Asian Equities: On the Path to Recovery
Some of the risks that started to unfold in the second quarter developed further in the third, ranging from tightening regulatory policies—especially for the internet and new economy sectors in China and Korea—to the debt default crisis of Chinese property giant Evergrande that led to concerns of spill-over risks outside China. Additionally, challenging new COVID outbreaks emerged across the ASEAN countries. As a result, markets experienced several event-driven sell-offs, and Asian equities ended the third quarter in negative territory.
Meanwhile, the style rotation from growth to value stocks also extended to the third quarter as the post-pandemic reopening of economies continued across the world. Specifically, value cyclical sectors such as materials and energy were relative outperformers, helped by surging commodity prices, while consumer discretionary and communication services sectors were laggards on the back of heightened regulatory pressure and weaker-than-expected consumption recovery over the quarter.
The Path Toward Normalization
Looking forward, while we expect near-term market volatility to continue in the region, it is likely to be increasingly subject to the idiosyncrasies of each market. For example, regions like ASEAN that had lagging vaccination rates have gradually improved, and outbreaks have been contained. This means that the economic recovery and growth acceleration across the region may come later than expected—with ASEAN likely to outperform other regions. Some countries are already expected to reopen their borders to foreign visitors in the fourth quarter, starting with Singapore, Malaysia and Thailand.
The normalization of the global economy will also likely lead to the resumption of supply chain migration from China to Southeast Asia, while China looks to continue its value chain upgrade and consumption restructuring. However, restarting the global economic engine will likely be a bumpy process. Inflationary pressures, caused by supply chain dislocations, and geopolitics, could also introduce volatility to equity markets. Inefficiencies within the supply chains may require some time to resolve and return to pre-pandemic dynamics.
At the same time, major central bank policies are expected to diverge in the fourth quarter. While the U.S. Federal Reserve is expected to taper in the coming months and raise interest rates in 2022, monetary and fiscal policies in China could be marginally easing due to moderated growth, particularly to cushion the impact from the industrial output decline from recent power shortages. The frequency and severity of further regulations should also be moderated.
Asian Equities Look Well-Supported
We are constructive on Asian equities and expect returns in the fourth quarter to be driven by a substantial recovery in corporate earnings, particularly in the markets with heavier domestic composition. External balances for South Asian economies are also much healthier than before, and are therefore likely to be less vulnerable to currency movements. When it comes to ASEAN equities, we believe they will be supported by the continued rally in commodities, given that a number of these countries are endowed with both soft and hard commodities. Meanwhile, although Chinese equities have suffered from the various regulatory crackdowns, valuations are significantly discounted, in our view—and the recent regulations look likely to foster a more positive environment for long-term sustainable growth in China. Further, relative valuations for Asian equities look compelling to us after a prolonged period of underperformance.
As we look across the markets today, we see value in companies with exposure to secular growth themes such as technological ubiquity (digitalization and connectivity of everything), evolving lifestyle and societal values (sustainability, millennial/Gen Z consumption, healthy living), and de-globalization (supply chain diversification/bifurcation and reshoring). The recent share price corrections in some companies have made valuations more attractive, creating opportunities to build positions in high quality companies at attractive prices.
At Barings, while the stylistic rotations have caused some recent volatility, our approach remains anchored in our Growth-at-a-Reasonable-Price (GARP) investment philosophy. At the stock selection level, this approach helps us to avoid overpaying for a company’s growth, while at the portfolio construction level, it helps limit exposure to unintended styles or risks.
