Pacific Basin Market Overview – July 2011
Nomura Asset Management
August 8, 2011
Equity markets in the Pacific Basin edged higher in July despite the ongoing sovereign debt issues troubling both Europe and the U.S. and the pressure from a slowdown in China’s economy. Smaller ASEAN (Association of Southeast Asian Nations) economies continued to provide support this month, so the MSCI AC Asia Pacific Free Index including Japan and the MSCI AC Asia Pacific ex Japan Free Index closed 1.33% and 0.03% higher, respectively.
Negative external factors, including a surge in the value of the yen and deteriorating economic conditions overseas, eventually overwhelmed the nascent optimism about the earnings growth of Japanese companies. The Tokyo Stock Price Index (TOPIX) in July declined by 1.2% in local currency terms. Although robust global equity markets and improved economic indicators from the U.S. underpinned Japanese equity prices at the outset, several negative external factors such as the sovereign debt crisis in Europe and the congressional standoff over raising the U.S. debt ceiling undermined the market later. As these concerns intensified, the yen appreciated against both the Euro and the U.S. dollar. The yen’s surge undermined market sentiment and effectively swept aside positive factors such as the recovery in corporate earnings in the aftermath of the March natural disaster.
Japanese economic indicators revealed in July pointed to a steady recovery in production. The Industrial Production Index advanced by 3.9% month-over-month (mom) in June as a broad range of industry groups including transport equipment, electronic components, and communication equipment released solid output data. Meanwhile, the survey of production forecasts highlighted an on-going production recovery, with growth of 2.2% (mom) and 2.0% (mom) for July and August, respectively. Trade figures in June also indicated the onset of normalization in foreign trade activity, showing a nominal trade surplus for the first time since March. Nominal exports in June decreased slightly, but the 1.6% year-over-year (yoy) decrease followed double-digit declines in April and May. Nevertheless, the lackluster domestic economic conditions persisted. Real consumer spending was unexpectedly weak in June, declining for a ninth consecutive month by 4.2% (yoy). Meanwhile, core Consumer Price Index in June remained flat, rising only by 0.4% (yoy).
Export-oriented sectors including Automobiles and Electronics underperformed mainly due to concerns that the strengthening yen would detract from the earnings of companies in these sectors. In contrast, the commodity sector performed steadily as rising basic material prices bolstered the earnings of trading companies.
Equity valuations in Japan are at reasonable levels. While the TOPIX forward P/E ratios (Price-to-Earnings) for fiscal year 2011 and 2012 are 15.0 and 11.9, respectively, they appear to be fair relative to the global equity markets, while the P/B ratio (Price-to-Book) of 1.1 remains close to a historically low level.
Markets in India and Australia underperformed by the biggest margins this month with the MSCI indices declining by 2.5% and 2.2%, respectively. A cyclical slowdown caused by Inflationary pressures, tighter liquidity conditions, and an unresponsive government, were factors that contributed to the Indian market’s decline. Australia’s market performance suffered due to a decline in REIT (Real Estate Investment Trusts) shares which fell due to downbeat residential markets and poor retail sentiment. Financials stocks also weighed on the Australian market amid concerns over rising funding costs.
Further tightening in China combined with a declining Purchasing Managers Index extended China’s downward trend (-0.8%) during the period. China’s Consumer Price Index accelerated to 6.4% (yoy) in June with food prices rising by 14.4% (yoy). Consumer related stocks outperformed again on strong domestic demand, with retail sales growing by 16.8% in June. However, railway related stocks plummeted following a high-speed train disaster, which led to public fury. MSCI Hong Kong gained 2% over the same period.
Korea climbed 1.7% in July. The gains were led by refiners, despite some apparent pressure from the government not to raise domestic fuel prices. Consumer stocks with exposure to China and the luxury goods market also outperformed. Taiwan, on the other hand, underperformed the region and declined 1.3%, mainly due to the weak demand outlook for technology stocks. Stocks that outperformed were concentrated in the Consumer sector.
Most ASEAN markets ended on a positive note, with Thailand (+11.6%) delivering the strongest performance following the general election. However, Malaysia ended lower (-0.4%) with utilities dragging down the index. MSCI Singapore gained 4.6% during the period due to the outperformance of the banks as headline domestic lending growth reached 26.2% in June, the highest rate for 20 years. The Philippines (+6.7%) showed a similar trend with banks leading the other sectors on strong loan growth figures. Indonesia continued its parabolic path (+6.8%) driven by slowing inflation and robust growth.
Market Outlook and Strategy
Our latest Pacific Basin strategy meeting was held against the backdrop of an increasingly turbulent environment in the developed economies. Whilst the U.S. debt ceiling limit was eventually raised, the apparent spread of the European sovereign debt crisis and concerns that the world economy might be about to enter a sharp slowdown are having a serious impact on confidence in the global equity markets. We are adopting a slightly more sanguine outlook. Our base case scenario is that the crisis in peripheral Europe will be contained, but growth rates in the developed economies will remain soft.
Asia Pacific markets have been resilient so far, and they are now seen paradoxically as relatively safe havens. In addition, the greatest risk to the Asian economies is excessive inflationary pressure, so the current global environment should help to alleviate this pressure.
We acknowledge that August and September are seasonally weak months for Asian equities. Superimpose this factor over fragile confidence in the equity market globally, and we can expect further downside in the near term. However, we are still confident that regional markets can rally strongly into the year-end. Valuations are attractive, corporate profit growth is strong and domestic investor confidence is buoyant.
As for Australia, we remain our underweight position. The domestic economy and manufacturing sector are facing severe pressure from high interest rates, rising costs, declining property prices and a very strong currency. However, commodity prices remain buoyant, so we will remain our focus on resource stocks.
Our negative view of the MSCI China Index is well known and remains unchanged. We acknowledge that such bearish views are becoming more mainstream, although it has not yet reached levels where a contrarian approach is warranted.
Conversely, we will remain overweight with our position in Korea. We harbor some concerns about overly optimistic short-term profit expectations, but the longer-term picture remains positive.
We still like the smaller ASEAN markets such as Thailand. While the decisive election result was a surprise, the economy and corporate earnings continue to deliver positive news. In addition, valuations are still reasonable.
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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. P/E (price-to-earnings) ratio is the value of a company’s stock price relative to company earnings. Forward 12-month P/E ratio is calculated using the closing price of portfolio holdings divided by the sum of the 12-month forward earnings per share. P/B (price-to-book) ratio is the ratio of a stock’s latest closing price divided by its book value per share.
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