Despite attractive historical valuations, global mutual funds remain underexposed to Asia and emerging markets (EM), according to BNP Paribas Asset Management. Its head of Asia and global EM equities Zhikai Chen points out that foreign institutional investors have net sold US$111 billion ($155.9 billion) in EM Asian markets (excluding China) since the MSCI EM Asia index peaked last year.
“Quite a bit of money has been pulled out of the EM Asia markets, and this has been reflected in how our valuations in Asia have corrected. MSCI Asia is currently trading at about two P/E points below its 10-year average, while MSCI EM is trading about three P/E points below its 10-year average. There are substantial discounts to valuations in Asia at this particular time,” says Chen.
Despite a weak macro backdrop, Asia earnings has posted positive surprises — with North Asian economies such as South Korea (56%), Thailand (56%) and Taiwan (51%) having the most number of companies beating consensus estimates, the French banking group found.
Chen says: “On a bottom-up basis, a lot of these companies are still seeing a significant tailwind from the price increases that they saw previously. [However], a lot of the attention is pulling forward towards what investors expect to see for the remaining part of the year and the year ahead.
“Given the situations that we’re seeing in the developed world, it is probably not surprising that in South Korea and Taiwan, the tone has become a bit more conservative — and to a certain extent, perhaps a bit bearish given the demand outlook.”
So-called “idiosyncratic” sector opportunities in Asia EM equities identified by BNP Paribas include those in energy and materials, no thanks, or, thanks to the energy crisis in Europe.
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“Oil prices have surged significantly this year, as well as all sorts of hard commodities. That naturally helps EM non-Asia, particularly EM Latin America (Latam) and EM Middle East that’s represented by Saudi Arabia, UAE and Qatar, given their natural resources endowment.”
The firm also likes financials — Chen explains that banks with exposure in emerging economies were compelled to increase their provisions during the height of the Covid-19 pandemic. There was also extraordinary fiscal and monetary support across the globe, including EM economies which created a condition where the anticipated asset quality cycle during the pandemic did not occur, he says.
"This provides a significant cushion from the economic activity drop in 2020. And as a result, even by the end of 2020, it was very clear that a lot of the provisions that the banks were providing were not needed. So we have seen the reverse of those provisions in 2021, which saw EPS accelerate from the 2020 levels, and that’s continuing in 2022.”
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With the additional tailwind of the economic reopening in EM Asia, loan growth is also accelerating across the board in markets such as Indonesia, the Philippines and Singapore. Chen says this paints a fairly good top-line picture for banks, particularly those in deposit-rich economies like Singapore and Hong Kong.
‘Stormier’ outlook
Nevertheless, the broader economic picture has its share of challenges. Three months ago, when recessionary fears had just cropped up, BNP Paribas’ view was that it was overdone. In particular, it thought that the US was much more resilient, says BNP Paribas head of EM research Asia Pacific Siddharth Mathur.
“Now, I think the outlook has become a little ‘stormier’ — it’s undeniable that there are many storms on the horizon. We’ve got to the effect of policy tightening across the developed world, we’ve got energy shocks impacting the European economies. In China, we’ve got zero-Covid policy being a big headwind while the property market issues are still not resolved,” he says.
Due to these, the firm’s global growth outlook has evolved to be a little bit more negative, says Mathur. He adds that inflation, which will remain the main theme in the next 12 to 18 months will be tamed but not defeated. This will have implications on central banks policies, as the firm believes there are more rightenings to come and rates would be higher for longer.
While the forward-looking indicators point to a further deceleration in US growth over the coming quarters, the still-solid labour market and substantial excess savings should prevent a full-blown recession from materialising in the US in the short term.
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“We think those will provide good support to the US’s slower, definitely below-trend growth. That’s what policymakers want, by the way, because we think it will take a long time of below-trend growth to soften inflation. However, we do not think a recession is likely,” says Mathur.
Europe, meanwhile, is a different story. From Mathur’s perspective, the energy crisis in Europe is serious and a recession is inevitable for the rest of this year. That said, the firm does think that it will be somewhat “shallow” and that there is a potential going to the end of 2023 for Europe to start to do better.
Over at the EMs, rates have already been hiked quite substantially, says Mathur. Inflation had been so high in Central and Eastern Europe, Middle East and Africa, Latam and Asia that central banks have had to respond, he adds.
While most emerging economies are close to cycle peaks in benchmark rates, BNP Paribas still sees further hikes by several major EM central banks. Southeast Asian central banks, for example, are likely to hike further, albeit gradually, to take rates back to neutral. Despite the significant hiking cycle and the impact on domestic economies, the firm does not expect substantial rate cuts in 2023, with inflation proving sticky.
EM currency clusters
In terms of currencies, BNP Paribas is bearish on GBP as the UK’s large current account deficit and low real rates would lead to the currency’s continued weakness. On the other hand, the firm is being bullish on the AUD as the currency’s external flow picture appears positive and higher energy prices continue to support its terms of trade.
“We’re ‘patiently’ bullish on USD/JPY, we think we are heading close to a peak. This has nothing to do with expectations of intervention from the Bank of Japan, and instead has everything to do with the US rates, which we think are also close to a peak,” says Mathur. The yen is now at its lowest level versus the greenback in 24 years.
Meanwhile, the firm is also of the belief that EM commodity exports will outperform DM [developed markets] commodity exporters over the next six to 12 months, reflecting greater terms of trade sensitivity. “Digging deeper into EM, it used to be a very homogeneous asset class, but this is no longer the case. In fact, there is now fairly substantial differentiation in the asset class — this has to do with several factors including very different inflation trends and wide divergence in terms of trade,” says Mathur.
BNP Paribas’ analysis shows that there are three EM currency clusters: the commodity cluster which includes BRL and MXN; the euro cluster which includes CZK and HUF; and the Asia cluster which includes MYR, KRW and PHP. Previously, the Asian cluster has been mainly driven by the USD. In recent years, however, it has become idiosyncratic, Mathur highlights.
Within the Asia cluster, the firm likes differentiation with respect to trade baskets and external accounts. “We like, for example, the THB, IDR, and SGD. And against that, if we were to do relative value trades, we would fund these positions out of currencies in North Asia — we think KRW and TWD have the potential for more depreciation,” says Mathur.
