Asia’s economic recovery is expected to outperform the rest of the world in a solid yet “unspectacular” fashion in the second half of the year, driven by domestic demand, falling inflation and supportive monetary conditions, according to UBS Asia mid-year outlook 2023 report.
This follows the region’s robust 1H2023, which saw bull markets in Taiwan, South Korea and Japan despite rapid central bank tightening and US banking stresses. Moving forward, macro conditions appear firmly tilted in Asia’s favour, while developed markets are likely to be bogged down by the cumulative effects of monetary tightening in the coming quarters.
UBS expects Asia to register a moderate 2H recovery to around 4.9% GDP growth this year, compared to the near 1% growth expected in the US and Europe. However, this is unremarkable compared to pre-pandemic trend growth of around 5.5%.
In this environment, differentiated opportunities to improve returns can be found by taking a more granular view of the beneficiaries of key macro tailwinds in Asia, UBS finds.
Chinese equities remain compelling
After posting the best three-month returns (57%) on record from cyclical lows in October 2022, Chinese equities have corrected 20% from the January peak and are down 3% year-to-date. The underperformance is particularly striking compared to the 14% year-to-date gain in the US and 11% in global equities despite the comparatively poor growth, policy and earnings picture in developed markets.
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The overwhelmingly bearish sentiment in China stems from several concerns, including the sustainability of the post-reopening recovery given sluggish April and May macro data, more measured policy support given high government debt loads, and ongoing geopolitical tensions.
UBS expects China’s recovery to continue as modest policy support emerges and geopolitical tensions gradually stabilise. The firm believes the setup for Chinese equities is compelling at a time when pessimism is nearing a peak.
Assuming that Chinese equities are likely to shift from laggards to outperformers, UBS holds on to its constructive view of mid-teen upside through year-end, seeing value in adding more defensive segments to steady performance through volatility.
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UBS has tilted a small portion of its China exposure to more defensive, high-yielding dividend segments like insurance, utilities, select banks and high-quality state-owned enterprises (SOEs), while holding onto the new economy and consumer names. The central government’s goal of enhancing intrinsic SOE values should result in steady dividend policies, higher return on equity, improved corporate transparency and ultimately, stronger investment sentiment.
UBS expects the performance divergence for Chinese internet stocks after 1QFY2023 results to continue. For instance, E-commerce and online food delivery portals will likely continue to contend with margin pressure amid a competitive landscape, although their revenue growth could partly offset the squeeze.
Following Chinese consumers’ purchases downsizing, UBS believes the shift in spending will allow related online portals to expand their wallet share, thus translating into higher revenue growth than peers.
Meanwhile, online gaming portals will offer more defensive exposure, given the increasing ad spending from online and offline merchants. Additionally, steady, predictable new game pipelines should further strengthen their cash flows amid the normalisation of new game approvals.
China’s earnings growth will likely move lower next year, in line with moderating economic growth. However, UBS points out that select stocks and sectors that can maintain or improve growth prospects will likely outperform in such an environment in the medium term. For 2024, these could include IT software, consumer staples, and white-goods names that can generate steady or growing demand in domestic markets and are built on local supply chains.
Banks for the next billions
Across Asia ex-China, UBS prefers India and Thailand, while seeing opportunities in Asean new economy leaders, regional banks and Asian dividend stocks. Over the past year, the soaring cost of capital and universal pressure on Asean’s new economy players have spurred a shift in focus to profitability from growth at all costs, while companies burn less cash in pursuit of market share.
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These supportive trends are particularly prominent in the Asean ride-hailing and e-commerce segments, where the profitability push is beginning to reflect improving margins. These segments also demonstrate a high sensitivity to falling US rates and should benefit as long-end rates come down — UBS forecast a 100-basis-point fall for 10-year US Treasuries over the next 12 months.
Meanwhile, Indian, Indonesian and Philippine banks score highly across profit and sales growth metrics, UBS adds. The firm sees these stocks as “compounders”, with yearly rates between 10% to 20%, supported by underlying trends such as robust loan growth, stable provisions and a massively underbanked adult population. Additionally, net interest margins play a smaller role in their earnings than their peers, making these lenders relatively more resilient in a peaking or falling rate environment.
Dubbed “banks for the next billions”, South and Southeast Asia banks have historically outperformed the Asia ex-Japan banking sector when 10-year rates are flattish or falling. UBS expects earnings for these banks to rise at a clip of 15% CAGR through 2024, more than double the 7% CAGR pace for broader Asia ex-Japan banks, justifying a slight premium.
As US rates near a peak, UBS highlights another standout in quality Asia dividend stocks. Forward dividend yields at around 6.4% are considerably higher than the historical average of 4.7%, while US and European dividend stocks are trading at yields similar to their respective historical averages.
The divergence is partly because many Asian dividend stocks have not fully recovered to pre-Covid-19 share price levels. The more pertinent driver is an ongoing shift in corporate policy; companies have been increasing their dividend payouts and returning capital to investors to boost shareholder returns. This is reflected in a 7% year-to-date rise for Asia dividend stocks which have far outperformed their global peers. UBS believes further upside is likely over the next three to six months.
Specifically for Singapore and Malaysia, UBS has a rather cautious view, rating the markets of these two countries as “least preferred”. UBS says that Malaysia’s earnings picture is “relatively weak”, while the net interest margins of the three Singapore banks, which account for nearly half the weightage of the Straits Times Index, are likely to continue declining. “We see less near-term upside for these markets than elsewhere in the region,” says UBS.
Consolidation following a sharp rally
UBS has a relatively cautious view of Japan, at least in the near term. The Japanese market has caught much attention from international investors in recent months, and the year-to-date performance of 15% is a testament to that fervour.
However, UBS believes there will be a near-term consolidation likely given the “sharp” rally and investors with a shorter view take profit. In addition, valuations, at around 14.6x earnings, are no longer cheap versus their 10-year historical average of 13.7x, even though still attractive relative to the S&P 500.
Also, international investors are likely to have already built-up Japanese equity positions from extremely low levels in 2022, and share buyback announcements tend to be more muted during the middle of the year. There is also uncertainty surrounding US rate hikes in the coming months, says UBS.
UBS believes that the downside will be well-protected in 2023. “Japan still offers relative safety at these levels given relatively solid corporate earnings; low risk of recession as Japan’s economic cycle is behind many other countries due to its delayed reopening and ultra-loose monetary policy; thirdly, a greater push from the Tokyo Stock Exchange to improve shareholders’ returns; and last but not least, modest short-term yen appreciation,” UBS says.
UBS’s advice for investors is to look for reopening beneficiaries that will enjoy earnings growth from greater domestic and international travel demand. “A subdued yen is an impetus to visit Japan, and China’s reopening should boost Chinese tourist arrivals,” says the bank.
Also, Japan’s large-cap banks, trading at just 0.6x book value, offer tactical opportunities with their solid balance sheets and liquidity and a relatively high dividend yield of 4%.
The push by the Tokyo Stock Exchange for the companies to reform will help pressure them to enhance their ROE, increase share buybacks or pay more dividends. “The possibility of business portfolio restructurings or increased investments to increase ROE could be a re-rating catalyst for Japanese equities in the longer term,” says UBS.
