Two unprecedented events reshaped our views of the markets this year: first, the invasion of Ukraine, and then the lockdowns in China. Both exacerbated the supply constraints that the world had yet to work out from 2021. While China has lifted some restrictions, the pressures on energy and commodities arising from the Ukraine conflict have not eased. We remain cautious, expecting volatility to persist for the rest of the year. Yet we also anticipate attractive opportunities to arise from the bottoming of the cycle. We have less conviction on the Asia ex Japan market as a whole due to a host of variables whose turning points are hard to call. As such, we continue to focus on the fundamentals of individual companies in making our investment decisions.
Key to market stabilization in Asia is the region’s Covid recovery. We believe this hinges on three interlinked phases. The first is reaching high rates of vaccination to protect populations from severe illness. This, in turn, feeds into the second phase, in which the level of confidence about living with the virus rises, as demonstrated in Singapore. In the third phase, as the virus becomes endemic, economies would return to normal. That said, we expect a multi-track return to normal in Asia, with countries like Singapore ahead of the pack, while Hong Kong and mainland China continue to follow dynamic zero-Covid policies.
Note: The Oxford Coronavirus Government Response Tracker project calculates the Stringency Index based on nine metrics: school closures; workplace closures; cancellation of public events; restrictions on public gatherings; closures of public transport; stay-at-home requirements; public information campaigns; restrictions on internal movements; and international travel controls. A higher score indicates a stricter response. Since government policies may differ by vaccination status, the index is calculated for three categories: for the vaccinated, non-vaccinated, and a national average which is weighted based on the share of people that are vaccinated.
Navigating the evolving investment landscape will be challenging, as money tends to chase the latest stocks or sectors on an upward trend (currently, these are commodities-related) at the expense of fundamentally solid, but non-trending, stocks. As such, from a portfolio perspective, asset allocation may detract from one’s performance versus the benchmark, making stock selection essential.
As China gradually lifts Covid restrictions, we believe the market will offer plenty of value opportunities, and more so than Southeast Asian markets, where valuations relative to quality have become harder to justify. China’s policy easing is supportive for equities, adding to the reasons why China cannot be ignored in global allocations when most of the rest of the world is tightening. We remain overweight on Hong Kong and China, as we have been since the start of the pandemic, as we see signs of a bottoming of the cycle. Some of our investments in manufacturing have not been left unscathed by the lockdowns in China, but because these companies have diversified their locations across China and Asia, the downsides to their business have not been as significant as those for their competitors.
While some may argue that today’s market is paradise for value pickers, we remain balanced in our approach. Last year, the market, fueled by liquidity, rushed into growth stocks, such as e-commerce initial public offerings (IPOs), pushing up valuations to astronomical levels, but many of those have pulled back over the past few months amid the rate hikes and the Ukraine war. Today it’s tempting for investors to be swept by the next trend into value plays, shielding the fallout from growth. Indeed, there is a season for value stocks; however, some stocks remain cheap for a good reason, whether a poor execution track record, industry structural changes that do not sustain business models, etc.
Similarly, high valuations in rising rate environments will be toxic. With every sector but commodities under pressure, discipline in stock selection is important to avoid disappointment. This supports our long-held approach of being style neutral, neither value nor growth, so we have the flexibility to position for long-term opportunities. Our investment convictions continue to be guided by the strength of a company’s business model – its ability to survive the current crises and grow market share despite challenging conditions, and the ability of the management team to execute in various scenarios. In other words, in volatile markets, we labor in our investment philosophy to monitor and stress-test companies’ ability to survive and assess their downside levels against their upside potential.
Another issue that is top of mind for investors is inflation and its impact on earnings. As Asian economies recover from Covid, prices are naturally expected to rise, but with the unprecedented supply shocks this year, this has led to a sharp rise in raw materials prices in a short period of time, hurting many corporations’ margins. Though we expect raw materials prices to come under control when lockdowns ease in China and many other locations, it is hard to see a correction to pre-Covid levels in the short term, meaning inflation’s impact will be felt globally for some time.
While there may be no immediate clarity as to how key parts of Asia will emerge from Covid, we believe investors must not lose sight of the long-term opportunities in the region. Asia will remain the growth engine of the world over the long term. While the disruptions over the past two years may have profoundly changed the shape of supply chains such that companies may seek a fragmented rather than centralized approach, Asian economies will remain at the core of supply chains for many years to come, due to their economies of scale, efficient cost of production, and high labor productivity.
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