Pacific Basin Market Overview
Nomura Asset Management
April 14, 2011
Asian equity markets began the year in a particularly volatile state as they came to terms with regional inflationary pressure, unrest in the Middle East and North Africa, and the natural disaster in Japan. Notwithstanding these negative factors, most markets in Asia rebounded in late March to end the quarter on a positive note. The MSCI AC Asia Pacific Free Index including Japan, however, decreased by 1.4% in the first quarter of 2011, while the MSCI AC Asia Pacific ex Japan Free Index increased by 1.5%.
The Tokyo Stock Price Index (TOPIX) ended the first quarter of 2011 with a loss of 4.4%, mostly due to an 11.2% decline in local currency terms in March. Overseas data initially helped to lift the Japanese market, as did the yen’s depreciation. Meanwhile, encouraging earnings results for the October-December quarter boosted confidence too. However, the sudden decline in Japanese stock prices, following the devastating earthquake and tsunami that hit northeastern Japan, effectively erased the market’s earlier gains. Over the subsequent two trading days, most Japanese stocks declined due to a large sell-off triggered by concerns over economic losses from the disaster and the threat of radioactive contamination from a stricken nuclear power station. At the same time, a surge in the yen’s value exacerbated the negative sentiment and added to the market turmoil. Successful coordinated currency market intervention by the G7 central banks effectively caused the yen to fall back again, which helped to resuscitate the equity market from its post disaster slump. Towards the end of March, the equity market began to stabilize again along with the yen’s depreciation, but prices continued to fluctuate in nervous trading in tandem with the news on the nuclear power plant situation and concerns about electricity blackouts and supply-chain disruption, which could have an impact on industrial production.
Sector performance numbers at the end of the first quarter seemed to reflect the degree of expected disruption from the natural disaster. The Infrastructure sector’s decline was mainly due to a succession of daily limit down sell offs of Tokyo Electric Power Co., Inc. (TEPCO), the operator of the crippled Fukushima Daiichi Nuclear Power Station. The largest utility company saw its market value collapse on expectations of huge clean-up costs and damages claims. Financial stocks were dragged down too, led by a sell off in the insurance sub-sector on expectations of huge disaster related claims. In contrast, the Machinery sector was relatively stable, as companies such as construction equipment manufacturers were thought likely to benefit from reconstruction.
Although economic data releases had not incorporated the impact of the earthquake, the figures indicated that external demand and ongoing production growth continued to drive the Japanese economic recovery until the disaster. Japanese manufacturers kept expanding production to meet growing external demand. Industrial production in February advanced for a fourth consecutive month, gaining 0.4% month-over-month (mom). The survey of production forecasts showed a 1.4% (mom) rise in March and a 1.3% (mom) decline in April to indicate an ongoing recovery. Meanwhile, trade statistics continued to indicate stable growth. Exports in February climbed 9.0% year-over-year (yoy) as exports to all major regions grew steadily. On the other hand, domestic demand remained lackluster. As the negative impact of the withdrawal of stimulus subsidies is still being felt, real consumer spending declined for a fifth consecutive month, by 0.2% (yoy). Core Consumer Price Index data offered no signs of change in the persistent deflationary trend, falling by 0.3% (yoy) in February.
MSCI Australia Index gained 3.2% and the Energy and Financial sectors led the market for the quarter. Some energy stocks surged on the back of strong oil prices while others declined as investors sold nuclear power related shares following the Japan earthquake on March 11th. Financials also performed well, but Utilities and Consumer Discretionary sectors lagged behind the market. MSCI India Index tumbled 5.2% and emerged as the region’s worst performer despite a strong rebound in March. All sectors fell, although Telecommunication, Automobiles, and the Healthcare sector suffered the steepest falls, while Energy outperformed the benchmark.
Lackluster economic numbers left the Chinese market largely range-bound throughout the quarter, ending 2.9% higher. Exports grew by a meager 2.4% (yoy), and imports 19.4% (yoy), in February, both below recent trends, resulting in a rare trade deficit. The March reading for the China PMI (Purchasing Managers Index), however, rose from a low of 52.2 in February to 53.4 in March. Energy and Materials sectors led the gains while the Consumer sector was the largest drag on the performance. Cement related stocks surged along with increasing average selling prices and better than expected results. In Hong Kong, the MSCI benchmark declined by 0.8%. Industrials accounted for most of the gains while real estate stocks were a drag on the performance.
Korea was the strongest outperformer in the region during the first quarter with that MSCI Index gaining 6.5%. Automobiles and the Energy/Materials sectors led the gains along with strong vehicle sales and high refining/petrochemical spreads respectively. Underperformers included the Consumer (Retail) sector, which was hurt by declining consumer sentiment. Petrochemical stocks in Taiwan followed a similar trend (+8.4%) and outperformed this MSCI benchmark, which fell by 4.2%.
In the ASEAN (The Association of Southeast Asian Nations) region, markets that performed well in the first quarter of 2011 included Indonesia (+4.7%), Malaysia (+3.7%) and Thailand (+3.5%). Meanwhile, the Philippines and Singapore underperformed during the month and declined 4.4% and 0.7%, respectively. Indonesia’s Financials sector led the gains with the economy being one of the strongest in the region after reporting better-than-expected gross domestic product. Energy names in Thailand surged along with strong oil prices while Malaysian stocks showed a similar trend. Real estate stocks in Singapore weighed on the MSCI Index performance due to additional cooling measures from the government, while Financials outperformed after underperforming last year.
Market Outlook and Strategy
Asia Pacific markets ended a turbulent quarter on a high note, with many stock indices approaching their previous highs. This was an impressive performance given the plethora of negative influences such as the natural disaster that hit Japan in March and political upheavals in the Middle East. In our opinion, this demonstrated the underlying resilience of investor sentiment in the region.
We therefore remain positive about the regional market prospects. Earnings results have generally matched what were already lofty expectations. Valuations are inexpensive and investors are becoming more sanguine about the impact of slowly rising inflation on corporate margins and the level of interest rates. In addition, when foreign investors begin to realize that inflation increasingly will turn into a global rather than an emerging market problem, then capital inflows into the region will resume.
The major risks are still external. A sharp spike in oil prices will likely have a serious negative impact on Asian economies. The beginning of the tightening cycle in Europe, which we predict could be as early as this quarter, might not be fully factored into share prices yet.
The third year of an economic recovery, although generally rewarding, is often more fraught with difficulties. Costs of labor and materials are indeed rising, and margins must therefore start to fall. As such, this should be a year to favor experienced and seasoned company management, and for investors focused on stock selection.
We believe that Asia equities are now in a bull market. Therefore, we have an aggressive sector allocation strategy geared towards expanding economic activity. We are substantially underweight with respect to slower growing and defensive sectors such as Utilities and Telecommunications. We uphold our secular bullish view of commodity prices and therefore have a significant overweight exposure to Australian resource companies.
Secondly, we have a substantial underweight exposure to Chinese stocks. Looking at this market objectively, it is fair to suggest that most Chinese companies give very little attention to the interests and returns of minority shareholders. They are managed primarily to maximize the long-term potential for wider national economic growth purposes, and the rationale of a Hong Kong listing is to provide low cost funding to fulfill this objective.
However, we are bullish on China’s long-term growth prospects, and now believe that valuations of many such Chinese companies have reached appealing levels. However, we still prefer to gain exposure to the Chinese growth story through Australian resource companies that sell to China, Taiwanese Technology sector stocks that manufacture there, and Hong Kong property stocks that are finding growth opportunities in the Mainland.
Our recent research trip to Korea reinforced our positive stance towards this market. Companies there have been aggressively pursuing market share and branding and, at the same time, consolidating to become more cost efficient. In the short-term many industries will also benefit from supply disruptions in Japan. Of more significance has been the gradual erosion of the Korean discount applied due to poor corporate governance. This received a boost recently when Korea’s largest pension fund said it would adopt environmental, social, and corporate governance principles in its domestic equity decision-making.
We have kept the large overweight exposure to the small ASEAN markets such as Philippines, Indonesia and Thailand. This hurt the performance late last year, and in early 2011, but we are confident of our investment thesis. These countries generally have large and young populations where incomes are rising strongly. As such, the consumer, property, and banking sectors look very attractive. They also have a growing, risk taking investor class that is increasingly purchasing domestic equities.
International investing involves certain risks and increased volatility not associated with investing solely in the U.S. These risks include currency fluctuations, economic or financial instability, lack of timely or reliable financial information or unfavorable political or legal developments. These risks are magnified in emerging markets. Securities focusing on limited geographic areas and/or sectors may result in greater market volatility. Investing in securities issued by smaller companies typically involves greater risk than investing in larger, more established companies.
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MSCI AC Asia Pacific ex Japan Index is an unmanaged free float-adjusted market capitalization index that is designed to measure the equity market performance in the Asia Pacific region excluding Japan. The Tokyo Stock Exchange Price Index (TOPIX) is an unmanaged capitalization weighted measure (adjusted in U.S. dollars) of all shares listed on the first section of the Tokyo Stock Exchange. One cannot invest directly in an index.
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