Investors should strike a balance between investing in China’s value cyclical and reopening beneficiary equities as the country shows nascent signs of recovery coupled with continued liberalisation, says UBS regional CIO Kelvin Tay.
These value cyclical stocks include those operating within the energy sector and selected names in telecommunications and banks, as well as metals, mining and construction materials. Meanwhile, the reopening beneficiaries include digital economy, consumption, automotive and electric vehicle supply chain, tech and industrial as well as renewable energy counters.
Speaking at the bank’s 2022 mid-year outlook presentation on July 5, Tay says the best entry point for equities in general is in a stock market where the GDP and earnings growth has bottomed and recovering, stocks are cheap, investors are bearish and policymakers have turned stimulative. Where these criteria are concerned, China has certainly “ticked all the boxes”, he adds.
Citing the Goldman Sachs Financial Conditions Index, Tay notes that financial conditions in China are easing, while the US and the Euro area are seeing tightening financial conditions. The stock market has also outperformed — in June, the S&P 500 was down 8% while MSCI China was up 6.2%.
Since its March low, MSCI China has rebounded by almost 30%, Tay highlighted. “And even then, the market is actually not expensive — it is still trading at near bargain basement valuation matrices,” he adds.
In China, policy easing has been gradual instead of a big bang approach. Its cut of reserve requirement ratio, for instance, stood at 25 basis points year-to-date while over 100 cities have relaxed property purchase restrictions with 20bps cut off the benchmark loan prime rate for first time homebuyers.
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“The Chinese are not accustomed to cutting interest rates down to zero in one weekend, or expanding the balance sheet by about US$4.5 trillion ($6.2 trillion) to US$5 trillion in just a couple of months. The gradual easing suits the market very well and in fact a lot of flexibility and autonomy is actually given to the provinces.
“Interestingly in 2020, despite Covid-19 raging in the first quarter, the Chinese government only stimulated up to 5.3% of its GDP where fiscal policy is concerned. That compares with the 20% we had in Singapore, Germany and the US. You can actually understand why inflation was pretty much under control in China unlike what is happening in the US,” explains Tay.
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China has also seen nascent signs of recovery. This includes 100 biggest property developers seeing new home sales up 61.2% month-on-month, which Tay describes as “unsurprising” given the continued underlying demand for property amid the ongoing pandemic.
On June 29, China’s Ministry of Industry and Information Technology removed the asterisk that was previously added to a person’s travel e-card if they have travelled or stayed in a city that had recorded Covid-19 cases in the past 14 days — restricting them from travelling to certain regions and cities.
After the removal, searches for cross-provincial travel surged fivefold on travel services portal Trip. com, Tay says. “Removing the asterisk means a removal of a huge barrier to domestic consumption in China.”
Other signs of recovery include targeted fiscal policy measures at provincial level such as Shanghai’s 50-Step economic package and Guangzhou’s RMB8,000 ($1,656) subsidy per eligible new energy vehicle purchase,relaxation of zero-Covid-19 policy to seven days of central quarantine and a week of home isolation, and its National Press and Publication Administration approving the release of domestic games in April and June.
Not all bad news for Asia
China has continued on the path of liberalisation, as priority shifts to growth. Tay says that the number of industries on China’s negative list for financial market access has actually dropped to 31 in 2021, from as high as 62 five years ago in 2017. The country’s property market has also likely stabilised, as Tier-1 cities have seen an uptick in price and volume.
Meanwhile, inflation is on the rise in Asia ex-Japan, and figures from UBS and economic data provider CEIC show that as of early July shows that Thailand, India, Singapore and South Korea recorded the highest headline consumer price index (CPI) at 7.1%, 7.04%, 5.6% and 5.4% y-o-y respectively.
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China, the Philippines and Singapore also recorded the highest energy inflation at 28.4%, 28.3% and 22.4% respectively. Meanwhile, Taiwan, Indonesia and Thailand recorded the highest food inflation at 6.9%, 5.3% and 4.8% respectively.
Food is a bigger component of CPI in Asia ex-Japan, says Tay. In India, Philippines and Thailand, the weightage of food in the CPI basket stood at 48%, 46% and 40% respectively. “It is easier for me to tell you to drive less and take public transport, but I cannot tell you to eat less. Therefore, where food inflation is concerned, some of these countries have it really hard because it is difficult to control.
“What some governments have done is to implement price ceilings and price controls. Malaysia is one of the countries that are doing this in a big way and we do expect the fiscal deficit in Malaysia to jump significantly when the government announces the budget in November this year,” says Tay.
Are wages growing at a pace of beating the inflation in Asia-ex Japan? Not really, says Tay. In fact, the real wage growth y-o-y across some countries like Indonesia, Taiwan, Malaysia and Thailand are actually in the negative at –1%, –0.8%, –0.4% and –0.1% respectively as at 1QFY2022. Tay says that higher food prices may affect income more, which may result in a cut in discretionary spending which may impact the margins of certain companies.
But investors cannot be negative on Asia ex-Japan as it is not all bad news — aside from being “quite sheltered” from the negative news in Europe and US, Asia’s trade share is also poised to grow further in the next decade, Tay says.
Additionally, foreign direct investments (FDI) are coming back to Asia ex-Japan after a Covid-19 pause. Tay also notes that Malaysia has recorded a surprisingly prominent amount of net FDI inflow, coming from many years of negative FDI growth. This year, the amount of FDIs approved in Malaysia stood at US$72 billion.
The bulk of the flow was into Penang, famed for its strong electronics manufacturing base, and seen as a draw as companies reconfigure their supply chains in a bid to diversify from concentration risks in China, Taiwan and Vietnam.
Asia ex-Japan stocks are also cheap: Tay says the region’s stocks are trading at near crisis levels, priced at 11.3x 12 months forward P/E, below its historical median of 12x. On average, Asia ex-Japan P/B bottomed at around 1.2x, compared with the current level of 1.3x. Meanwhile, Asean stocks are valued at 13.4x 12 months forward P/E, in line with historical median valuation.
Indonesia and Thailand are two countries UBS likes in terms of its exposure within the region. “To us, this market is very attractive at this level and we think investors need to have Asia ex-Japan in their portfolios,” adds Tay.
Build long-term portfolios
In the second half of the year, there is no base case scenario of whether the market would go towards stagflation, reflation, soft landing or a slump. Hence, investors should look at building a robust portfolio that can grow regardless of where the economy is heading, says UBS Global Wealth Management head chief investment officer Asia Pacific Tan Min Lan. This involves taking steps to protect against the risk of stagflation and economic slump, as well as positioning for opportunities that could arise in a soft landing or deflationary scenario.
A very important first step is to build and manage liquidity buffers, which should be sized to meet three to five years of cash flow to mitigate the risk of forced selling, earn yield and capture opportunities as it arises, she says. The liquidity portfolio can consist of a mix of cash, short duration bonds and structured investments.
Meanwhile, hedge funds can deliver performance even when stocks and bonds are falling in the stagflationary environment, adds Tan. For example, in the current year up to May, the benchmark hedge fund index was down by less than 3% compared to 12.8% for MSCI All Country World Index and 11.1% for the Barclays Global Aggregate Bond index.
The next step is to improve the resilience of one’s equity portfolio. To manage the risk of a more significant slowdown in economic activity, investors can add their exposure to “defensives” such as the healthcare sector as well as quality stocks, says Tan.
Investors should also consider investing in value stocks. UBS’s analysis shows that when inflation is above 3%, value stocks outperform growth stocks, regardless of the stage of the economic cycle.
“Additionally, despite their recent outperformance, value stocks are still trading at a PE discount of about 47% to growth stocks globally, versus an average historical discount of around 29%,” she adds.
Finally, investors should take advantage of the sell-off by building long-term positions in areas where structural fundamentals remain intact. They should also look at investing in the private markets, as investing in private equity following public market declines has historically been associated with strong returns.
“The average return on global growth buyout funds that are launched a year after a peak in public markets has actually averaged at around 18.6% per annum,” says Tan. Striking the right balance between protection and growth is personal to each investor, she concludes. “And in uncertain times like this, we need to take proactive steps, both to manage the potential fallout and also to capture opportunities that could arise.”
