- Asia can look forward to stable growth in 2017, underpinned by a structural transition from manufactured exports to services-based consumption.
- Our improving view on Asia reflects our improving view on China’s economy, where we believe the domestic economy – particularly the services sector – should surprise to the upside.
- A supportive confluence of firming economic growth, reasonable valuations and improving profitability suggests to us that emerging Asian equities should perform well in 2017, possibly outperforming their global counterparts.
By John Woods, Chief Investment Officer Asia Pacific, Credit-Suisse
The enviable stability that has characterized Asian growth over the past five years appears set to continue into 2017, with the region likely to expand by 5.9%, similar to the rate recorded in 2016. Of the ten major economies we cover, seven are expected to post higher rates of growth. Only in three is growth likely to decelerate.
Absolute rates of growth in Asia Pacific remain at healthy levels, particularly by international standards. Indeed, Asia’s growth rates have been remarkably stable, varying less than 1% over the past five years, which speaks volumes for the flexibility policy makers enjoy in managing the economy through fiscal or monetary stimulus.
Nevertheless, stimulus is essentially cyclical and can support an economy only for so long. Investors can expect little change in the shallow downward drift in growth – a by-product of an apparently permanent downshift in global trade – which we believe is likely to continue until the region’s economic superpower, China, begins to stabilize. Accordingly, the focus among policy makers in the region has been to promote alternative sources of growth.
Economic rebalancing – from manufactured exports to services based consumption – represents Asia’s critical growth risk.
Fortunately, Asia’s transition appears to be firmly under way. What is more, such is the scale and speed of change in the consumer and infrastructure segments that the two sectors will likely dominate client investment strategies for years, perhaps decades, to come.
In 2016, for example, consumption and investment in Asia (ex-Japan) contributed 3.4% and 2.0%, respectively, to the region’s growth of 5.9% (with net exports contributing 0.1%). Inevitably, too great a reliance on consumption carries its own risks, particularly if financed by debt.
Between 2008 and 2015, for example, according to the Institute of International Finance, booming property prices, auto purchases and goods purchased on household finance and credit cards, among other things, saw consumer credit as a proportion of GDP increase from approximately 38% to 55%. While such metrics are not particularly high by developed market standards, they mask significant differences across the region.
For example, in 2015, India and Indonesia reported household debt/GDP ratios of just 10% and 15%, respectively. Conversely, for the same year, the household debt ratios for Korea (88%) and Taiwan (83%) were clearly high and, looking forward, pose risks to growth should interest rates rise and/or should households choose or be forced to delever. In particular, Malaysia (71%) and Thailand (70%) represent real risks, as their metrics essentially doubled between 2008 and 2015.
However, our base case for 2017 does not anticipate a forced deleveraging of household debt, or corporate and/ or sovereign debt. It is highly likely that the worst of Asia’s credit boom is over and accumulation of further debt will likely moderate over time. As such, we believe that capital inflows will remain resilient, reflecting ample USD liquidity and a stable real interest rate differential between Asia and the USA. We further think that currency depreciation expectations remain within prudent bounds.
The second leg of Asia’s growth initiative, investment in infrastructure – or “infra-spending” – is regarded as complementary to consumer spending and an effective means of stimulating growth, creating jobs and raising productivity. In 2017, infraspending is expected to add around 1.5% to regional growth (vs. 0.5% in 2016), driven largely by China and its mega USD 160 bn One Belt, One Road (OBOR) initiative. Moreover, such spending is likely to continue for many years.
For example, in its Q3 2016 development report, the Asian Development Bank states that countries in Asia will invest in infrastructure projects worth USD 8 trn by 2020. Driving the spending, beyond the need to repair and upgrade existing infrastructure, is the relentless drift of people toward cities across the region. The pressure this exerts on existing and often creaky infrastructure requires often massive spending on transport, social welfare and public utilities.
With global investors hunting for yields amid record-low interest rates and public-private partnerships fast becoming a more accepted type of business arrangement, spending and investing in infrastructure projects will likely mean more projects are successfully funded and implemented. Infrastructure spending is not without risks or costs, however, as China’s legendary appetite for building things shows.
Subsidized money (from state-owned banks) can lead to misallocations in investment, resulting in excess capacity, colossal waste and (inevitably) impaired loans in the banking system. However, such is the region-wide demand for investment spending that its overall importance to growth is set to rise, with its strategic importance signified by the opening of the Asian Infrastructure Investment Bank in Beijing in 2016
Improving view on China
Our cautiously constructive view toward Asia reflects our improving view toward China. After some six years of apparently relentless economic deceleration, the China economy is showing signs of stabilization, which has encouraged us to revise higher our GDP growth forecast to 6.6% YoY from 6.5% YoY for 2016 and to 6.3% YoY from 6% YoY for 2017.
In particular, we see China’s “new” services economy continuing to offset the drag from the “old” manufacturing based economy. For example, while China’s external sector may experience challenges, strength in the domestic economy – particularly the services sector – should surprise to the upside.
The ongoing recovery in global commodity prices should underpin industrial profits, which in turn should support the labor market and consumer spending. The property sector, too, will likely remain buoyant, leading to falling inventories and a pick-up in fixed asset investment. Against such a positive backdrop, marked volatility in the CNY is unlikely, although we continue to expect a modest, controlled depreciation to 7.00 against the USD by year-end 2017.
A supportive confluence of firming economic growth, reasonable valuations and improving profitability suggests to us that emerging Asian equities will perform well in 2017, possibly outperforming their global counterparts. To the extent that global liquidity has long been the marginal price setter for Asian equities, performance may be even stronger should capital inflows increase.
Consensus expectations of 12.3% earnings per share growth for the MSCI Asia ex-Japan (vs. –5% in 2016) underscore analyst optimism, with cyclicals – financials, technology and commodities – outperforming. We expect the China and Hong Kong markets to lead regional equities in 2017, as the recovery in earnings, attractive valuations and buoyant liquidity accelerate south/north-bound flows.
India’s robust macro story remains intact, and a rebound in earnings growth should continue to steer the market higher. South Korea and Taiwan equities are likely to fare better than their Southeast Asian counterparts, which are grappling with either subdued earnings or expensive valuations.
In terms of fixed income, despite the likely rise in US interest rates and modestly stretched valuations, we expect Asian USD investment grade credit to post total returns of around 4% in 2017, well down from the 8% recorded in 2016.
Using the JACI Investment Grade Index as a portfolio proxy, our total return expectations reflect a running yield of 3.8% and an expected spread tightening of 45 bp, compensating for a rise in underlying 5-year US Treasury yields of around 30 bp.
With yields at record lows, our return expectations are less about valuations than technical factors, in particular foreign capital seeking superior risk-adjusted yield opportunities. However, there are risks to our view, specifically the effect on spreads if sovereign and corporate creditworthiness erodes should debt levels increase and default rates tick higher.
Our base case for Asia’s growth – and credit – outlook suggests this will not be the case. Nonetheless, we continue to closely monitor developments to ensure that our recommended exposures remain prudent and appropriate.
Source : https://www.credit-suisse.com/media/assets/microsite/docs/investment-outlook/investment-outlook-2017-apac.pdf