1st March 2016
Richard Sennitt, manager of Schroder Asian Income, discusses China and the Asian market outlook
We caught up with Richard Sennitt, manager of the Elite Rated Schroder Asian Income fund, to hear his views on what's happening in China and to get the outlook for Asian markets in the year ahead.
How have Asian markets performed over the past couple of years?
Because China has dominated the news, I think people might be feeling that all Asian markets have been universally gloomy, but that's not the case.
If you take a look at global stock markets over the past couple of years, there's been the sort of 'cheer leaders' at the top, the US and Japan, which have done pretty well, and then at the other end, emerging markets outside of Asia have been particularly poor performers, given that they're mainly commodity-driven and those prices have been very weak.
But in the middle, if you look at Europe, the UK and Asia ex-Japan – over the last couple of years they've performed broadly in line. So although Asia hasn't done particularly well, it's been roughly on par with those other markets.
What are the main concerns in Asian markets currently?
There are three main issues: there's obviously China; then there's the impact of a stronger US dollar, rising interest rates, and the knock-on effects; and then there's company earnings across the region.
If you look at China, firstly, there's been a massive build up of debt. Most of that is corporate debt, as opposed to government or consumer debt, and it has led to large over-capacity in the industrial and manufacturing areas.
That has put tremendous downward pressure on pricing. If you look at the Producer Price Inflation (PPI) index—so basically companies' output—it has been negative for the past few years and is running at nearly negative 6% at the moment.
It's very difficult, if you're a company running a business and you've got those falling prices. And that's obviously had a knock-on effect on the economy.
I'm currently very underweight China (but overweight Hong Kong), and I'm particularly steering clear of the big Chinese banks. One of the reasons I don't like the banks is because I think in this environment you're going to see an increase in credit costs and non-performing loans.
So is China getting any closer to the much-heralded economic 'rebalance'?
If you look at the breakdown of economic growth between the tertiary sector, which is sort of the services economy, and the secondary sector, which is the industrial output, you can see services have not done too badly. It's been been weaker, but it's still growing at a reasonable clip. The industrial side of the economy, however, has been under real pressure.
So when people talk about re-balancing Chinese growth away from the investment-led sector and into the services – that is happening, but it's happening by industrial output collapsing rather than services growth growing much faster.
One of the other reasons the industrial area of the economy has been weaker is the increasing focus on clamping down on corruption. The number of senior officials who are being investigated is very substantial and there's been an unwillingness for government officials to do much. People are less willing to sanction projects.
Are we in 'Asian financial crisis' territory?
Another big concern people have with China at the moment is its depreciating currency and the effect this will have on corporates' ability to re-pay loans they may have taken out in US dollars.
I think people do worry about whether the situation is a re-run of the Asian financial crisis. But I'd say, generally, external currency debt as a proportion of the debt in most of these economies is relatively low at the moment – perhaps with the exception of Malaysia.
On the flip side of this, because commodity prices have been so weak, the current account side (a country's net balance of trade and foreign income) has been very strong. Weak oil prices and weak commodity prices are a benefit to Asia because they're importers.
So the trade balance has been rising very strongly in Asia, which has been behind the reason we've seen such decent improvements in the current accounts of pretty much every country. Only Indonesia and India are running current account deficits at the moment.
So that, too, is very different from the Asian financial crisis.
Is there a more positive outlook yet for corporate earnings across the region?
Earnings have been revised down and that's continuing to happen. Companies have really been under pressure, not so much because margins have been particularly bad, but more because of disappointing top line growth.
That's partly because economies haven't been particularly exciting, but also because inflation has been weak, so companies have very little pricing power. Also, the usual pick-up in exports that we would have seen at this stage in the cycle, with what's gong on elsewhere in the world, hasn't really come through.
But from a company perspective, we are seeing value in many areas of the market. For example, we like some of the Hong Kong property companies and some of the Taiwanese names are becoming more attractive.
People's sentiment towards Asia is pretty poor, but this has historically been a pretty positive indicator of forward returns.
We believe valuations are attractive, the question is just what will be the catalyst in the market to move things higher in the near-term – particularly given that we've had negative earnings revision.
I think on a longer-term basis, though, the markets at these levels look pretty attractive.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Richard's views are his own and do not constitute financial advice.
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