Asia Outlook 2019

Damian Taylor and Robert Campbell, portfolio managers in our Asia team, look at the key opportunities and risks for 2019.

6 December 2018

What’s on your radar for 2019?

In the coming year, we expect to see the continued development of the four powerful secular trends which are supporting Asian economic growth: consumption, trade, infrastructure and technology.

Rising wealth is fuelling consumer spending, thanks to high employment levels and wage growth. The middle class (the largest market for consumer goods and services) is expanding rapidly and it’s estimated that approaching 90% of the next billion people entering the middle class globally will live in Asia*. Trade, meanwhile, is an increasingly important driver. Asia is now its own largest trading partner and the region is seeing the benefits of proximity, high economic growth, a broadening of manufacturing bases and lower trade barriers.

This boom in trade, alongside population growth and urbanisation is creating an ever-larger need for infrastructure in the region. The degree of urbanisation in Asia today is less than 50%, compared with nearly 75% in Europe and 82% in Northern America**. Finally, Asia is already home to several world-class technology companies at the forefront of innovation, from consumer electronics and semiconductors, to social media and e-commerce. These businesses are continuing to invest significantly in research & development.

This boom in trade, alongside population growth and urbanisation, is creating an ever-larger need for infrastructure in the region.

In particular, rising labour costs and raw materials prices are prompting many businesses to increase focus on how they use technology to offset input costs. We expect this to continue in 2019. Whether this is companies that can provide competitive solutions to these challenges, or those that can adopt solutions better than their peers, it is an area we are always keen to watch carefully. As an example, companies are using technology to meet cost headwinds by reconfiguring production lines, adding more automation and using developments in material science to make components stronger and lighter at the same time.

What are the risks in 2019?

It’s fair to say that the main factors affecting equity market sentiment (liquidity, earnings momentum, bond yields and oil prices) are less supportive than they were 18 months ago. Depending on which of the major central banks you are looking at, quantitative easing (QE) is either being reversed, tapered or stalled; estimates revisions have rolled over; while Brent crude has been significantly higher than its 2017 average for most of 2018.

The strength of the US dollar has been a much talked about risk for the region’s equities. Historically, there is a strong inverse relationship between the US dollar and Asian markets. In 2017, the weaker US dollar coincided with large flows into emerging market equities, this growth in flows has slowed significantly since the dollar recovered from the end of April. Likewise, the issue of a US/China trade war has also dominated headlines. Trade tensions do represent a challenge to the established global economic order and there are some longer-term implications for global growth, but they are not our greatest concern. Our focus though is more on liquidity and how the unwinding of QE plays out in asset markets and leveraged investment strategies.

However, there are still some clear positives for investors in Asia. Valuations are now back to slightly below 10-year averages, (a result of the MSCI AC Asia ex Japan falling significantly since its peak in January 2018). And, despite stronger prospects for the region’s economic growth, the Asian market is trading at a 25% discount to global equities***.

Our focus though is on liquidity and how the unwinding of QE plays out in asset markets and leveraged investment strategies.”

What’s everyone missing?

From our perspective, it feels like the long-term implications of the Greater Bay Area (GBA) development plan have escaped a lot of people’s attention. This initiative, launched in 2017, aims to unlock the combined potential of Hong Kong, Macau, Shenzhen and the surrounding nine cities in the Pearl River Delta area of Guangdong province. Despite only comprising around 5% of China’s 1.4 billion population, the area contributes around 12% of GDP.

The GBA has already attracted world-class technology companies: Shenzhen is the headquarters of media and internet giant Tencent; while China’s top three smartphone manufacturers are also based within the zone. We believe there is the scope for the area to become a Chinese equivalent to the San Francisco Bay area in the US, with industries focused on financial services, cloud computing and artificial intelligence already basing their operations in the GBA.

…there is the scope for the Greater Bay Area to become a Chinese equivalent to the San Francisco Bay area.

The investment opportunities from this will be vast. We should see increased demand for business travel and accommodation, as well as infrastructure growth to improve connectivity between the main cities in the GBA. In addition, there will need to be links from those cities to the rest of China, as well as all the other service structures required for the influx of people and capital. The parallels being drawn with the San Francisco Bay area demonstrate what an exciting opportunity there is in the development plan; for bottom-up stockpickers this should be a rich seam of opportunities.

* Source: Statista
** Source: Statista, Population Reference Bureau
*** Source: Martin Currie and MSCI, based on LTM p/e ratios as at 28 November 2018.

The information provided should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of the security transactions discussed here were, or will prove to be, profitable.
The opinions contained in this document are those of the named manager(s). They may not necessarily represent the views of other Martin Currie managers, strategies or funds.

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