We are all reflationists now; but higher levels of inflation and interest rates are not kind to equities. Throw in the rising differences of opinion between the world leaders and it is easy to find oneself thinking about the 1970s.
Such concerns are compounded by the fact that equity valuations are generally demanding and global growth is elusive. Sure, Asia might enjoy a kicker from US growth and the region may get dragged upwards with general US bullishness, but it is difficult to see either as being particularly sustainable.
Our general cautious stance and positioning across our Asia Pacific portfolios have not changed very much over the last six to nine months. We are thinking hard about how risks might unfold and the potential impact on our Asia portfolios. A Trumpian view of the world should prompt concern at the rising risks around trade; the problem is that all of Asia, with the possible exceptions of the Philippines and India, lives mostly off of trade with America.
On the matter of rising protectionism and faltering trade, we are of the view that bilateral rows seem likely to escalate given the characters of the new global leadership. The world seems ever more divided along trade block lines and global trade flows are already weak.
As bottom-up investors, we do not invest on the basis of what we believe might happen at a macro level, but we are not complacent about the top-down risks to client portfolios either. We think a lot about what is going on, here we take a look at three countries with varying headwinds and how we are navigating them.
The Philippines is an interesting case, as the economy and even more so the stock market is dominated by domestic consumption. Furthermore, debt levels are considerably lower than the rest of Asia generally; they too have a new purposeful leader and many commentators are rather positive about future prospects.
As a relatively small and illiquid stock market that is consensually as well as heavily owned by foreigners, the de-rating risks seem quite high. However, we still own a number of companies in the Philippines, being particularly keen on the now seventh generation-run Ayala group as well as the SM group of companies.
In China, growth remains elusive and new ideas have been hard to come by and there has been little opportunity to add to existing holdings at lower prices. China’s economy seems rather finely balanced, with around three times as much debt required these days (15-20 per cent money/credit growth) per unit of economic growth (GDP +5-6 per cent). A surge in credit in 2016 has kept the economy moving, but has also produced unfortunate side-effects in the form of even higher property prices and capital outflows (due to the weaker currency).
Such an approach is ultimately unsustainable, but in the meantime debt levels could continue to climb. Given the testing environment, acknowledging that it may go on for some time, it is difficult to be optimistic about corporate prospects.
We continue to own Sun-Art Retail, which has perked up of late. Our view is that there should be a place for at least one national supermarket chain in China. Today, the market capitalisation is $8.5bn and this still seems fine in the context of the opportunity. The stock has rerated to 24x forward price to earnings.
One other area of interest lately has been Korea. Korea is always a famously challenging place to invest, but the country usually emerges stronger from adversity. The Korean economy desperately needs reform, but the institutions and regulations are second-rate. We do not hold out much hope for broad reform, but perhaps at the margin things will get less bad for a while. Many Korean businesses are in some ways amongst the most impressive and aggressively competitive in the world.
We think there are a number of candidates, which includes some LG group companies. We have been adding to LG Chemical. The shares trade at 1.2x book, with the share price having suffered on a badly explained plan to buy connected group company LG Life Sciences. We have increased our exposure to LG Household & Health (LGH&H) latterly too, having earlier sold on previous ebullience around duty-free cosmetics sales to visitors from the People’s Republic of China. LGH&H is trading at around 20x. Around a third of LGH&H’s profits are contributed by household products, with the rest coming from cosmetics.
Against a challenging backdrop, with tailwinds differing from country to country we continue to find opportunities in testing climates.
Richard Jones is a portfolio manager on the First State Stewart Asia team