Pacific Basin Market Overview - May 2012
Nomura Asset Management
June 12, 2012
Depressed market sentiment, high volatility, and low trading volume together resulted in another difficult month for the Pacific Basin region’s equity markets. Following a great start to the year, Asian markets gave most of these gains back during May, as worries about the health of the Spanish banking system stoked deeper concerns about the progress of the eurozone debt crisis, with Greek elections looming on June 17th as well. U.S. data continued to disappoint, raising fears that the economic recovery could be stalling. The MSCI AC Asia Pacific Free Index including Japan declined by 10.2% and the MSCI AC Asia Pacific ex Japan Free Index declined by 10.9%.
The Tokyo Stock Price Index (TOPIX) in May declined by 10.5% in local currency terms amid a worldwide equity market slump. Risk aversion intensified along with renewed anxiety over the European debt crisis and the release of unexpectedly weak economic indicators from the U.S. and China. Japan underperformed the other major stock market indices, as losses were compounded by the stronger yen exchange rate against the euro.
Some indicators revealed signs of weakness in the Japanese economy too, chiefly due to stagnant external demand. Industrial production in April decelerated from its growth rate in March, advancing by 0.2% month-over-month (mom). Slower external demand was balanced by inventory building activity as companies attempted to maintain production levels. Inventories are likely to have been boosted by the active inventory build-up in the Automobiles sector amid robust global demand for passenger vehicles. Therefore, the survey of manufacturers' production forecasts indicated that output would drop 3.2% (mom) in May, later rising by 2.4% (mom) in June. Sustained improvements in production activity would require a solid recovery in the overseas economies. Exports in April grew by 7.9% year-over-year (yoy), inflated by comparison with the post-disaster slump from March 2011, but this growth rate does not seem sustainable given the prospect of stagnant demand in Europe, the U.S., and China. Meanwhile, there has been a healthy recovery in domestic demand, supported by a gradual recovery in employment and wages. Real consumer spending in April rose by 2.6% (yoy).
Amid a bearish global investment environment, defensive sectors such as Telecommunications, Consumption, Medical, and Infrastructure were generally favored. However, one of the more defensive sectors, IT Technology, posted the largest losses in May. Social networking and game service related stocks plunged after the Consumer Affairs Agency introduced new controls on charges and gambling through online social gaming platforms. Export-oriented sectors were subdued amid unstable overseas conditions and the yen’s appreciation. The Financials sector performance was also weak. Securities companies declined steeply along with the market downturn.
The MSCI China Index lost 11.4% this month, largely in response to much weaker than expected April macroeconomic data, while the Index dipped again later after initial talks of further policy easing were quickly dismissed. The Energy (-16.2%) and Consumer Discretionary (-15.0%) sectors led the decline. Energy names were sold off on muted domestic demand prospects and elevated inventories. News from Chinese Banks was generally grim this month. Chinese property names were among the few outperformers, on hopes of stronger sell-through as developers cut selling prices. The MSCI Hong Kong Index (-10.6%) followed closely behind China, with Consumer Discretionary (-15.2%) stocks suffering the steepest declines. The HSBC Hong Kong PMI Index dropped to 50.3 in April from 52.0 in March, partly due to a drop in new orders from mainland China. Gaming stocks underperformed on expectations that they could miss revenue forecasts for May and press reports highlighting a shortage of skilled labor.
The MSCI India Index declined 11.9%, and was also undermined by Consumer Discretionary (-21.9%) stocks. Gross Domestic Product (GDP) growth of 5.3% for the first quarter of 2012 (1Q12) marked a further slowdown from 6.1% during the previous quarter. Sales of domestic passenger cars in India slowed to a 7% (yoy) growth rate in April from 16% in March. The MSCI Australia Index (-13.6%) was one of the worst performing markets in May, as Australian Resources, Materials (-16.5%) and Energy (-14.9%) sectors became the best way for investors to express the ensuing poor demand growth in China and lower oil prices. Dividend payments helped to keep the Financials sector (-14.2%) in step with the broad index, but they lagged behind the overall market slightly after back-to-back periods of outperformance. Defensive stocks, such as Telecommunications (-6.6%), were relatively steady.
The MSCI Korea Index suffered a similar decline, closing 11.4% lower in May. The Technology (-16.2%) sector bore the brunt of the sell down. This was followed closely by Energy (-12.9%) due to the recent decrease in crude oil prices. Korean Automobile manufacturers also extended their outperformance. Taiwan’s performance was somewhat better, declining by only 5%, helped by news that there will be no capital gains tax following the resignation of the Finance Minister. The issue had plagued the market over the last month. Weakness in the Energy (-12.3%) sector was offset by Telecommunications (-2.1%) and Technology (-4.4%).
The ASEAN (Association of Southeast Asian Nations) markets were not spared from the regional selloff, although there was some wide variation in the extent of their losses. Defensive countries such as the Philippines (-4.5%) and Malaysia (-4.5%) fared better in May. Singapore (-11%) underperformed, together with Thailand (-11.7%) and Indonesia (-12%). Malaysia’s first quarter GDP exceeded expectations, expanding by 4.7% from a year ago, but growth moderated from 5.2% in the fourth quarter of 2011, with resilient domestic demand and stronger Investment growth. Thailand’s 1Q12 real GDP rebounded strongly after the floods, with domestic demand providing the growth impetus. However, the market was sold off due to concerns about its relatively expensive valuations compared with Indonesia, which was also sold off further in May amid continued trade finance concerns. The Indonesian rupiah remained under the spotlight in May given its continued depreciation. Bank Indonesia (BI) left the reference rate unchanged at 5.75% at its May 10 meeting, the second meeting in a row in which the BI has kept rates on hold.
Market Outlook and Strategy
Positive momentum from the beginning of the year gave way to a sudden reversal as the global and regional equity markets plunged in May. Yields on major 10-year sovereign bonds also reached record lows. Our reasonably positive view of the Asia Pacific economies and the region’s stock markets has proven premature as the peripheral European economies lurch from one crisis to another.
We stand by our view that investor sentiment has now reached a state of excessive pessimism. Even though the U.S. economic recovery has slowed somewhat, the sharp drop in energy prices will help to reboot consumption growth. Core Europe is still in reasonable shape, while most of the emerging markets are demonstrating some resilience. Chinese economic growth has evidently slowed down, but we expect further policy measures to improve the liquidity situation. Declining inflation will also allow the authorities to reduce interest rates in the second half of 2012, enabling a gradual recovery later in the year.Â
Our underweight position for Australia will be maintained. Domestic market sectors are being squeezed by rising costs and anemic demand. Resource stocks are vulnerable to rising labor, power, and energy costs and from a blowout in capital expenditure charges. We have been discussing whether to reduce our overweight exposure to resource stocks given this margin compression, but the sector currently looks oversold.
We still like the smaller ASEAN markets of the Philippines and Thailand. Markets here are no longer cheap but we feel they are still going through a secular re-rating phase, benefiting from higher economic growth and strong domestic consumption. However, we do have some concerns about recent policy initiatives in Indonesia that seem to work against the interests of foreign investors, so we will monitor the situation closely.
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