What does the future hold for Asia equities?

With zero-Covid relaxed, what is in store for Asia equity investors?

In its economic outlook for Asia and Pacific, released in October, the IMF cited three “formidable” headwinds faced by the region, one being China’s zero-Covid policy.

“[The] policy and the related lockdowns, which, coupled with a deepening turmoil in the real estate sector, has led to an uncharacteristic and sharp slowdown in growth, that in turn is weakening momentum in connected economies,” the IMF said.

With China having since announced relaxations to zero-Covid restrictions, what could this mean for Asia equity investors?

The relaxation process may not be smooth, but the direction is clearly towards reopening, which should positively impact China’s domestic economy, says Jian Shi Cortesi, GAM investment director.

“We have seen in the past year that almost every country experienced economic rebound when the country exited Covid. This should also be the case for China," Cortesi added.

“Given the huge economic size of China and its strong trade ties with the rest of Asia, a rebound in China’s economy will be positive to other Asian countries. This will be particularly helpful when global demand is weakening. We believe China’s Covid reopening will be a strong catalyst for the region next year.”

Peter Monson, co-portfolio manager of the Nikko AM Asia ex-Japan Fund, agrees that an easing of China’s zero-Covid policy should significantly improve prospects within China and for the broader Asia region, but he also notes it is unlikely to be smooth.

“Our emphasis is on fundamental change and the prospect for undervalued sustainable returns. China has become more and more important for regional growth in recent decades at the expense of EU and US demand,” he adds.

“Covid policy easing together with targeted stimulus should provide some growth support around the region, when the EU and US are likely to see slowing growth as a result of severe monetary tightening.”

Assuming zero-Covid can be exited effectively, John Leiper, chief investment officer at Titan Asset Management, likewise, forecasts a “meaningful” boost to economic growth.

Leiper says: “China is also well placed to stimulate the economy, given its differentiated approach to doing so previously, in terms of monetary and fiscal policy. We’ve seen signs of this [in November] with Chinese lenders set to pump over $160bn (£129bn) of credit into property development companies.”

While the region may find some policy and growth support from China, Monson at Nikko adds: “We are still subject, to varying degrees, to further tightening of global financial conditions.

“This creates challenges for some, and means we are likely to find more resilient investment ideas in domestic demand-oriented segments, or those benefiting from shifts in the global capital expenditure cycles, towards both energy transition and supply chain security.”

So despite zero-Covid restrictions being relaxed, challenges remain for Asia equity investors.

US concerns

The first and foremost concern is still US monetary tightening and the US dollar, the rise of which is not positive for Asian or emerging market equities, says Joseph Lai, chief investment officer at Ox Capital Management.

He says: “When the US tightens, it is difficult for the rest of the world not to tighten, if the economies want to maintain currency stability against the USD.

"However, it is likely that the bulk of the rapid interest rate rises is behind us. It is likely that we will see better times ahead.”

When it comes to emerging Asia, James Syme, senior fund manager at JO Hambro Capital Management, says the US dollar’s effect on emerging market equity returns should not be underestimated or overlooked.

“At some point, global financial and economic conditions will see a weaker US dollar, with associated capital flows into the rest of the world. That is likely to see very strong returns across the emerging market equity landscape, including in emerging Asia.”

Jorry Nøddekær, fund manager at Polar Capital’s Asian Stars, likewise identifies a US recession as a concern of the market.

“As we read it, the market does want some form of mild recession, such that we can ‘kill’ the inflation. But we want a recession where the consumer survives relatively well.

“The dream-case scenario for Asian equities, with its strong growth bias, is that we get a very mild recession in the US, such that Asian companies’ revenue lines are minimally impacted, outside some very heavy export-driven companies with limited pricing power; but we get inflation down, and the US dollar down.”

One of the attractions of managing an Asian equity fund, however, is the range of countries that can be invested in, says Jupiter Asian Income fund manager, Sam Konrad.

“From developed economies such as Australia and Singapore to emerging economies such as India and Indonesia, there are always countries that we like from a top-down perspective, whatever the macro challenges the world or some economies in the region may be facing.”

So, what are some of the other countries in Asia that managers think investors should also consider?

Japan

“In Japan companies like Nexon, a games provider heavily exposed to the Chinese market, and Fast Retailing, the owner of clothing brand Uniqlo, stand to benefit strongly from a Chinese reopening,” says David Raper, portfolio manager at Comgest, who adds that both experienced share price jumps the day after several Chinese cities eased Covid rules.

Turning to the country’s currency, Nomura Asset Management's chief investment officer Yuichi Murao says: “The yen’s rapid depreciation has discouraged global investors from venturing into the Japanese equity market, which has nevertheless registered a positive one-year return in local currency terms (as of November 30) but also poor results in US dollar terms.

“However, the Japanese equity market could become one of the most attractive asset classes in 2023, with the economy likely showing positive GDP growth as the domestic economy finally achieves a delayed post-pandemic recovery.

"Reopening the borders also allows inbound tourists to take advantage of a historically cheap yen.”

Vietnam

Vietnam is following in China’s footsteps in its economic rise, says Cortesi at GAM. “The process is very similar to how China has grown in the past 30 years. As a key beneficiary of supply chain relocation, Vietnam enjoys a positive long-term outlook.”

Raper at Comgest also cites attractive growth opportunities in Vietnam. “The country has a young and vibrant workforce, and is benefitting from the shift of supply chains outside of China. Consumers in Vietnam should continue to benefit from the strong economic growth.”

Although he says Vietnam represents one of the best long-term structural growth stories going, Leiper at Titan adds: “We adopt a top-down global macro view, investing across asset classes and regions.

"We currently retain a positive outlook for Chinese equities given attractive valuations, extreme investor positioning, divergent monetary and fiscal policy relative to the rest of the world and diminishing zero-Covid policy headwinds.

“As such, and given our medium-term horizon, this may not be the right time to enter Vietnamese equities specifically, or frontier markets in general.”

India

“We see India as an economy relatively insulated from disappointing Chinese or global growth, and as a beneficiary of global companies looking to diversify their manufacturing away from China – a trend that has already started and is likely to continue for many years to come,” says Konrad at Jupiter.

Cortesi at GAM agrees Indian manufacturing is benefiting from companies adopting a ‘China plus one’ or ‘China plus two’ strategy. “The demographics and low labour cost also bode well for India’s long-term growth.

“However, following its tremendous outperformance over northern Asian markets such as China and Korea, Indian stocks currently look expensive relative to other Asian markets. This could limit the upside of Indian stocks next year.”

When it comes to the country’s short run prospects, outperformance by India’s equity markets, when compared with much of Asia, as well as the valuation differentials with other markets, is the “only issue” for Robert Horrocks, chief investment officer at Matthews Asia.

But, he adds that India looks set to maintain perhaps the fastest growth rates of all the major economies in which the firm invests.

Korea

A number of countries are developing industries around the demand for renewables, electric vehicles and hardware technology, says Monson at Nikko. “This is also true on a more stock-specific level in both Korea and Taiwan.”

Cortesi likewise says Korean stocks look interesting. “Interest rates in Korea are likely to peak next year, and could potentially even start falling. This should support Korean stocks, especially with valuations near historical lows.”

TEMIT lead portfolio manager Chetan Sehgal also cites opportunities tied to the recovery in South Korea, especially in key export areas.

“The backdrop of large US rate hikes, slowing global growth leading to recession concerns, and elevated oil prices have led to severe weakness in South Korea’s currency.

“However, a weaker won is a tailwind for South Korean exporters, as it enhances their competitiveness relative to peers, which we think leads to meaningful bottom-up stock-picking opportunities.

“As we look into 2023, a normalisation of interest rates and improvements in global growth could be positive for the South Korean stock market, which was impacted by a cyclical slowdown and higher energy prices.”

In more general terms, there is also optimism for the region as a whole next year. 

While Leiper at Titan says he has a fairly pessimistic outlook for 2023, he adds: “It’s not all doom and gloom. One relative bright spot is Asia, which is expected to drive global economic growth next year versus the US and Europe, where we forecast recession.”

Konrad at Jupiter is similarly optimistic. “Asia enjoyed economic growth rates higher than any other region in the world in 2022, and we expect that to continue in 2023. 

“Economic growth does not always equate to positive returns for equity investors however, which is why picking the right stocks in the right sectors is as vital as ever.”

Chloe Cheung is a senior features writer at FTAdviser