2019 midyear outlook—Asian equities

Asian equities held up strongly in the first half of 2019, despite the negative impact of escalating China-U.S. trade tensions. As the two countries continued talks in the first four months of 2019, markets were positive about the prospects of a deal. This optimism, combined with the U.S. Federal Reserve’s (Fed’s) increasingly dovish stance, boosted liquidity and investor sentiment in the region. By mid-April, Asian equities had posted a gain of roughly 16%.²

In May, however, this market consensus gradually disintegrated—U.S. President Donald Trump first threatened imposing new tariffs in mid-May, which was followed by an increase in tariffs on Chinese imports, and subsequent Chinese retaliation erased some of those advances. Although this rupture in expectations drove markets lower, Asian equities still held onto respectable gains³ for the first half of the year. China and Hong Kong, the most affected markets, remained firmly in positive territory. Crucially, election outcomes in Indonesia and India were viewed positively by investors and boosted markets in both countries.⁴

The resilience of Asian markets amid persistent macro volatility is significant. Granted, some things have changed since trade tensions escalated in 2018; most notably, the Fed’s dovish stance, including its June statement that opened the door to potential rate cuts, has effectively put a floor in the market. Capital inflows to Asian markets were also net positive for most of the first half.⁵

However, we also believe regional markets are potentially reflecting something deeper that will drive changes in the second half of 2019 and beyond: a renewed emphasis on research and development (R&D) and innovation among tech firms in Northeast Asia, as well as a rapidly evolving manufacturing, business, and human capital landscape in Southeast Asia.

As we’ve regularly noted, our base case for the China-U.S. trade war is for both sides to ultimately reach a trade agreement in 2019; investors should realize that the underlying issues behind the current dispute are structural and long term in nature. This is evident from the United States’ two-pronged approach to the dispute: Engage in negotiations to resolve trade issues, while also moving to cut off Chinese technology companies from U.S. suppliers.

Although it’s still too early to gauge the full implications of these moves, we believe it represents a potential long-term opportunity for Chinese and Asian technology firms. Indeed, although the growth prospects of some Chinese tech companies will inevitably be hurt in the short term, advanced technology suppliers in Korea and Taiwan may be key beneficiaries, as they’re able to supply both U.S. and Chinese firms over the short term. For example, semiconductor foundries and small design houses in Taiwan can benefit as China readjusts its supply chains.

Over the long term, regional technology firms are clear that even if trade sanctions are removed, a bifurcation in technology development and standards between the United States and China may redefine global supply chains in the future. As a result, we believe R&D and innovation will continue to be top issues in Asia tech companies’ boardrooms in preparation for such a scenario.

We also believe Asian equities should benefit from election results in South and Southeast Asia. Indeed, incumbent victories in India and Indonesia have removed investment uncertainty and laid the foundations for policy continuity. We see potential beneficiaries in the region from shifting supply chains; Vietnam, for instance, has emerged as one potential beneficiary from persistent trade tensions.

• Indonesia: President Joko Widodo’s electoral victory in April, followed by Standard and Poor’s subsequent sovereign credit-rating upgrade in late May, is evidence that his first-term economic reform agenda has borne fruit. That agenda will likely evolve in his second term: from an emphasis on investment in infrastructure to a broader set of goals, including supporting income growth among the poor/middle class, improving access to basic education, and promoting greater flexibility in the labor market.⁶ Progress in labor market reforms has notably lagged so far, and the country’s real economic growth performance has suffered as a result.⁷ Accelerating those reforms should help boost Indonesia’s long-term potential growth prospects. Based on Mr. Jokowi’s new mandate, we’re currently constructive on sectors in consumption, contractors, and financials in Indonesian equities.
• India: Prime Minister Narendra Modi party’s margin of victory in Indian elections surprised on the upside, which should give him greater flexibility in implementing difficult reforms. Domestic reforms carried out over the last few years have resulted in a more formal economy, with better public infrastructure and a healthier state of private sector banks. Despite some near-term slowdown, this backdrop provides a solid foundation for medium- to long-term growth, which we believe will gradually improve in the second half of 2019. We remain constructive on large private banks, as they’re gaining market share with both deposits and loans. We also see a continuing improvement in asset quality. Elsewhere, we’re also constructive on industrials, which is benefiting from robust public spending on power, roads, and housing.
• Vietnam: We’re actively looking for opportunities in the country for several reasons. First, the government’s macroeconomic management has notably improved from previous years. Growth has stabilized, and the central bank has kept inflation under control, translating to a more stable currency. Second, we believe Vietnam will be a primary beneficiary of shifting supply chains in Asia—at the expense of China. Many multinational regional electronics producers have set up production facilities in the country, with more looking to do so as the threat of a long-term technology schism heightens. Some businesses have also increased trade with Vietnam by building up supply chains in the country for textiles. In fact, Vietnam was one of the fastest-growing sources of U.S. imports from Asia in the last quarter and could potentially overtake the United Kingdom as a key supplier to the United States if it maintains that pace.⁸

On the last point, as discussed by my colleague Kai Kong Chay in his midyear outlook, China-U.S. trade tensions have reinforced the rebalancing of supply chains, creating opportunities for regional players in both Northeast Asia (Taiwan) and Southeast Asia (Vietnam, Bangladesh, to fill the supply gap. China is the anchor of supply chains and trading blocs throughout the region, and now that Chinese businesses have the incentive to diversify away from manufacturing, its Asian neighbors stand to benefit. Increasingly, regional business should also employ a “one plus one” (essentially China plus an ASEAN country) approach to rebalancing their supply chains, which can open up new opportunities across the region.

Our overall view of Asian equities is positive, although we acknowledge that volatility may be part of the near-term landscape. ASEAN countries should benefit economically from China’s policy tools as the trade tensions unfold: whether it’s managing the trajectory of the renminbi, continued monetary easing in the form of lower reserve ratio requirements, lending-rate cuts, or developing local brands. While nimble small-to-medium enterprises in the ASEAN bloc stand to benefit from the changing dynamics of trade beyond the region, internally, Asia should continue to strengthen through deepening reforms, political stability, and more vibrant domestic economies.

All of which, in our view, speaks to the larger point: The Asian equities market is evolving and creating new economic opportunities even amid persistent trade tensions. Indeed, if market observers believed 2018 was the year of tariffs, and 2019 is the year of technology, then 2020 may be the year of talent. Although we live in a world dominated by numbers from the rate of tariffs applied on goods to the latest GDP print, investors should look beyond the data to understand how these disruptions are forcing countries to focus on human capital building and sowing the seeds for long-term reforms that will ultimately create a more dynamic and innovative region.

1 Bloomberg, as of June 21, 2019, MSCI country indexes, total returns in U.S. dollars. 2 Bloomberg. The year-to-date gain for the MSCI Asia (ex-Japan) Index was 16.00% as of April 17, 2019. It is not possible to invest directly in an index. 3 Bloomberg. The MSCI Asia (ex-Japan) Index was up 10.68% year to date as of June 21, 2019. It is not possible to invest directly in an index. 4 Bloomberg, as of June 21, 2019. 5 JP Morgan, June 2019. 6 “In Indonesian Election, President Joko Widodo Leads in Voting Returns,” New York Times, April 17, 2019. 7 “Realizing Indonesia’s Economic Potential,” IMF, October 25, 2018. 8 Imports from the Southeast Asian economy jumped 40.20% in the first three months of 2019 from a year earlier, while orders from South Korea rose 18.40%, according to the U.S. Census Bureau, as of May 2019.