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Seven trends brightening Asia's equity outlook
While investors should stay vigilant for evolving risks, Asia ex-Japan equities look set to regain ground
Anh Lu 5 Jan 2022

As the world embarks on a long journey to the other side of the pandemic, Asian equities investors may be able to see light at the end of the tunnel in 2022. The Asia ex‑Japan market appears well-positioned to recover as China’s regulatory cycle peaks out and a more benign inflation outlook sets in. As extreme inflationary expectations and policy risks start to subside we believe there are seven key emerging trends that will likely shape Asia’s investment landscape in the long-term and offer attractive opportunities for active stock pickers.

Inflation: Less risk for Asia

Inflation has been one of the biggest risks to financial markets as high inflation has proven to be more persistent than expected in many developed markets. We remain constructive on the longer-term economic and inflation outlook for Asia ex-Japan. Fiscal and current account balances remain supportive to both equities and currencies. More stable currencies than in the past have contributed to the relatively benign regional inflation outlook for 2022. Current inflation pressures in many Asian countries are more driven by temporary supply shocks in food and energy than by strong domestic demand, which means regional central banks are less likely to respond with monetary tightening. The more benign inflation outlook for Asia ex-Japan reflects less fiscal stimulus to fight the pandemic than in developed economies in 2020 and growth that fell further below trend, producing downward pressure on inflation.

China’s regulatory cycle reaching its peak

China’s policy risk is top of mind for investors. But we believe we are nearing the end of the current regulatory cycle in China. While the focus of many foreign investors has been on China’s unexpectedly severe regulatory clampdown and its near‑term negative impact, we remain impressed by the dynamism and depth of the large Chinese stock market that is too big to ignore. We think that Beijing does not wish to derail the future growth of the affected sectors but, rather, seeks to bring more balance to the ecosystem and with greater social stability. With a high rate of initial public offerings, new Chinese businesses continue to impress and climb the innovation curve, finding ways to compete with the established players. It provides bottom‑up investors with a stream of good idiosyncratic investment ideas. We also think that this round of regulations may trigger a reset or consolidation in the affected industries, potentially creating new opportunities.

New regulations most heavily affected a relatively small number of new-economy growth stocks. They had become overvalued, partly due to concentrated buying by many overseas funds that focus heavily on the benchmark index. The result was falls of bear market proportions in a relatively small number of expensive stocks, many of which were listed overseas in the US or offshore in Hong Kong and are well-owned by international investors. Now that broad market stability has been restored, the summer’s sharp but narrow correction appears less significant with the benefit of hindsight.

Following the correction in China, we believe risk/reward is looking attractive for Asia ex‑Japan markets relative to other markets. Regional growth stocks, for example, are attractively priced once again. In terms of valuations, we believe that those of many high‑quality growth businesses in Asia ex‑Japan remain in line with their historical levels. However, we still see large valuation discrepancies in certain areas, such as stocks expected to benefit from the transition to green energy.

Spotlight for Asian equity investors in 2022

We believe that for Asia ex‑Japan, some emerging long‑term trends, such as the greater focus on environmental protection or industrial infrastructure upgrading, can help to provide guidance in seeking attractive bottom‑up investment opportunities. In all, we have identified seven key long‑term trends to monitor:

  • China’s greater focus on environmental protection
  • Industrial infrastructure upgrading
  • Demographic dividend (dual‑income no kids power of spending, or DINKs)
  • Chinese households diversifying their savings
  • China’s changing internet ecosystem
  • Import substitution
  • Rising intraregional trade

Many of these trends are intertwined with China’s shift to “dual circulation”, which aims to give more emphasis to the domestic economy and stimulate innovation in all industries (not just those involving the internet or new-economy sectors), create higher‑earning employment, and use the vast domestic market to gain scale and global competitiveness.

Trend 3 above is a positive demographic dividend for China that may come as a surprise. The number of DINKs in China is estimated to quadruple in the next decade, potentially reaching the US level. We believe that the investment implications for consumption patterns are considerable, with increased spending on premium products and services, including those related to lifestyle, health, leisure and wealth management. This positive boost to consumption is expected to make itself felt before the negative impact of China’s aging demographics take over.

Turning to earnings, the 2021 third‑quarter earnings season in Asia was rather mixed, with 50% of companies reporting that they beat consensus earnings estimates. Sustaining margins may be an issue for earnings in 2022. On a positive note, the analyst consensus projects a recovery in the contribution to regional earnings growth from China’s internet sector following a lackluster, regulation‑hit 2021. Over the past six months, all sectors except real estate, consumer discretionary, and communication services have seen positive growth in 12‑month forward earnings estimates.

Looking ahead, we expect that Asia ex-Japan equities to regain ground, supported by secular tailwinds and positive economic backdrop. However, investors should stay vigilant for evolving risks, including a new coronavirus variant that has not been proven to be responsive to current vaccines, the potential of a mistake by the central banks that tighten monetary policy too soon, further geopolitical tensions between the US and China, and a more severe‑than‑expected property‑led economic slowdown in China.

Anh Lu is a portfolio manager for Asia ex-Japan Equity Strategy at T. Rowe Price.

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