2022 Asian equities: opportunities in a diverging market landscape

Throughout the COVID-19 pandemic, both last year and in 2021, we foresaw a divergence in the performance of Asian equity markets. In 2020, Northeast Asian markets with superior virus containment measures and relatively higher vaccination rates led the region, while ASEAN countries¹ lagged due to concentrated urban populations, limited access to vaccines, and less developed healthcare infrastructure. 

Looking at regional market performance year to date (as of December 21, 2021), this dynamic has undergone some changes. Some North Asian markets, such as Taiwan, continued their outperformance on the back of strong technology-related exports; however, South Korea and China faced greater challenges, the latter for idiosyncratic reasons related to a raft of high-profile regulatory challenges. India also posted impressive results in 2021 on the back of strong economic performance after a severe COVID-19 wave in the first quarter. Finally, most ASEAN markets (except for Singapore) lagged the region in 2021 as mobility restrictions and recurring bouts of COVID-19 stymied a robust rebound.

2021 Asian equity market performance, 2021 (YTD)

Asia’s macro environment—highlights for 2022

COVID-19

Amid the spread of the Delta variant, an increasing number of Asian economies, most notably in Southeast Asia, have reached critical mass with their vaccination program. And as Southeast Asia adopts living with COVID-19 strategies, the subregion may also introduce reopening strategies. Should governments exploit the opportunity and manage the pandemic without lockdowns, this could boost service-sector and consumption growth. There will be exceptions, namely China and Hong Kong SAR, which will continue to maintain a zero-COVID-19 strategy.

Asia’s vaccination rates

That said, the threat from further waves of the pandemic should dissipate, as most countries and territories in the region are projected to reach vaccination rates of around 80% by the end of 2021. After two years of tackling and controlling the spread of the virus, governments in the region have acquired a better understanding of how and when to deploy border restrictions, community controls, and lockdowns. Various governments are rolling out booster shots to enhance overall levels of immunity while the development of Omicron is believed to be contagious but with less serious impact. We’re hopeful that the impact of COVID-19 will be reduced in 2022 with the possibility of COVID-19 transforming from pandemic to endemic in the coming years.

U.S. taper

The U.S. Federal Reserve’s (Fed’s) tightening is imminent: The U.S. central bank’s tapering process started in late 2021 and is due to conclude in summer 2022. A rate hike may follow in late 2022 or 2023. The normalization of monetary and fiscal policies warrants careful monitoring but isn’t a cause for concern at this stage. Macroeconomic stability indicators, such as real rates, real rate differentials, inflation, current account balances, and foreign reserves in most Asian economies are at levels that would not pose an immediate risk should there be sharp, near-term policy tightening. In short, most Asian economies are in better shape than they were in 2013 when the Fed announced a tapering of its quantitative easing program. Unless we see an expedited tapering process, Asia looks well prepared for this normalization.  

Exposure to China’s growth pattern

It’s worth noting that as China slows, economies that are more exposed to changes in its growth patterns, such as Taiwan and South Korea, are expected to feel a more significant impact, as the demand from developed markets will concurrently shift from goods to services. That said, in the wake of 2021’s reopening, consumer spending in developed-market economies has started to rebalance from goods back to services, a process that marks the start of normalization in global trade growth. We’ll be mindful of this development when China begins to loosen its policy to mitigate the slowdown.

China’s decarbonization policies—along with weather disruptions—have pushed energy prices higher, presenting risks to the upside for inflation. Supply chain issues have also lasted for longer than expected, creating pressure on both the supply and cost of goods. In response, some central banks are turning more hawkish, but we’re not in the stagflation camp. Besides, Southeast Asia still has the capacity to absorb demand-led inflation, as the threat of runaway inflation is relatively low.

Growth

It’s important to set things in perspective. The three macro factors aforementioned undoubtedly represent growth headwinds for Asia. However, their impact is expected to be felt differently in North Asia compared to Southeast Asia. As such, we expect GDP growth in China to slow from 8% in 2021 to around 5% in 2022, lower than the growth projection in Southeast Asia. Our positive outlook for Southeast Asia is further propelled by 6% to 7% expected growth momentum in India.

ASEAN economic growth is expected to outpace China in 2022

Our positive view toward Southeast Asia is further reinforced by the higher real yields on offer in the region’s major economies, namely Indonesia and India, which are attracting capital flows.  

Real yields in Asia (%) 

Source: Bloomberg, as of December 18, 2021. 

Southeast Asia’s strategic roles and 2022 outlook

We believe that Southeast Asia will be a strategic beneficiary from the previous tensions between China and the United States, at least over the medium term, as there may be foreign direct investment in specific sectors. These include battery suppliers in Indonesia, auto companies in Thailand, and the information technology (IT) supply chain in Malaysia.

While physical ASEAN integration has been disappointing, digital integration within the bloc is more encouraging. Currently, over 30 big-tech unicorns are due to be listed, and this process is expected to extend to fintech, logistics providers, and e-commerce players.  

These companies share some features:

1. The business lines of many of these unicorns will adapt more readily to regionalization.
2. Unlike traditional industries, e-commerce, the internet, and e-gaming are less regulated.
3. ASEAN governments have fewer regulatory concerns about big tech.

The near-term outlook for ASEAN is expected to improve as economies reopen, with most of the bloc’s countries relaxing movement and travel restrictions, albeit gradually. Strategically, Southeast Asia should play an important postpandemic role in Asia’s economic trajectory. The China Plus One initiative has encouraged multinational companies to diversify their business lines and production bases into regional markets.

In Indonesia, higher commodity prices (coal and palm oil) will be supported by healthier domestic consumption. As the world’s fourth-largest nickel supplier, Indonesia is also well positioned in the electric vehicle supply chain. Furthermore, the country’s digital economy is enjoying strong organic growth, with rising demand for fintech providers, logistics warehouses, and associated services. 

Malaysia’s economy is also moving toward a gradual reopening, hence the boost for the local technology sector. While higher wages are a headwind for corporate earnings, they can encourage domestic demand. Meanwhile, in Thailand, infection and hospitalization rates are declining. The announcement of quarantine-free travel shows that a resumption in tourism activities remains critical for the Thai economy, which is currently supported by the export sector.  

India remains a local and bottom-up investment story with a stable regulatory environment. We expect economic activity to continue improving as vaccination rates increase. The country’s recovery is well supported by a host of structural reforms, including a low corporate tax levy, indirect tax reforms, and the Bankruptcy Act. These developments, coupled with government-led policies on formalization, digitalization, and manufacturing revival, are expected to lead to long-term growth. Import substitution will play a significant part in the Made in India policy in 2022 and, therefore, offers investment opportunities. These companies also stand to benefit from the ongoing economic recovery and production shifts away from China.

North Asia’s structural growth drivers could deepen further in 2022

The structural growth drivers in Asia will evolve around two key themes:

• Consumption upgrade and China’s decarbonization plans
  As noted, we think there’ll be softer near-term growth in China as business models realign with the government’s aims for common prosperity. In general, we expect the earnings of companies with solid branding and pricing power in the export sector to outperform that of businesses exposed only to domestic demand. Regarding the consumption upgrade theme, we believe the winners shall be those that can adapt quickly to local tastes. We’ve seen local brands gaining market share from foreign brands in many categories such as sportswear, skincare, and cosmetics. Value is emerging in a few internet bellwethers, and much of the regulatory risk associated with the sector is currently priced in. Also, we continue to like companies that are benefiting from China’s decarbonization plans. We see solid investment opportunities in the renewable energy sector, which enjoys strategic priority for government funding. Construction of wind and photovoltaic bases has already been accelerated, thanks to the elevated pace in government bonds and favorable policy support. However, we'll be more selective going forward, as higher raw material prices for alternative energy may impede the pace of investment in this area. 
  
  
• Increasing IT-led demand leading to advanced chip migration
  South Korea and Taiwan should continue to provide value in the tech supply chain. With the rollout of 5G technology and the rising adoption of electric cars, chips will need higher processing power, speed, and heat resistance. As such, we expect demand to evolve and migrate from DDR4 to DDR5 memory chips. In Taiwan, we’re seeing developments in how chips can be upgraded in specification and through the use of new materials, as well as advanced packaging. Besides, the growth of tech companies in South Korea will be helped by the long-term structural demand for higher computing memory and processing power, and the structural shift to electric vehicle batteries and fintech services. 

1 ASEAN refers to the Association of Southeast Asian Nations, an economic union comprising 10 member states in Southeast Asia. The ASEAN Five refers to Indonesia, Malaysia, the Philippines, Thailand, and Vietnam.