Economic trends

Asia’s market rally set to continue

Asian equities have had a strong start to the year, with China and South Korea leading the way

Asia’s equity markets have had their best start to the year since 2009, rising almost 30 per cent so far this year, and the rally is likely to continue for the rest of the year.

Driven by US dollar weakness, a solid earnings recovery and a diminishing chance of punitive US import tariffs, China and South Korea – our preferred Asian markets – have led the pack, posting gains of 36 per cent and 31 per cent respectively.

Consensus forecasts suggest earnings growth in Asia ex-Japan is likely to increase by 18 per cent this year, following a 1 per cent decline in 2016, with China leading the recovery. Meanwhile, South Korean equities, for which exports are an important growth driver, have been favoured by investors amid easing of political risks and reduced likelihood of US import tariffs rising.

A weaker dollar, besides allowing Asian central banks full control of their monetary policy, is generally supportive for Asia as it results in an increase in capital inflows, boosting demand for its stocks and bonds.

Room to run

Looking ahead, the factors behind the Asian equity rally – US dollar weakening, positive earnings expectations and low likelihood of a US import tariff – are likely to remain in place for the rest of the year, but there are new catalysts that could help sustain it too, such as policy paralysis in Washington, which is good news for Asian and global asset markets as it reduces the risk of additional US stimulus at time when there is little spare capacity in the US economy.

So Asia’s equity market has further room to run, but will China and South Korea continue to lead
the pack? We think so.

There are clear catalysts that may enable Asia ex-Japan markets, and China and South Korea in particular, to post solid returns in the second half of this year

The recent decision by MSCI, a provider of index data, to include China’s locally listed ‘A shares’ in its global list of equity market indices is significant. Although the short-term impact is likely to be modest, given the weight of the included shares in the MSCI Emerging Markets Index is a mere 0.7 per cent, looking ahead to 2025, the weight of the A shares could increase to 12 per cent.

Another driver of Chinese equities is China’s increased focus on maintaining financial stability. Plus, we believe the Chinese government is keen to support a positive wealth effect from rising real estate prices ahead of the government’s congress meeting in autumn.

‘Trapped liquidity’ is the other likely driver of China’s equity markets for the rest of the year. Chinese companies have been on an acquisition spree until recently, having spent USD246 billion in overseas acquisitions alone in 2016. This is reminiscent of the acquisitions by Japanese companies prior to the Japan’s bubble bursting in the late eighties.

Keen not to repeat the same mistakes, policymakers have withheld approvals for overseas acquisitions this year, pressuring banks to reduce credit for such transactions, resulting in acquisitions plummeting by 67 per cent in the first four months of this year. We think the tightening is positive as it traps liquidity within the domestic economy. It will also help reduce corporate debt in China from growing any further, given that most of these acquisitions are debt-financed.

Easing tensions in South Korea

When it comes to South Korea, in our view, there are a number of positive developments that will support equities in the second half of this year – the most significant being the decline in political risk following the change in government which has led to an easing of tensions with China. Other factors include reforms aimed at improving shareholder returns and accelerating corporate restructuring.

We believe there are clear catalysts that may enable Asia ex-Japan markets, and China and South Korea in particular, to post solid returns in the second half of this year. In fact, we think returns could be strong enough to outperform global equity markets for the first time since 2012.

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