Pacific Basin Market Overview
Nomura Asset Management
July 16, 2012
Europe’s sovereign debt crisis continued to hound the global equity markets throughout the second quarter, while economic data from the U.S. was also lackluster. The MSCI AC Asia Pacific Free Index including Japan fell by 7.42% and the MSCI AC Asia Pacific ex Japan Free Index declined 7.4% during the three months ending June 30, 2012.
Despite a late recovery, the Japanese equity market fell during the April-June quarter, owing to instability in the European financial system, economic distress in Europe, the U.S. and China, and the yen’s appreciation. The Tokyo Stock Price Index (TOPIX) during the review period fell 9.9% in local currency terms. However, the losses were mitigated by a 7.0% rally in June, aided by positive policy news from the Europe Central Bank and an extension of the U.S. Federal Reserve’s “Operation Twist” policy of targeting lower long-term interest rates.
After deteriorating significantly through April and May, investor risk aversion started to settle gradually and global equity markets recovered some ground in late June, incorporating expectations for a U.S. economic recovery, along with unexpectedly solid durable goods orders and housing related indicators in the U.S.. The Japanese market rebounded after underperforming over the preceding two months.
Despite the lingering risk from the overseas economy, some indicators showed that the Japanese economy was not as weak as feared. While industrial production fell by 3.1% month-over-month (mom) in May after a 0.2% fall in April, the slide could be short lived given the Survey of Production Forecasts, which indicated output growth of 2.7% (mom) in June and 2.4% (mom) in July, respectively. Exports in May also indicated healthy results, increasing by 10.0% year-over-year (yoy), buoyed by the recovery in production activity since last year’s natural disasters. Nevertheless, the strong trade results seemed to diverge from the demand outlook in Europe, the U.S., and China, so there remains a risk that exports might lose momentum. Further steady improvements in the Japanese economy, and eventually the corporate sector, would require a more solid recovery in the overseas economies. In addition, domestic demand exhibited a modest recovery in line with output normalization. Real consumer spending in May rose by 4.0% (yoy).
Amid depressed external conditions and the yen’s upward trend, export-oriented sectors including Commodities, Electronics, Capital Goods, and Automobiles lagged behind the market during the quarter. While all sectors increased amid an improvement in investor sentiment in June, defensive sectors such as Telecommunication Services, Medical, and Infrastructure continued to outperform. This trend seemed to demonstrate the cautious attitude of investors amid recent evidence of economic weakness, particularly in Europe and China.
The MSCI China Index fell 7.7% during the quarter, largely due to much weaker then expected domestic macroeconomic data. The market enjoyed a short rebound in June following an interest rate cut, but the rally was short lived. Consumer Discretionary (-17.4%) and Materials (-17.1%) stocks led the decline. Some luxury brands carried average retail discounts of more than 10%. Cement names were behind some of the profit warnings reported during the period. Utility companies were the best performers (+4.9%) as they benefited from falling coal prices. The MSCI Hong Kong Index lost 6.4% over the quarter, largely driven by casino names which fell by between 10% and 21% during the period. Hong Kong Exchange (-15.6%) was punished for announcing its intention to acquire the London Metal Exchange (LME) at GBP 1.4bn, implying that the purchase would be completed at an eye watering 180 times 2011 earnings.
The MSCI India Index was the worst performing market for the quarter, falling 10.2%. Telecommunication Services (-22.2%) and Information Technology (-14.2%) led the decline. The MSCI Australia Index fell 6% during the period with the Energy sector (-15.0%) being one of the worst performers. Materials (-14.2%) underperformed on concerns of slowing demand from China while the Industrials sector (-14.7%) was weak following a slew of earnings downgrades. Defensive sectors outperformed – Telecommunications and Health Care gained 11% and 7.5%, respectively.
The MSCI Korea Index closed 8.7% lower for the quarter. The Energy sector (-18.7%) bore the brunt of the sell down on lower oil prices, weak petrochemical demand and refining margins. Industrials (-14.8%), which include shipbuilders and construction stocks, underperformed along with the weakening order outlook. On the other hand, Utilities (+10.3%) and Health Care (+19%) outperformed during the period. Similarly, the MSCI Taiwan Index fell -9.5%, again weighed down by the Energy sector (-13.2%). Information Technology and Materials fell by 11.4% and 10.5%, respectively. Consumer Staples bucked the trend and gained 5.9% during the quarter.
The ASEAN (Association of Southeast Asian Nations) region fared slightly better during the second quarter, although Indonesia (-8.9%) was the exception. Indonesia’s Energy sector (-35.8%) was the worst performer given its exposure to falling coal prices. The Philippines was the top performing market for the quarter with Financials (+6.2%) leading the pack. The MSCI Thailand Index fell 6.6% over the quarter, led by Materials (-18.8%) and Energy (-13.6%). The MSCI Singapore Index fell 5.4% with Commodity/Consumer Staples (-23.0%) stocks declining the most. The MSCI Malaysia Index dropped 4.6% and Consumer Discretionary (-11%) was the weakest sector.
Market Outlook and Strategy
The global economic environment has deteriorated appreciably during the last couple of months. Growth in Europe is waning due to the imposition of fiscal austerity measures, and could see a marginal contraction in 2012, while the ongoing household sector balance sheet adjustment in the U.S. is resulting in sub-par growth. Growth in the large emerging economies is also predicted to slow, although Japan will experience relatively buoyant conditions. This backdrop is generally unhelpful for stock markets, although it does suggest that monetary policy will remain extremely accommodative, with interest rates staying at historically low levels and the potential for further quantitative easing measures.
Despite this difficult investment environment, we have a reasonably upbeat view of the Pacific Basin regional markets. Valuations are extremely depressed, much of the potentially bad news is priced in, and investors have generally established bearish positions with high cash levels and defensively positioned portfolios.
With regard to country allocation, we remain overweight in India. Investors have become overly pessimistic and consumption will remain a key growth driver, irrespective of the difficult political environment.
Meanwhile, we have decided to reduce the exposure to Australia further. If the world slows even more than anticipated, then the Australia Resource sector and Australian dollar are both extremely vulnerable.
The smaller ASEAN markets of the Philippines, Thailand and Indonesia remain well insulated from the global problems. However, these markets are no longer cheap so we will keep our current level of overweight positions.
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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