Year-to-date, three of the five best-performing stock markets in Asia are in Southeast Asia. Adjusted into US dollars, their total returns are between –0.7% to –12%. The region lifted Covid-19 restrictions in the last few months only, so is experiencing post-pandemic demand now.
We expect it to remain resilient despite monetary tightening and global recession risks. Over the last 34 years, in previous periods of heightened recession risk in the US and rising bond yields, Southeast Asian markets outperformed.
Current factors that would support a firm showing include a boost from international re-opening (which has lagged domestic re-openings), a buffer provided by commodity prices like palm oil, rubber and rice, whose prices are still 20% to 50% higher than their 10-year averages; inflation that is relatively benign, and last but not least, a less aggressive rate hike and tightening cycle compared to the US.
We are positive on all Southeast Asian equity markets under our coverage, with a preference for Singapore, Indonesia and Vietnam.
A resilient 1H 2022 showing
While not immune to global equity risk aversion, Southeast Asia still managed to outperform world markets in 1H. Indonesia (up 2.4% in local currency price return terms, down 0.67% in US$ total return terms) is one of a handful of markets still in positive territory on a ytd basis, while three of the five best performing markets in Asia in USD total return terms (Indonesia, Singapore and Thailand) are from the region.
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The resilient showing has been underpinned by continued progress in re-opening. The pace of internal re-opening galvanised domestic demand and brought economic activity in Southeast Asia back to pre-Covid-19 levels (Thailand being the exception). A recent significant easing of border restrictions is expected to be an additional tailwind in coming months.
While Emerging Asia has seen net selling of US$50 billion ($70 billion) by foreign investors ytd, Southeast Asia has seen inflows.
Global slowdown and inflation are risks in 2H
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A more challenging global macroeconomic outlook is expected to pose risks in 2H. Central banks’ fight against inflation is likely to come at a cost to growth, with economists from Julius Baer ascribing a 15% to 25% probability of a recession in the US in the coming twelve months. Final demand from the ‘Big Three’ export markets — the US, Europe and China — makes up 44% of Southeast Asia’s external final demand and 14% of its GDP. The region will therefore not be immune to the effects of a slowdown.
The uptick in inflation also bears watching, with the drivers of inflation now shifting from higher energy prices, at the beginning of 2022, to rising food prices. Besides the hardship caused to millions, rising core inflation caused by higher food prices is likely to add urgency to central bank tightening and the pace of policy rate hikes. Growth tends to be negatively impacted as inflation hurts real consumer spending.
Still poised to outperform
While Asian equities typically deliver negative price returns when there is a high risk of recession in the US and rising 10-year US bond yields, analysis going back to 1988 has shown that Southeast Asia tends to outperform in such a scenario, with Indonesia delivering positive quarterly price returns and the Philippines, Thailand, Malaysia and Singapore posting price performance that — while negative — still compares favourably to the even more negative returns of North Asian markets.
In the current context, a number of mitigating factors supporting continued outperformance of Southeast Asia are also worth mentioning, and include:
Positive boost from border reopening: Compared to domestic re-opening, international opening is still in its early stages as quarantine-free entry for vaccinated travellers was only allowed in most countries from April onwards.
The boost that this should give to demand and supply could deliver significant impulses to activity over the next half a year. Markets for which tourism is a key contributor to GDP for example Thailand and Malaysia, should enjoy increased demand, while border easing should ease labour supply bottlenecks for markets like Singapore.
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Buffer provided by high commodity prices: Commodities account for a sizable proportion of exports for a number of Southeast Asian countries.
For countries with high oil and gas exports, such as Malaysia, higher oil and gas prices should support fixed investments via more capex spending. For countries with more palm oil exports, namely, Malaysia and Indonesia, we expect a positive spillover effect on rural consumption as a result of record crude palm oil prices. The possibility of higher rice prices in Thailand and Vietnam, as per media reports that both economies are in talks to raise rice prices, could lift rural incomes in these markets. Both countries, together, account for a quarter of global rice exports.
General inflation that has been more subdued: Inflationary pressure brought about by the recovery in domestic demand in Southeast Asia has not been as significant as in the US as fiscal transfers to households have not been as substantial.
Additionally, the re-opening has been delayed and only just started to take off, with social distancing requirements and travel restrictions only removed fully in the last several months. Supply chain disruptions in Southeast Asia have also been less damaging as the region experienced fewer infrastructure bottlenecks (like ports, for instance). In addition, producers in the region tend to be located at the upstream end of supply chains, and are hence less disrupted than those downstream as shortages escalate.
Food inflation that is still generally benign: While food inflation has been trending up in Southeast Asia, core inflation has not yet breached respective inflation targets. Compared to wheat prices which have spiked, the price of Southeast Asia’s main staple — rice — has only risen moderately since the start of 2022 and is still below its 2021 peak. Global stocks of rice remain relatively ample. In fact, the stocks-to-use ratio for rice since 2019, at over 30%, is much higher than it was in the run-up — and during — the 2008 food crisis.
Central bank rate hikes likely to lag the US: Southeast Asian central banks are expected to lag the Federal Reserve. Their aim is to reduce the degree of monetary accommodation needed to support the ongoing recovery, rather than embark on tightening per se.
The street expects up to five more rate hikes in the Philippines from 2H 2022, three in Thailand, four in Malaysia and three in Indonesia. The Singapore central bank is the only exception, with off cycle tightening expected, so as to keep inflation in check.
Investment implications
We are positive on Singapore, Indonesia and Vietnam, and would view them as core positions for Southeast Asian portfolios.
Singapore enjoys strong economic growth and offers investors the added tailwind of a strong currency on the back of policy tightening. Vietnam is the most immediate beneficiary of supply chain diversification out of China and is well positioned for a rebound, as it is the worst performing market in Southeast Asia. Meanwhile, Indonesia should benefit from higher commodity prices, with the most potential for continued recovery post Covid-19, as domestic demand has yet to fully return to pre-Covid-19 levels.
We are also positive on Malaysia and the Philippines as near-term hiding places, although in the longer term, key risks to watch for these markets are twin deficits for the Philippines and political risk (from the possibility of an early General Election in August) for Malaysia.
Separately, some exposure to China may be worth considering. China led in the recovery post the Covid-19 pandemic and led in the downturn underway. It now appears to be bottoming. After a year of weakness, we see merit in an investment case built around its growth supportive policy environment, well controlled inflation, fading policy risks and cheap valuations.
Mark Shirreff Matthews is head research Asia, and Jen-Ai Chua is an equity research analyst Asia at Julius Baer
