Asia's response to the 2020 pandemic benefited the region. However, with the risk of a bubble forming in some areas, investors now need to be wide awake when picking stocks, says Abbas Barkhordar of Schroders.
Despite global turmoil from the Covid 19 pandemic, equity markets were generally robust in 2020, according to Abbas Barkhordar, Fund Manager Asian Equities at Schroders. The Asia region excluding Japan was no exception. "In many ways, the region was first to be hit by the pandemic and has been the first to recover from it. Many countries were able to successfully combat the virus, allowing economic activity to resume more quickly than elsewhere", says the expert.
While Asia's overall performance has been encouraging, he said, there are striking differences at country and sector level. North Asian countries such as China, South Korea and Taiwan, which have generally had the most success in containing the pandemic, outperformed stock markets in India and the ASEAN region.
Market performance
At the sector level, strong demand for digital services and home office devices led semiconductor suppliers and other technology companies to outperform, Barkhordar notes. Other areas that have benefited from the pandemic have been e-commerce – part of the non-basic consumer goods sector – and communications services. Companies in these sectors tend to be based in North Asia, he said, contributing to the strong performance of these countries. "In contrast, traditionally economy-sensitive sectors like energy and finance lagged behind. These sectors generally make up a higher proportion of the market in South and Southeast Asia", Barkhordar adds.
During 2020, optimism about a rapid economic recovery was fueled by very encouraging news on successful vaccines and tremendous fiscal and monetary support from governments and central banks, the fund manager notes. These factors will continue to support the markets in 2021. However, as growth expectations have increased, long-term interest rates have also risen, which may have an impact on markets.
Vaccines drive high earnings expectations
"As a result of the price rally, stocks now appear relatively expensive relative to their long-term averages, at least compared to their historical earnings and book values", says Abbas Barkhordar. This suggests that markets are pricing in a fairly robust recovery in earnings, he.
In fact, consensus expectations for corporate earnings have been raised significantly as confidence grows in the recovery and successful vaccine rollout. For the Asia ex-Japan region, market expectations for this year are for profit growth of around 25% year-on-year or. 15% for 2022.
Earnings expectations
The equity specialist does not think these figures are unrealistic. However, much will depend on the further course of the pandemic, especially how countries deal with new variants of the virus. Thus, forecasts of future profits may be more uncertain than usual, it said. Given valuations, he believes the markets could be disappointed on this point.
In addition, summarized key figures are of limited value. As the past year has shown, there can be significant differences both between markets and within markets.
Private investors get in on the action
"Another phenomenon that has contributed to a rise in markets around the world in recent months is the sharp increase in activity by private investors. This was probably particularly the case in the US – we remember GameStop, for example – but there are also signs of this in Asia," says Abbas Barkhordar, according to Barkhordar.
Rising retail investor activity may be contributing to the more inflated valuations seen in some parts of the market, he added. Some of the "overheated" Market sectors such as biotechnology, software and electric vehicles are trading at or near historic highs in terms of their valuation metrics.
According to the expert, these valuations are sometimes based on extremely high projected growth, often far into the future, and they are therefore very vulnerable to changes in sentiment or interest rate increases. By contrast, low-valued sectors – banks, real estate, capital goods, utilities – have not attracted retail investor interest, Barkhordar notes. This, he said, is one of the reasons these sectors are currently looking more favorably valued overall.
Active stock selection to identify hidden champions
This demonstrates the importance of active stock selection in the region. It is important to be able to select stocks in areas that are overlooked by investors and may be underperforming – but whose recovery prospects are underestimated by the broader market, he said. Likewise, areas with a low margin of safety should be avoided. Their so far solid momentum could turn into the opposite at any time.
This applies to sectors as well as countries. Relative growth could soon shift to countries in South and Southeast Asia, which have so far underperformed compared with North Asia. With the recovery spreading, this is a "catch-up game," says Barkhordar.
China has already taken some measures to tighten the monetary reins and calm more speculative areas, he said. The fund manager expects support and liquidity from governments and central banks to be withdrawn sooner in countries that have already performed well. It is therefore very important to be active in asset allocation to account for such differences, he said.
Barkhordar also points out that Asian equity markets compare very favorably to the rest of the world in terms of the earnings potential and robust dividend streams that Asian companies offer. This is partly a legacy of the Asian financial crisis. "Companies in the region generally had more conservative balance sheets at the start of the crisis than peers in other regions. They also stood out for more reasonable payout ratios, especially compared to the U.K.", notes Barkhordar. He therefore sees no reason why dividends should not recover in step with profits.
Balance sheet comparison regions
Barkhordar adds that the value of investments and the returns they generate can go down as well as up, and investors may not get back the capital they originally invested. Past performance is not indicative of future performance and may not be repeated.