Asia recovers from its hangover

A lost decade for Asian stocks is over. Last week the MSCI Emerging Markets Asia index, which covers the major developing economies of the region and leaves out Japan, returned to its pre-crisis high of October 2007. “It might seem odd”, says Steve Johnson on, that Asian equities have only just returned to square one, given that most developed indices have been hitting new records all year and Asia is “increasingly the engine of the global economy”. Asia ex-Japan’s GDP has jumped by 150% in a decade, car ownership has tripled, and corporate profits are up 43% .

The main problem, says Johnson, was that Asian stocks were extremely overvalued in 2007, and a pin to prick the bubble duly arrived in the form of the financial crisis. Invesco Perpetual’s William Lam points out that the market was on a price-to-book ratio of three and a free-cash-flow yield of under 2%. Now, the respective figures are 1.8 and almost 7%. Note too that other emerging-market regions are still far below their 2007 highs, thanks to their dependence on commodities, which have struggled in the past few years. Asian states are mostly net raw-materials importers.

Asia is also far more exposed to the IT sector, which has burgeoned in the past few years. It now comprises 27% of the benchmark MSCI Emerging Markets index, making it the biggest sector, notes Frank Heininger in Finanz und Wirstchaft.

So thanks to the likes of Samsung and Alibaba, the reputation of emerging markets as simply volatile producers of commodities needs a bit of a rethink. The correlation between emerging markets and industrial metals prices has fallen to 0.2 from 0.8 in 2012 (1 would imply lockstep). Tech firms comprise 40% of the MSCI Emerging Markets Asia index. The strongest global growth in years bodes especially well for Asia’s export-dependent economies (see below). The dollar rally has subsided. A stronger greenback tends to tempt global investors away from risky assets such as emerging markets and back to the world’s biggest economy.

Investors should also note that Asian firms have become more generous with dividends, says Marla Brill in Financial Advisor magazine. Indeed, reinvested dividends accounted for two-thirds of the total returns of the MSCI Asia Pacific ex-Japan Index between 2005 and 2016. “And… the rise of the consumer class is still very much part of the investment picture.” Throw in valuations around the historical average, and the rally should endure. 

Why Seoul is set to soar

Investors keen “to hitch a ride on Asia’s spectacular stock rally” should consider South Korea, says Assif Shameen in Barron’s. It’s not only the region’s cheapest market, but profits are expected to rise by 54% this year.

South Korea is one of the world’s most open economies, so the world economy’s strongest performance since 2011 is giving exports – semiconductors, smartphones and cars are key products – a big boost. They grew at a double-digit year-on-year pace in the first eight months of 2017. Rising consumer confidence, partly a result of plans to hike the minimum wage sharply, is buoying household spending. GDP rose by 1.4% quarter-on-quarter between July and September, the fastest rate for seven years.

Analysts often point out that Korea, on a forecast p/e of under ten, is cheap because of opaque and cronyist corporate governance. But things may finally be changing on this front, notes Shameen; the government wants to introduce a Japan and UK-style stewardship code. Korean stocks, already up by a quarter this year, should have further to go.

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