Pacific Basin Market Overview - July 2012
Nomura Asset Management Co.
August 9, 2012
Most equity markets in the Pacific Basin region recovered somewhat in July after a weak second quarter on expectations of further monetary easing and measures by the European Central Bank to forestall a Euro currency crisis. However, when we examine the sector results, it is hard to conclude that the recovery was accompanied by an improvement in sentiment. In most cases, the leading sectors were defensive high yielding stocks in sectors such as Telecommunications or Consumer Staples, while cyclical and more economically sensitive stocks lagged behind. The MSCI AC Asia Pacific Free Index including Japan gained 1.3% and the MSCI AC Asia Pacific ex Japan Free Index gained 3.6%.
The Tokyo Stock Price Index (TOPIX) declined by 4.4% in local currency terms in July. External events again tended to overshadow the Japanese market, mainly transmitted through the negative earnings impact of the strengthening yen. The lack of policy progress in tackling the European debt crisis, which led to renewed fears about the fiscal stability of Spain and Italy, caused the euro to slump relative to other major currencies. The yen appreciated against the U.S. dollar too in reaction to unexpectedly weak economic indicators from the U.S.
Sectors that are dependent on overseas demand such as Automobiles, Electronics, and Commodities, underperformed significantly due to the stronger yen and the slowing global economy. Meanwhile, ahead of the reporting season for the first quarter of this fiscal year (ending March 2013), the overall market seemed concerned about the risk of downward revisions to earnings estimates given these negative global factors.
Considering the weakness in global manufacturing sector sentiment indicators, the economic slowdown overseas already seems to be having a negative impact on Japanese exports. Exports in June fell by 2.3% year-over-year (yoy), mainly due to declining shipments to Europe and China. Moreover, industrial production in June disappointingly remained almost flat, declining by 0.1% month-over-month (mom) despite market expectations of a monthly rise. Surveyed manufacturers forecast a sharp 4.5% (mom) upturn in production in July, mainly driven by demand for electronic components and finished goods. This industry intends to increase production volume temporarily due to the prospective launch of new smart phone models. Industrial production is also supported by reconstruction demand related to the earthquake in March 2011. Domestic demand seemed to show a healthy recovery as real consumer spending in June climbed 1.6% (yoy), partly supported by “eco-car” subsidies for low emission vehicles. However, it appears likely to take a while before demand can return to a firm uptrend given the slowdown in the global economy.
China’s equity markets underperformed during the month, with the MSCI China Index gaining just 1.3% due to a lack of stimulus policies and poor economic numbers. Signs of an ongoing slowdown included an incremental decline in the official July Purchasing Managers’ Index (PMI) to 50.1 from 50.2, while the Consumer Price Index (CPI) slid to 1.7% (yoy) from 2.2% in June. Telecommunications was the best performing sector. Hong Kong (+3.5%) performed a little better, supported by gains in property stocks. Sectors that underperformed this month include the Consumer Discretionary (-1.6%) and Information Technology (-3.2%) sectors.
Australia (7.4%) outperformed, with defensive sectors such as Telecommunications Services (+11.3%) and Consumer Staples (+10%) leading the market. The more economically sensitive Materials (+2.6%) and Industrials (+3.1%) sectors lagged behind. India’s equity market (-0.7%) continued to underperform, weighed down by the Information Technology (-7.8%) and Industrials (-4.1%) sectors. Once again, defensive sectors were the best performers – Healthcare (+3.4%) and Consumer Staples (+2.9%).
Korea closed 3.6% higher for the month. Telecommunications (+15.8%), Energy (+11.9%) and Information Technology (+7.8%) were the outperformers during the period while Health Care (-5.9%) and Consumer Staples (-0.3%) underperformed. US technology names caused technology related stocks in Taiwan to trend lower. Energy (+7.2%) and Consumer Discretionary (+6.4%) stocks were among the leading performers.
All of the ASEAN (Association of Southeast Asian Nations) markets posted gains in July, with Singapore (+7.6%) emerging as the strongest performer in Asia as investors flocked to high yielding stocks coupled with a strong currency. Indonesia (+5.6%) also did well with Materials (+14.9%) outperforming the benchmark. Malaysia edged up 3% in July, mainly driven by defensive, domestic related stocks. Thailand closed 2.6% higher, largely attributed to the outperformance of banks as they reported better-than-expected earnings. The Philippines (+2.1%) underperformed the region in July.
Market Outlook and Strategy
Our economics team has become slightly more cautious about the outlook for the developed economies given the seemingly daily news of further deterioration in the Eurozone’s ongoing debt woes. Within Asia, China’s economy may not rebound as quickly as the market expects in the second half of 2012. In addition, the longer-term outlook points to significantly slower growth prospects due to demographic headwinds and the need to reduce the over-reliance on fixed-asset investment.
The slowdown in China and the chronic weakness in Europe are also beginning to have an adverse impact on key export sectors in other Asian economies, particularly Taiwan, Korea and Indonesia.
In our view there are two significant factors that need to be understood in making country, sector, and stock decisions. First, the developed economies will be subjected to an extended period of global de-leveraging and financial repression. Essentially, these economies must grow more slowly than they have previously. The second point is that interest rates will remain below the rate of inflation.
In our view, this environment will lead investors to seek, and re-rate countries that have budget and current account surpluses and sectors that traditionally deliver consistent profitability. They will also favor companies with sound balance sheets, strong free cash flows, good dividends, proven ability to manage their cost base in an environment of slowing nominal gross domestic product, and sound corporate governance records.
We will maintain the deep underweight position in China. This is undoubtedly a very cheap market now, and with inflation falling rapidly, monetary policy should become more accommodative. In addition the authorities seem intent on trying to resurrect the ailing domestic A-share market. They have lowered the costs of dealing, made it substantially easier for foreign investors to participate, and also encouraged share buybacks for those companies trading below book value. We will monitor these developments, especially since a rebound in the A-share market could have positive implications for Hong Kong listed Chinese companies. Unfortunately at the current stock level it is still difficult to find attractively valued stocks that fulfill all of the requirements listed in the previous paragraph. Corporate governance failings are still a serious and material issue in our opinion.
Meanwhile, we will keep the overweight positions in smaller ASEAN markets. They are not cheap but we feel the structural improvements are still not fully reflected in equity prices.
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