Earnings growth for Asean equities had been more resilient in 2022 and is forecast to remain so in 2023, Boston-based investment firm Cambridge Associates (CA) highlights in its Asean equities report.
CA’s regional head for Asia Aaron Costello and associate investment director for capital markets research Vivian Gan point out that Asean’s sectoral overweight to financials as well as its underweight to growth and technology sectors imply that corporate profitability has lagged that of its emerging markets (EM) and Asia ex-Japan counterparts in recent years.
As at Dec 31, 2022, the trailing 12-month return on equity to Asean equities was 9.4%, versus 12.9% for EM equities and 10.6% for Asia ex-Japan equities.
In recent years, however, Asean’s banking profits are holding up while the region’s broader equities have been supported by the reopening of the tourism sectors as well as a rise in commodity prices, the latter of which is favourable for commodity-exporting countries such as Malaysia and Indonesia.
Costello and Gan note that analysts are forecasting Asean earnings per share to grow 31.3% in US dollar terms in 2022 and 14.3% for 2023 — significantly higher than their global counterparts. The earnings per share growth estimate for Asia ex-Japan, for example, is 5.7%.
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Asean was a relative safe haven for investors in 2022. In local currency terms, Asean equities returned -0.1% last year, outperforming Asia ex-Japan and developed markets (DM) equities — both of which were down more than 15%.
“While Asean currencies have been under pressure, the market has also held up in US dollar terms, returning -4.1% for the year compared to Asia ex-Japan equities, down 19.4% and DM equities, which returned -17.7%,” they add.
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Due to its sectoral overweights and underweights, the Asean market has been insulated from the recent China tech crackdown and equity sell-off, on top of being less sensitive to rising rates which have impacted the South Korea and Taiwan technology sectors.
Improving earnings expectations for the region have also helped to offset the drag from a compression in valuation multiples caused by higher inflation and global central bank tightening, Costello and Gan say. Furthermore, Asean banks have seen stronger earnings in 2022 as the region’s interest rates moved higher in tandem with the US’s rates.
The market is also overweight to other cyclical sectors such as industrials and real estate, which have benefited from the economic reopenings and domestic market rebound.
Valuations and currency impact
Unlike in 2013, when valuations for Asean equities were at elevated levels, valuations are now at low levels, CA highlights. This is in part due to the past few years of muted performance.
Asean equities currently trade at an average return on equity-adjusted P/E of 14.2x, which is the 27th percentile of historical observations while valuations relative to global equities also remain low at the 29th percentile of historical observations. Although there is dispersion at the country level, absolute valuations for all regions are below the historical median — except Thailand which trades close to fair value, Costello and Gan say.
“Given the past few years of political turmoil, valuations for Malaysian equities are depressed at the 8th percentile. However, there is upside market potential if newly appointed prime minister Anwar Ibrahim can maintain stability within his coalition government and drive investor confidence,” they add.
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While the dataset for Asean equities is relatively limited, the market is very sensitive to global economic downturns. Valuations have collapsed during these instances — such as in the years of 2001, 2008, and 2020 — before rebounding sharply.
Valuations relative to global equities, on the other hand, have tended to move in longer cycles. Current levels of valuations, both in absolute and relative terms, suggest that there could be further upside to Asean equities in the near term. This bars any global recessionary shocks, say Costello and Gan.
With regards to the currency component, CA notes that Asean equities were hit hard during the 2013 taper tantrum due to foreign investor outflows. It is then expected to face similar pressure amid the US Federal Reserve’s (Fed) tightening regime.
“Over 2022, Asean currencies were indeed down 5.1% on average against the US dollar, although this compares favourably to the euro (-6.2%), pound (-11.2%), and yen (-12.7%). The Singapore dollar in particular managed to appreciate 0.5% against the US dollar in 2022, as the Monetary Authority of Singapore aggressively tightened policy to combat rising inflation,” Costello and Gan say.
Questioning whether Asean currencies can remain supported, Costello and Gan point out that real exchange rate valuations for Asean currencies versus the US dollar have declined from the elevated levels seen in 2013 — the currency basket now looks cheap relative to history.
They add that the region’s current accounts should remain supported by the continued reopening of tourism sectors, as well as a rebound in the Chinese economy and demand following the lifting of its zero-Covid policy.
However, real-yield differentials between Asean and the US have narrowed in recent months, which could erode the support for the region’s currencies, CA further notes. This comes as inflation in the region ticked up over the second half of 2022 and as the Fed moved aggressively to tighten policy while some Asean central banks such as Bank Indonesia and Bank of Thailand were slower to do so given their focus on economic recovery.
Favourable tailwinds
Some concerns regarding Asean equities include the relatively smaller size of the market. With a free float market cap of only US$622 billion as at Dec 31, the market is one tenth the size of broader emerging markets, Costello and Gan specify.
“However, we do highlight that the Asean market is not as illiquid as one may perceive, in terms of the average size of the company as well as the trading volume, both of which are comparable to that of the EM universe,” they add.
In the long-term, the region stands to benefit from further US-China decoupling, as companies seek to diversify their supply chains away from China. The pace of change will depend on how quickly and successfully Asean countries can develop the required supporting infrastructure to bring down logistics costs, which are currently high relative to China.
“The increased internet availability in Southeast Asia such as Indonesia and Vietnam has created more interest in venture capital areas such as consumer tech, fintech, and software-as-a-service. This could result in a longer-term shift in the sectoral composition of the region and boost corporate earnings and profitability.
“China’s sharp pivot from its zero-Covid policy could drive a reversal in foreign investor fund flows from Asean and into China, and thus reverse recent performance momentum. However, China’s reopening will ultimately support growth in the region as a whole. Over the longer term, Asean markets seem to have favourable tailwinds and may continue to see increased investor interest,” they conclude.
