Pacific Basin Market Overview
Nomura Asset Management
October 10, 2012
Regional equity markets remained largely directionless and volatile during the third quarter amid the summer trading lull. Government policy action towards the end of the quarter triggered the biggest market moves. However, the euphoria was short lived following the announcements of the European Central Bank’s (ECB) Outright Monetary Transactions (OMT) and the Federal Reserve Board’s (FRB) third round of quantitative easing (QE3). Instead, investors remained worried about China’s economic slowdown and the stubborn absence of growth in the developed economies. The MSCI AC Asia Pacific Free Index including Japan strengthened by 4.49% and the MSCI AC Asia Pacific ex Japan Free Index gained 8.45% during the three months ending September 30, 2012.
The Japanese equity market fluctuated within a relatively narrow range during the July-September quarter of 2012, swayed by indications of global economic distress and monetary policy announcements from the central banks of Europe, the U.S. and Japan. As a result, the Tokyo Stock Price Index (TOPIX) during the review period declined by 4.2% in local currency terms for the quarter. The market rallied and stabilized with a 0.8% gain in September in response to the announcement of additional monetary easing policies by many of the major central banks. Underlying concerns over the European debt crisis receded somewhat in reaction to the ECB’s decision to authorize the purchase of government bonds of Eurozone countries experiencing financial difficulties, and the U.S. Federal Reserve’s “QE3” announcement. The Bank of Japan also announced plans for additional monetary easing by unexpectedly expanding its asset purchase program. However, the equity market faltered again at the end of the third quarter, incorporating fresh fears of a global economic slowdown, especially in China. Although the expansion of public investment by the Chinese government might help to lift economic growth towards next year, there remains the risk of a further economic slowdown in the short term. Stocks that have some sales exposures to retail consumers in China underperformed along with a boycott of Japanese products, though this does not seem to have had any significant negative impact on corporate earnings so far.
Waning growth in the overseas economy continued to depress Japanese exports. In August, exports declined by 5.8% year-over-year (yoy) for the third month in a row. While exports to the U.S. kept rising, shipments to the European Union (EU) and China remain subdued. Besides, industrial production fell by 1.3% month-over-month (mom), in August, the second consecutive monthly decline. Production volume for electronic components and devices suffered a surprise decline due to inventory adjustments. Industrial production is likely to remain weak for a while given the stagnant overseas demand. Actually, surveys of manufacturers suggested a decline of 2.9% (mom) for September and a flat production trend in October. Meanwhile, domestic demand continued to show a gradual recovery as real consumer spending in August rose 1.6% (yoy), partly driven by spending on summer seasonal goods.
In response to monetary easing in Europe, the U.S., and Japan, the Financials sector outperformed in September on expectations that the policy shift would help to alleviate credit risk. Other domestic demand led sectors, such as Information Technology and Infrastructure, also advanced amid a generally bearish attitude towards the global economy. About 20 to 25 percent of net profits for the major automobiles manufacturers come from the Chinese market. Therefore, their earnings could suffer appreciably if sales in China continue to fall amid tense diplomatic relations between Japan and China.
The MSCI China Index closed 3.97% higher, in anticipation of government policy action during the Golden Week holiday. However, the poor trade balance and lackluster macroeconomic data only highlighted the deteriorating state of the domestic economy. Defensive stocks continued to lead the outperformance with Healthcare up 19.6%. Cement names also outperformed on hopes that prices will stabilize with signs that demand might pick up, given that social housing was back in focus. Gold stocks also performed well thanks to the FRB decision. After being hit by slowing sales and price weakness, Chinese automakers and dealerships with exposure to Japan declined further due to heightened Sino-Japanese tensions. The MSCI Hong Kong Index saw even stronger gains at 11.76% for the quarter. Real Estate (+18.8%) was the best performing sector on the back of the U.S. Fed’s “lower for longer” interest rate strategy. Except for Technology, all other sectors saw positive returns, with Financials leading at +13.8% and Industrials at +12.4%.
The MSCI India Index broke out of its recent range in September, and closed the quarter as one of the best performing markets, with a 14.92% gain on a surprise reform package from the government. The Consumer Discretionary sector led the way, gaining 20.7%. Similarly, the MSCI Australia Index gained 8.79% in the third quarter, led by Healthcare (+14.1%), Consumer Staples (11.2%) and Financials (+10.9%). Iron ore prices rebounded in September after a free fall the month before.
The MSCI Korea Index closed 9.82% higher for the quarter, led by the Telecommunications (+26.0%) and Energy sectors (+25.5) as crude oil prices recovered. The MSCI Taiwan Index (+7.84%) also fared well in the third quarter, led by an 18.2% gain in the Consumer Discretionary sector, while Industrials (+3.9%) underperformed.
The ASEAN (Association of Southeast Asian Nations) region’s performance lagged slightly behind the rest of Asia in the third quarter, although Thailand (+9.94%) and Singapore (+9.26%) showed very strong performances. Thailand led through a very strong performance in the Consumer Discretionary sector (+56.3%). Singapore’s strength was supported by the outperformance of the Industrial sector (14.1%) and Financials (10.9%), as investors chased dividend yields. In Indonesia (+7.2%), Energy (-3.6%) was the weakest sector. Defensive stocks such as Telecommunications (+20.5%) led Malaysia’s outperformance in the third quarter.
Market Outlook and Strategy
The world’s major central banks recently implemented another round of quantitative easing in an effort to boost flagging economic growth. Action taken by the ECB to provide liquidity in return for credible government spending cuts is considered both necessary and positive for the region’s economies. However, the U.S. Federal Reserve’s third round of quantitative easing was not particularly necessary in our view and any benefits are unlikely to reach their intended targets on Main Street. Instead, these actions will continue to boost asset prices globally and will artificially suppress long-term interest rates, keeping them below the rate of inflation. Therefore, despite the Central Banks’ best efforts, a period of sub-par global economic growth is likely due to the effect of de-leveraging by OECD (Organization of Economic Co-operation and Development) individuals and governments and rebalancing of growth in China in the context of a peak in China’s domestic labor force.
Slow economic growth, negative real interest rates, and abundant liquidity may continue to aid the upswing in the Asia Pacific stock markets. Markets with relatively low exposures to the global economy but with buoyant domestic sectors and heavy gearing to property and banks appear most likely to benefit. These include Thailand, the Philippines and Indonesia. Meanwhile, elsewhere, high quality companies with attractive stock dividends and sustainable business models that can prosper in this difficult economic environment should continue to outperform.
We hold an underweight position in Australia. Iron ore and coal prices are not likely to benefit from QE3 and are forecast to remain depressed as the Chinese economy rebalances away from Fixed-Asset Investment and towards consumption.
For now, we will maintain the underexposure to China. However, we are focusing our attention on the A-share market. There is a good chance that we are close to a final climactic shakeout in the Shanghai A-share market. If this index does finally start moving higher, it may have a positive impact on Hong Kong listed China shares. Our forecast for slower economic growth is not necessarily incompatible with a potentially more bullish prognosis on equities. We note that strong economic growth was not necessarily helpful to the stock market over the past 18 years. Perhaps a period of slower activity, where scarce capital is allocated more rationally, could produce a better outcome for the Chinese equity market.
We believe Hong Kong property stocks will be undoubted beneficiates of QE3 despite the new Chief Executive’s attempts to slow price appreciation.
Korea will remain overweight, and we will stick to higher quality names. As for the smaller ASEAN markets, we will keep the overweight exposures for the reasons of buoyant domestic demand and ample liquidity cited earlier in this commentary.
We also need to highlight the seasonality influence on stock markets both globally and within the Asia Pacific region. While it is hard to isolate the reasons for this, it is clear that the October to March period has traditionally been the strongest for share prices. We see no reason for this not to be the case over the upcoming few months and therefore we will be maintaining low cash levels.
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