Equities and fixed incomes in emerging Asia have experienced a lost decade, lagging global indices. This is despite the fact that these economies have accounted for around 70 & of world GDP growth. It is attributable to the good performance of US stocks, especially in some industries, the revaluation of the dollar, US fiscal expansion, its tax cuts -which explain 40% of improvement in margins as well as share buybacks.
But the next five years should be totally different, with higher growth and low inflation, commitment to reforms, improved margins, reasonable valuations and currencies upside potential, with returns more in line with the expected dynamism in the region.
Specifically, we expect emerging Asian equities to be the best-performing asset class over the next five years, providing 10.8% average annual return in dollars, including 12.1% for China equities. Keep in mind that we start from reasonable valuations, with multiples below average relative to expected growth. To this adds good forecast for bonds, with 6.9% annual return in local currency.
In fact, currencies represent an additional source of return. Emerging market currencies in Asia are undervalued, given that the region has a current account surplus and a much less expansive monetary policy than developed markets. This is the case with the renminbi, which has been much more resilient than other emerging-market currencies. Although it is a slow process that can take years and requires investor confidence, the renminbi will tend to appreciate as China’s legal system becomes more reliable, capital is allowed to flow freely and its financial markets expand. A renminbi-based currency zone has already been de facto created, attracting foreign capital.
Asian assets are underrepresented
The fact is that emerging Asia is too big a region to be ignored. Indeed, Asian assets are underrepresented in global portfolios. If the investor goal is to match the real returns that the traditional balanced portfolio has generated in recent years, a larger proportion of capital will have to flow to emerging economies in Asia. Specifically, for investors using the dollar as a base currency, the optimal weight in Asia may be 25 to 30% (close to Asia’s economic weight in global GDP), up from 7% today, half of it chinese and without currency hedging, for a real annualized return of 3.5% over the next five years.
Growth with low inflation
It should be borne in mind that emerging Asia has prospects for growth and low inflation, a trend that has accelerated with the pandemic. These economies are in better shape, not least because their monetary policies have been much less expansionary and had inject much less stimulus than developed countries. There is also a credible commitment to reforms and these economies are increasingly diversified. With an average annual inflation of 2.2% – lower than that of US or the euro zone , real GDP growth in emerging Asia over next five years may be 5% per annum, compared to 2.5% in the US or 1.6% in the Euro Zone.
Indeed, low inflation in emerging Asia is predictable given the rising productivity, currency appreciation, excess savings and the Central Bank of China that, unlike the Federal Reserve, will not tolerate inflation- which in fact has been even lower than that of the US for the past ten years.
E-commerce, financial services, green transition and semiconductors
Opportunities abound. In particular, we look at structural issues related to digitalization, innovation, rising middle class and demographic development, with opportunities in e-commerce, financial sector, green economy and semiconductors.
North Asia is a world leader in e-commerce. China has the highest e-commerce penetration in the world, with the highest absolute revenues (three times that of US) and fastest growth rate, which can be maintained by revenue per user and innovation. Taiwan and Korea, meanwhile, lead the manufacture of chips, especially more advanced semiconductors. Samsung Electronics and Taiwan Semiconductor Manufacturing Co of Korea are expected to jointly account for 43% of the fixed capital investment of the global semiconductor industry this year.
In addition, China is the world’s largest investor in renewable energy and the largest producer of solar and wind energy. Even though China accounted for half of global electric car sales in 2019, the penetration of electric vehicles remains low, at 5%. But it is expected to reach 35%, world’s largest by 2030. Its electric vehicle industry has achieved significant technological prowess, enjoys cost advantages and improved brand perception compared to its peers. In addition, Korea has three companies that represent 50% of the global battery market.
In South Asia, we are seeing growth accelerate, especially after the pandemic, which has driven the digitization of financial services, with new fintech companies able to scale their business models. In this regard, India has made great strides in financial inclusion, starting from a low base. India is favored by demographic developmenst, innovation and productivity growth.
For its part, Vietnam, which has attracted numerous foreign companies and may become one of world’s leading manufacturing centers. Its workforce is young (average age 31 years), with wages around a third those in China, good connectivity with supply chain/logistics centers (Guangdong,Singapore), adherence to multiple free trade agreements including South Korea and the EU and a very competitive tax regime of incentives and moratoria to encourage new investments. It has been among the biggest beneficiaries of trade tensions between the U.S. and China.
Chinese bonds: safe haven with a diversifying effect
In addition, Chinese bonds has moved from niche to safe heaven investment with diversified effects. It offers the best combination of return/risk. China’s five-year bond has performed well during the pandemic, with very low correlation with other bonds. Low inflation and a conservative and predictable Central Bank contribute to this. Moreover, although the renminbi has a long way to go to be a reserve currency, interregional trade ties are being strengthened, attracting an economic center of gravity, so that what we call the renminbi zone already accounts for 27.3% of world GDP. Its weight as a reserve currency can go from the current 4% to 18%.
In addition, emerging Asia’s investment-grade corporate debt is attractive by fundamentals and valuation.
Opportunities outweigh risks
Of course, there are risks. Developing Asian economies face major challenges, from China’s accumulated debt to challenges that will not be resolved in decades, especially demographic decline, climate change and weak governance, deglobalization since 2007 and tensions in supply chains, as well as geopolitical issues. But many of these challenges can be overcome with a combination of technological development and innovation and all together, the opportunities pay off.