Could decoupling be the new black?

Asia’s market is rebounding on the back of internal stimulus says Andrew Beal at Henderson TR Pacific investment trust, who argues that decoupling is back in vogue. But how likely is it?

The word “decoupling” might be about to come back into fashion. Andrew Beal at Henderson TR Pacific investment trust says the region is rebounding on the back of massive internal stimulus and domestic demand suggesting it can power ahead irrespective of what is happening in America and Europe.

It’s a bold statement. Decoupling was last in fashion back in 2007, when sub-prime worries were first emerging. We were told not to worry, as Asia would shrug off a slowdown in the West as it built airports, roads and ports, and its domestic population began to consume large numbers of goods.

Well, it didn’t happen. One of the striking aspects of the credit crunch was how correlated markets – and econo­mies for that matter – were in their reaction. Evidently, a large number of Asian countries depended hugely on exports to Western markets, and when demand shrank, their GDP (Singapore being the worst example) shrivelled faster than anywhere else.

But Beal is confident the worst is over. Indeed, he argued as early as the start of this year that Asia was oversold and would rebound, and saw it as “an ideal buying opportunity for Henderson TR Pacific”.

The bet paid off. Markets in the region bottomed in early March, as the last foreign investors switched off the lights and left. During the last two quarters of 2008, Beal says that foreign investors withdrew about $70 billion (£42 billion) from the region, in the flight into cash. “There was a real flush out of foreign investor holdings across Asia,” he says.

But Beal was not selling. He started buying beaten-up banks and technology stocks, and has enjoyed a dramatic turnaround. By the middle of June, Asian markets rebounded by around 40% in sterling terms. Over three months, Henderson TR Pacific shot to the top of its small peer group and sits in second place over three years too. The MSCI Asia ex Japan index has slipped 15% over the past year, while Henderson TR Pacific is down just 1%. Over three years the index is up 23.7%, while the trust is up 35.8%.

One factor lies behind the turnaround, says Beal, and it’s the enormous fiscal stimulus from regional governments. “China has had the most enormous fiscal stimulus of around $400 billion. And we have seen similar fiscal stimulus and pump priming expenditure on infrastructure across the region,” he says.

There has been a big surge in lending by Chinese banks, he says, while in India lower interest rates have driven demand. Even foreign investors are returning, with inflows of $6- $8 billion in recent months. And the thing about the fiscal stimulus in Asia is that the region can afford it without saddling future generations with unsustainable levels of government debt.

“A period of consolidation in markets was inevitable. The power of the stimulus is that much greater in Asia because of a stronger structural position. China has public sector debt of only 17%,” he added.

Back to decoupling, Beal wonders if the ‘crunch’ in China and India was ever quite as bad as was reported in the West. “Okay, stockmarkets did not decouple and the correlation was very high, but the correlation in smaller export-driven economies such as Singapore and Taiwan was very different to China and India. There they had a much milder slowdown.”

But has the recent rebound in Asian stockmarkets pushed valuations rapidly back into expensive territory? Beal disagrees. “I like to look at price to book. It got to a low of 1.1x in March. We are now looking at 1.6 after the recent market recovery. But at its peak it was at 3x. We are still a very long way off peak multiples.”

He’s not about to cash in on his clever positioning of the portfolio earlier this year. Instead he reckons Asia is in an almost ideal position for future growth. Corporate earnings have fallen 40% since their peak in 2007 but Beal reckons they will recover rapidly over the next few quarters, with evidence that companies are rebuilding margins fast.

“A near ideal set of circumstances appear possible over the next couple of years. A western recovery that is enough to stabilise Asian exports but not too much to drive runaway commodity price inflation would ensure continued loose monetary policy and a pro-active fiscal stance in Asia. This would support further development of domestic economies in the region and be positive for asset prices including property and stocks.”

Beyond the cyclical recovery, he says the region’s fundamentals – young population, growing urbanisation and rising educational standards – all bode well for longer-term investors.

So how is he positioning the portfolio today? He likes banks and property, areas that so many of us in the West still regard as toxic. Industrial and Commercial Bank of China is his second-largest holding, followed by Agile Property, Yuanta Financial and Sun Hung Kai Properties.
“Asian banks were dragged down by the credit crunch, when they are well capitalised and highly liquid.” Banks were net providers of liquidity domestically, never leveraged into wholesale markets to finance their lending. Asia’s huge savings culture ensured they had more than enough cash to lend.

He also likes domestic market tech stocks that play on local demand, rather than shipping goods to the West. One example is Tencent (known as QQ) a Hong Kong-listed internet company that is the leader in China for hotmail-style accounts and instant messaging. It has 250m active users, even though it only launched in Shenzhen in 1998. That’s right. 250m. It’s gargantuan and is growing at 35%-40% a year. Since the market turned in March, its share price is up more than 50%.

But Beal’s confidence for the region does not extend across all major markets. He is cautious about South Korea. “It’s my biggest underweight. I don’t want to be exposed to big Korean exporters such as Samsung and LG. Not only do they have relatively poor international and domestic demand, they are also facing currency appreciation.” Neither can he find opportunities in Malaysia.

The recovery in the West, V or W or whatever , will never be more than anaemic. Meanwhile, Chinese growth never dipped below 6%. It’s a story that’s just impossible to ignore.