown in demand growth.

The markets will remain volatile over the months ahead. But there are areas in Asia that offer shelter to ride out the storm.

Written with?Mark Haefele, our Chief Investment Officer.

How to invest

Equities

• Near-term opportunities and risks. We favor China’s consumer discretionary sector (including the sportswear), select China internet platforms, and other Asia reflation names. We are cautious on companies with weak pricing power (particularly in staples and industrials), as well as cyclical hardware & storage and unprofitable tech stocks.
• Quality dividend names: Given the slowing macroeconomic backdrop, we like select dividend stocks with ample free cash flows for their attractive risk-reward. These include telcos, REITs, select banks, and consumer stocks.
• Secular themes, including leaders in Factory Asia 4.0 (5G+, greentech, automation & robotics) and the ABCs (AI, Big Data, Cybersecurity) of tech.

Bonds

• Prefer Asia IG names that offer 4% yield for not more than five years.
• Within the IG space, recent A/AA issues with less than five-year duration offer value.
• Very selective in HY – prefer select commodity players and non-China names.

Commodities

• Prefer actively managed commodity strategies versus passive indexes.
• Long “longer dated” oil contracts and energy equities.
• With select commodities likely to rebound, we recommend selling the price downside risks for a fixed yield.

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