Investing in Asia in Times of Uncertainty

The European debt crisis is likely to continue to cloud the investment outlook for Asia in 2012. Even if Europe is able to convincingly tackle its current problems, investors in Asia need to adjust to how global economies have permanently changed in the years since the onset of the 2008/09 financial crisis.

Adapted from Coutts 2012 Asian Investment Outlook


Global Risks Shadow Asian Outlook
The European debt crisis is likely to continue to cloud the investment outlook for Asia in 2012. Even if Europe is able to convincingly tackle its current problems, investors in Asia need to adjust to how global economies have permanently changed in the years since the onset of the 2008/09 financial crisis and how this altered environment will now drive long-term investment returns. 
In particular, an ongoing deleveraging of Western economies, together with generally lower expectations for secular long-term growth, suggests that the West will remain vulnerable to economic shocks in the years ahead. We are encouraged that policy makers around the world seem to understand the challenges currently presented to the global economy. The shocks, political polarisation and limited policy options available to the West continue to pose risks that could potentially hinder the long-term rebalancing of global economic activity towards Asia. 
In Asia itself, the cyclical backdrop has been improving. Growth and inflation rates have slowed in recent months, creating a regional backdrop that is more conducive to investment. Imbalances, as currently evident in regional property sectors, together with the wide disparity of incomes, suggest a slowing growth outlook in 2012.
Prospects For Capital Gains In 2012
Should Western economies grow at or near their current trend growth rates of around one to two percent, Asia should be able to make a gradual transition from supplying Western economies to selling increasingly to home markets. Falling inflation, easing monetary and fiscal policy,and strengthening currencies should allow domestic Asian demand to partially offset the loss of growth in key external markets in the US and Europe. 
Indeed, Asian equities (as reflected by the MSCI Asia excluding-Japan index) are underpricing such an outcome. In fact, since 1995, Asian equities have only traded significantly below current valuation levels in periods of crisis in the global or regional economy – the 1997 Asian financial crisis; the 2001 bursting of the global tech bubble; the 2003 SARS crisis; and the 2007-2009 global financial crisis. This undervaluation is also why the European crisis is a key concern for investors even at current valuation levels. If Europe and the US relapse into a greater crisis or recession, Asian investors could see a 15 to 20 percent decline in their investments (such a fall would leave evaluations consistent with the 2001 and 2007 to 2009 crises) from current levels. 
2012 Asia ex-Japan Growth Outlook 
Asian economies will slow down visibly as we look into 2012, as the effects of 2011’s policy tightening and weak European growth take hold. Inflation has probably peaked and as a result, we expect regional policy makers to shift towards easier monetary policies. Inflationary pressures should continue to ease in 2012, as the benefits of this year’s moves to surge monetary policy in many countries takes hold. We have already seen food and fuel prices dip from their peaks earlier this year. However, already low real interest rate levels suggest that central banks in the region will not move to cut rates too proactively. Asian policy makers will therefore seek to maintain stability and will not try to dramatically prompt a reacceleration of activity in 2012. As a result, we expect GDP growth in Asia (excluding-Japan) to track at near seven percent a year, slowing from the 7.5 percent we expect for 2011. 
Building an Asian Asset Portfolio
In the past, investors in Asia have focused on capital gains as a way of driving portfolio returns. Strong equity market rallies between 1990 and 1996 and, subsequently, between 2004 and 2007, served to reinforce this approach. 
However, since the Asian crisis of 1997 to 98, Asian equities have seen the drivers of return become more varied. Dividends have been the most consistent drivers while in recent years, currencies have also provided opportunities to augment total returns on Asian asset portfolios. 
ASEAN Economic and Foreign Exchange outlook
In 2011, ASEAN economies avoided many of the GDP-growth downgrades that their peers in the region suffered. Driving this tactic was the effective use of currency and other domestic policy tools. These contained inflationary pressures early in the year. Later in the year, their large domestic economies buffered the impact from the global slowdown in economic activity. 
ASEAN currencies suffered in the same fashion as the rest of Asia as a result of the European sovereign debt crisis in the second half of the year. Although the domestic economies were relatively insulated from the resulting market turbulence, continued reliance on foreign capital flows remains an important risk for investors into ASEAN. 
The strong capital flows between the European, Malaysian and Indonesian banking sectors prompted a five to six percent weakening of the Ringgit and Rupiah against the US dollar in the second half of 2011. This is comparable to the weakness seen in more trade-sensitive currencies of Singapore, Korea and Taiwan. In contrast, countries with weaker capital or global trade links, including Thailand and the Philippines, only saw a one-1.5percent weakening of their local currencies over the same period. 
As a result, while investors into ASEAN should continue to benefit from the large size of their domestic economies and flexible fiscal and monetary policy, further devaluations in their currencies remains a key risk, especially should the situation in Europe continue to deteriorate. Assuming the European crisis stabilises, we expect ASEAN currencies to broadly track the US dollar and weaken against regional counterparts including the Singapore dollar, the Chinese yuan, and the Australian dollar. 
Against this backdrop, we expect ASEAN economies to see stable GDP growth of near 5.5 percent a year in 2012. Such a scenario allows for a small acceleration in financial activity in Thailand following the recent floods. In addition, expansionary fiscal policy in Malaysia should underpin growth and be a key driver of the economy in the next two years. Inflationary pressure should become more moderate in 2012 across the ASEAN region. However, government policy action in the latter part of 2011 suggests that inflationary risks remain especially in Indonesia. 
Equity Market Outlooks
ASEAN (excluding Singapore) equity markets have weathered the crises of 2011 well. Equity markets fell modestly while the Philippine equity market has shown positive returns for the year. ASEAN equity markets outperformed others in the region in the first half of 2011, as domestic government policy shouldered much of the impact of high global oil prices. Moreover, large domestic economies in Indonesia and the Philippines both provided support to earnings as global growth expectations fell. 
Though the earnings picture should remain attractive, a more mixed valuation picture suggests selectivity in ASEAN is needed for this year. Indonesian valuations remain high, even after adjusting the premium-returns Indonesian corporations have earned since 2002. Equity valuations in Thailand sit historically cheap following the floods in late 2011. Earnings expectations are optimistic going into 2012 and they will likely require downward revisions early this year which may weigh on performance. 
Above-average dividend yields and a defensive sector-mix positions Malaysia as a potential refuge for investors in the face of regional and global volatility. Within itself, Malaysia’s Economic Transformation Plan (ETP) and the prospect of national elections will be key activity-drivers next year. However in periods of global uncertainty, Malaysia’s defensive sector mix (which includes the gaming and lottery sectors), added to the country’s listed companies pay the highest and most stable dividend payouts in Asia, may together prove to be a source of refuge for investors.