David Gaud is equity fund manager for Asia ex-Japan for Edmond de Rothschild Asset Management. He has previously worked at Société Générale, HSBC and Deutsche Bank.
Can you summarise the macroeconomic trends impacting Asia ex-Japan?
The Asia ex-Japan zone has emerged reinforced from the crisis, particularly the banking sector. Due to their robust balance sheets, Asian banks have moved into a credit cycle, which is picking up speed and growing by more than 20% in India, Thailand and Indonesia. Interest rates are at record lows and this is having a very visible positive impact on capital formation, consumption and the development of domestic capital markets.
Today’s moderate inflation is also favourable for Asian countries: it is an essential factor in improving the region’s return on equity, which is close to 14.8% in 2010 and expected to be more than 15% in 2011. At the same time, and even after the market’s good performance over the last 18 months, valuations are reasonable with the market trading on two-times book value for 2011. This is a long way from bubble levels of 2.8 to 3 times.
Geographically, growth structures vary but momentum is ultimately the same. China has started growing again and India continues to expand, so the entire region is benefiting from this. Countries such as Indonesia and the Philippines are also benefiting from demographic momentum. But it is China above all that is triggering initiatives in the region. Witness the Singapore Stock Exchange’s bid on the Australian Stock Exchange in Sydney in an attempt to keep up with Hong Kong and Shanghai.
Let’s not forget South Korea, which has in recent years made huge high-tech investment efforts in its cutting-edge industries. It has been rewarded with an increasingly dominant position in key sectors and has even become a threat to Japan. Take, for example, its success in winning nuclear projects in the Middle East and Turkey. The auto sector is another example: Hyundai’s operating margin is more than 8% compared with 3% for Toyota and Renault.
India has recovered well and should match China’s pace of growth from 2012. The biggest threat to India would be the sort of overheating that occurred at the end of 2007. That would cause the government to slam on the brakes.
What are your investment priorities at present?
Our investment process is based on seeking out growth themes in the region such as domestic consumption, infrastructure and growing inter-emerging country trade. We currently have big positions in growth themes as varied as agricultural commodities, tactile screens for phones and tablet PCs, heavy infrastructure equipment, renminbi internationalisation in Hong Kong and the Korean auto sector.
Playing growth themes that are highly dependent on China through smaller markets such as Indonesia, South Korea and the Philippines has paid off again this year, and we think the trend will continue. The best returns are not systematically on stocks listed on major markets. This is why it makes sense for an Asian fund to invest in smaller countries; they benefit as much, if not more, from the momentum generated by bigger, neighbouring countries.
Year-to-date, the Philippines has been the best performing Asian market along with Indonesia. When China is doing well, the Philippines can develop its exports, invest in infrastructure and create favourable conditions for listed companies. The Manila stock exchange has gained more than 50% year-to-date in euros. The country embodies the main attractions of emerging markets: a) domestic consumption represents 75% of GDP vs. 60% for India; b) infrastructure spending, which had been stuck at 3% of GDP for several years, has accelerated due to an ambitious public/private partnership program which will be launched before the end of the year. An initial $5 billion will be spent on trains and urban transport, motorways, and irrigation and water treatment projects; c) bank loan facilities, which are still underused but which have never been so cheap. HSBC Manila is offering mortgages at 5.99% for the first year, when rates were still above 10% only two years ago; d) from the shareholder structure angle, more and more quality companies are being listed and earnings growth for 2011 should exceed 15%, after rising by 25% in 2010.
What are the prospects for China itself?
China massively underperformed India over the first six months of the year because of monetary tightening and the introduction of measures to rein in the property sector. In making these moves, China was very much ahead of other emerging and developed countries. Tightening phases are always tricky for equity markets, but once the process is over, visibility is better than in countries that are still debating policy choices. China’s recent 25bp hike should help to stabilise the situation and even prove favourable for major Chinese sectors such as banks and insurance, which have been lagging the market. The move has also sent a strong signal that China can afford to normalise monetary policy before everyone else as its economy is doing well. The deviation in valuations between China and the rest of Asia had hit record lows, although earnings growth in China was not significantly lower. We are now seeing a catch-up phase. China is still trading at 12.6 times estimated earnings for 2011, the average for the region. I am also very bullish about several China proxy countries like Indonesia.
What do you expect to see in coming months?
The good third-quarter performance posted by Asian markets looks rather similar to 2004: a mixed first half (in 2004 interest rates rose in China and the US) and a vigorous rise in the second half due to four growth factors: 1) dollar weakness, and upcoming quantitative easing would suggest more of this; 2) a pause in China’s monetary tightening. After the recent rate hike, we should see the situation calming down; 3) upward revisions in earnings growth. At the beginning of 2010, growth over a one-year rolling period was estimated at 24-25%, and by the end of the year we should be at +40%. The outlook for 2011 is positive; 4) a soft landing for the global economy.
The OECD’s indicator peaked in February 2010 and should rebound again from the second quarter of 2011. There are real similarities here. If we extrapolate further, 2011 could look like 2005, i.e. more moderate earnings growth – in 2005, it was +5% over a rolling one-year period, but we expect +10% in 2011 – which would not upset stock markets. In 2005, Asian indices gained 36% in euros and 20% in US dollars over a one-year rolling period.