Investment Strategy:  Third Quarter – Specific Market Reviews: Emerging Markets and Asia

  • Q1 Chinese growth surprised on the upside at 6.4% y/y but as usual appears somewhat contradictory with weak domestic demand and contracting imports but surging industrial production. This looks rather strange and sure enough China’s industrial output growth hit a 17 year low in May. As you would imagine, the deterioration in the trade talks and imposition of US tariffs will weigh heavily on the outlook for growth, though the unpredictability of the talks and the reliability of the figures themselves makes this difficult to quantify. The Chinese purchasing manufacturing index has fallen below the 50 level (indicating a contraction in growth) and there has been a clear hit to both imports and exports since tariffs were imposed. Hopes in the West are of a strong reflationary push by the Chinese authorities to bail out everybody else. This is starting to happen but the fraught political situation between the US and China makes forecasting even more difficult than normal. 
  • India’s marathon election process concluded with a stronger than expected victory for the incumbent centre right party of President Narendra Modi. He is likely to continue his  broadly pro-business agenda though is unlikely to pursue a much more aggressive macroeconomic policy engendering wide-ranging land and labour reforms. India has been overshadowed in recent decades by China, held back by a culture of complex bureaucracy, shaky government finances and petty corruption but now has a chance to step more into the limelight. It is the world’s fastest growing big economy expanding at 7% per annum and is about to supplant the UK as the world’s fifth biggest economy with aims of being No.3 by 2030. 
  • Japan continues to confound with strong Q1 GDP growth of 0.5% q/q when forecasts were for a contraction in growth. This growth was driven by inventory building and government expenditure whilst household spending, private capex and exports all fell. This doesn’t bode too well for the future, especially with Japan being a ‘global cyclical’ and hence exposed to the uncertainty created by the trade wars. The big question facing the government is whether to go through with the upcoming rise in the rate of VAT from 8% to 10% which has already been postponed twice before. The BoJ remains the most dovish of Central Banks with no rate rise forecast in the foreseeable future, indeed for ever. As far as the stock market is concerned its more of the same, cheap market, great value play, but remaining forever ignored.
  • As major supply chain manufacturers and trading partners of both the US and China, Asian economies and stock  markets are in the eye of the trade tariffs storm. A tailwind though will be far looser US monetary policy, especially if it leads to a weaker dollar.
  • Emerging Markets as a bloc have produced strong returns this year with the MSCI EM Index returning 10% in both local currency and GBP. As usual there has been a wide diversity of returns between the individual markets which shouldn’t be viewed as a homogenous bloc with MSCI Russia the standout rising by a whopping 31% in GBP terms, made up of an 21% local currency return and, unusually, a 10% strengthening of the rouble. MSCI China rose around 13% in both local and GBP and Brazil around 15% in both currencies. India was the laggard but still returned 6% in local currency and 8% in GBP.
  • The MSCI EM Index is trading on a forward P/E of 12.5x which is about in line with its historic discount to developed markets with the MSCI World index trading on 15.5x forward earnings.

Summary: Asian and EM stock markets have produced strong returns this year, benefitting from the US led global trend and the tailwind of a stalled US dollar and far more dovish US monetary policy. China and the trade war continue to cast a vast shadow over the region. Japan remains a global laggard.

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