Recent months have served a timely reminder that market dynamics can shift rapidly. As investors mull the shape of portfolios amid potential concentration risks, Asia offers attractive long-term growth and income potential at compelling relative valuations, alongside diversification benefits. Marty Dropkin, Head of Equities, Asia Pacific, outlines how investors can position to capture long-term value and embrace what’s next in the region’s development.

Key points

• The investment landscape across Asia is changing, but the region’s growth story remains supported by structural trends and policy measures.
• Looking beyond short-term sentiment and generic newsflow to the fundamentals of individual securities, we see rich potential across a range of areas, with research excellence key to identifying and capitalising on this value over the long term.
• Recent events have served as a timely reminder that markets can shift rapidly and concentration risks remain. In this context, Asia’s next phase of development offers global investors attractive long-term growth and income potential at compelling relative valuations, alongside potential diversification benefits.

Putting Asia's sentiment-driven headwinds in context

Despite market challenges YTD in many Asian economies, alongside the drag of newsflow-driven sentiment in some areas, we believe fundamentals prevail and such volatility surfaces opportunities for investors.

In China/Hong Kong, concerns over unemployment and property prices weighed on consumer and corporate confidence. This impacted earnings and led to a compression in multiples in areas such as consumption and healthcare. Amid economic uncertainty, investors have favoured defensive stocks such as banks, energy and utilities companies for their more predictable earnings, cash flows and higher dividend payouts, despite their weaker earnings growth outlook. China's state-backed financial entities have also stepped in to stabilise the market at times, which favours these companies due to their large market cap.

China market returns YTD to end August 2024 mainly come from re-ratings, not earnings growth

Past performance is not a reliable indicator of future returns.

Looking beyond China, there have been broad and diverse brighter spots - notably tech-related-themes and India - where sentiment has been more positive. More broadly, previous market cycles indicate that sentiment can often drive valuations beyond what can be reasonably justified by fundamentals, leaving them vulnerable to a correction. At the beginning of August this year, we saw one such correction, driven by a confluence of changing expectations on economic growth, interest rates and outsize expectations around mega-cap technology earnings in the US coming back down to earth. The correction was a reminder for global investors of a number of current “home truths”, notwithstanding some recovery in the immediate aftermath.

First, there is more room for disappointment in the areas where expectations are high (and that have outperformed this year), for example in tech, the US and Japan.

Second, although the sell-off was orderly, it was rapid and substantial, highlighting embedded concentration risks and, arguably, evidencing the capability of a now much greater proportion of large-scale, fundamentals-insensitive programmatic trading across public markets - including passive ETF rebalancing and momentum-based, systematic trading - to move markets swiftly.

For Asia, the sell-off was a mixed bag. It was more keenly felt in, for example, Japan, Korea and Taiwan (the latter two because of tech). China, where equity valuations are already heavily discounted - with China P/E ratios at around 9x, as at end August 2024, significantly lower than US equity P/E ratios at around 21.6 x at end August 2024 - offered and continues to offer more of a cushion against downside price risk.

MSCI USA 12 months forward P/E versus MSCI China 12 months forward P/E (August 2024 to August 2024)

Past performance is not a reliable indicator of future returns.

Seeing through short-term noise to structural growth coupled with fundamentals-based edge

Change is a constant when it comes to investing across Asia. Decades of experience investing across the region have underlined to us how important it is to stay focused on the longer-term structural drivers of growth, together with the fundamentals of businesses able to play into those themes.

Across the region’s diverse markets, including India, Taiwan, South Korea and China, ongoing structural shifts in demographics - notably a growing middle class - together with increasing levels of intra-Asia levels of trade and global competitiveness continue to provide a runaway for growth across a range of sectors, including, technology, consumer, automotive and financials.

In terms of global competitiveness, the region is also at the heart of three megatrends that will transform the global economy for decades to come.

• On energy transition, global energy grid capacity constraints coupled with global demand for clean energy, alongside energy-hungry data centres that support the growth in AI are creating supply-side opportunities for Asia-Pacific industrial groups, for example, Huaming Power.
• On AI, Asia has not only developed globally competitive capabilities, but has a strong track record in putting technologies to commercially viable use, with the potential for automation gains to lift productivity across the region’s large manufacturing bases. Examples of Asian businesses playing into the AI supply chain include: Hon Hai Precision - a global leading electronics manufacturing services (EMS) provider with Apple among its key clients; Yageo - a Taiwan-based electronic component manufacturer offering a broad multilayer ceramic capacitors product portfolio; and Samsung Electronics - a global leader in memory chips, handsets, display panels and consumer electronics products.
• On supply chains, the China + 1 strategy - near-shoring production away from China - is driving opportunity broadly across ASEAN, leveraging the “demographic dividend” of larger working age populations in lower income countries. Larger Chinese businesses have a role to play here, spearheading the establishment of production bases outside of China, including in developing industries. Examples include Shenzhou Int'l - a Chinese vertically integrated manufacturer of sportswear, casualwear and innerwear with manufacturing capacity on both the mainland and overseas and BYD - one of the world’s largest electric vehicle (EV) manufacturers- with an EV supply base in Thailand covering ASEAN demand for EV with tariff advantages for manufacturing EV in local factories.

By overlaying fundamentals-based insights on the nuance of these trends - including looking beyond the obvious winners to less well-known beneficiaries - we believe we can identify areas of longer-term growth opportunities that are overlooked or underappreciated.

Getting beyond generic newsflow and short-term sentiment to build more solid foundations for conviction portfolios requires hard work. There is considerable texture both within domestic markets and across the region and, as with markets globally, significant dispersion between winners and losers. Key to success is deep, bottom-up, fundamentals-based research seeing real-time the changes on the ground, as new leaders emerge, innovation flourishes and individual businesses build competitive edge. To deliver that requires patience and high-calibre on-the-ground analyst teams that understand the DNA of companies they cover, have long-standing relationships with them and see the nuances of regional market dynamics and trends.

A different, diversifying set of macro-economic fundamentals and return drivers across Asia

More broadly, Asia’s economic cycles are increasingly asynchronous to Western developed markets. Asia ex Japan - particularly China - continues to face lower, less “sticky” inflation and lower pressure from “higher for longer” central bank interest rates than Western developed markets.

Trade balances too are shifting and Asia’s growth will increasingly be driven by intra-Asia/global south trade. For example, IMF Direction of Trade 2023 data puts the 2023 share of exports from emerging markets to emerging markets at about 45% of total exports, up from around 25% in the 2000s. More specifically, China’s share of exports to Group of Seven (G7) countries is decreasing (from close to a 50% share in 2000s to less than 30% at present), while its exports to non-G7 countries, particularly in the global south, are rising significantly.

Share of exports from EMs to EMs (2000-2023)

Source: IMF, Haver Analytics, Fidelity International.

China’s share of exports to G7 countries (2000-2023)

Source: IMF, Haver Analytics, Fidelity International.

These diversifying, asynchronous characteristics are currently available at attractive absolute and relative equity valuations. Macro factors that influence markets are one reason Asian markets offer diversification benefits to developed markets - especially at a time when many investor portfolios are more heavily invested in US equities.

Targeted policy measures and a strengthening Asia equity income narrative

This is not to say the region is challenge free, but policymakers are stepping in with controlled stabilisation measures, most notably in China’s property sector. While markets are eager for more China property stimulus, we believe the tangible, measured approach adopted and the recognition that this is a strategic imperative have begun to ease some of the question marks here.

We have also seen strengthening regional policy support around increasing income returns. Chinese regulators have expanded efforts to push local companies to pay either higher dividends or to buy back more shares in a bid to make them more attractive to investors.

In Japan, corporate-governance reforms pushed by the late prime minister Shinzo Abe have gained steam. In South Korea the government unveiled a “Corporate Value-Up Program” earlier this year to reduce the so-called ‘Korea discount’ with the aim of incentivising companies to prioritise shareholder returns. Recent elections in India and Indonesia are expected to deliver a continuation of supportive policies.

Asia offers diversifying, long-term income and growth potential

The landscape is changing, but the broader Asia investment story remains supported by structural trends, together with government ambition and backing for Asian businesses and markets to be regarded as world-class.

Distance from the on-the-ground picture in these markets can sometimes make them appear more complex for global investors and, consequently, make asset allocation decisions seem more challenging. Given this, there is a risk that generic news flow, ad hoc policy intervention or macro factors, such as periodic flare-ups in geopolitical tensions, drive headline sentiment.

While these factors always deserve careful consideration and local contextualisation, we believe that they often have limited influence on a company’s longer-term earnings outlook. Rather, over the long-term, successful companies will cement their positions regardless, based on fundamentals, including competitive market positioning, strong free cash flow generation and capable leadership. We believe that boots on the ground and diligent fundamentals-based research are key to seeing through the noise and identifying these companies over the long term.

As investors mull the shape and weighting of their portfolios after Q3 served a timely reminder that sentiment-driven investing is episodic, we believe that the next phase of Asia’s development can offer global investors attractive long-term growth and income potential at compelling valuations, alongside valuable diversification.

Important information

This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of investments in overseas markets. Investments in emerging markets can be more volatile than other more developed markets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only.