Growth outperformance in Asia could just be getting started, as evidence of persistent drivers begins to emerge. A full-fledged Asian recovery could build up over the next half of the year, accelerating growth across the region, contrasting the economic slowdown in the US and Eurozone, says Morgan Stanley Research in its Asia Economics Mid-Year Outlook.
According to Morgan Stanley’s chief Asia economist Chetan Ahya, growth differentials between Asia and the US are seen to improve to a difference of some 460 basis points by the fourth quarter of this year — the highest since 2017.
“We have been making the case for some time now that Asia will outperform. While recent developments will likely present some downside to Asia’s growth in the form of an export recovery being constrained, we see domestic demand remaining robust,” says Ahya at a recent webinar.
Good news for the region could arrive on other fronts as well. Ahya believes that the disinflation process is “well underway” in Asia, with cost push factors fading and headline inflation moving closer to targets, compared to the rising inflationary pressures the US and many parts of the Eurozone are still facing.
According to him, the next phase of disinflation will come from softer core goods inflation with the effects of weak commodity prices filtering through. In the next quarter, Ahya sees inflation moving back to within target ranges for 80% of the region.
This backdrop has seen Asian central banks pausing their rate hike cycles, creating a “less intense” drag on domestic demand from monetary tightening in Asia. Considering where Ahya sees inflation heading, he believes this pause is “durable” with further disinflation opening the room for rate cuts as central banks will not need to let real rates rise into “restrictive territory”.
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“Given different inflation outcomes, we expect Asian central banks to be able to cut rates even ahead of the Fed, with the early movers acting as soon as 4Q2023,” he reasons.
Ahya warns, however, that a sharp tightening of financial conditions in the US and renewed downward pressures on external demand could also result in Asia recoupling on the downside.
Meanwhile, he notes that if challenges in the Chinese property sector should deepen, creating risk aversion in the financial system and affecting consumer confidence, the resultant deeper slowdown in China would weigh on the rest of the region.
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China’s ‘countertrend’ recovery
In spite of the risks of a hard landing in the US and a protracted slowdown in China, the economist believes that Asia’s growth outperformance is just starting, with a complete recovery building up over the next two quarters across two dimensions.
First, he says that more economies in the region will join the path to recovery. Domestic demand momentum in Asia excluding China has already carried over into the half of 2023, indicated by strong Purchasing Managers’ Indexes (PMIs) across the region. Ahya expects this strength to be sustained and be given an incremental boost into the second half of 2023 as China’s “countertrend” recovery begins to pick up momentum.
According to Morgan Stanley chief China economist Robin Xing, growth in China should reach 5.7% in 2023, led more by consumption than investment, with the former being driven by a revival in services spending by mid- to high-income consumers.
In the coming months, Ahya says China will follow the path forged by other Asian economies, with wage and job gains driving the next stage of the consumption recovery as goods and low- to mid-income consumers pile on.
His base case sees imminent easing measures supporting investment activity in China to reduce its drag on growth this year. “China’s reopening and recovery, coupled with its pro-business stance, suggest that growth is set for a substantial rebound, in our view. We believe this recovery will provide an uplift to the rest of Asia.”
Second, most components of Asian GDP will continue to improve in the next half, with consumption moving towards a “balanced recovery” and investment and external demand to follow.
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Goods spending in Asia excluding China has already joined the initial strength in the services sector, with nominal retail sales surpassing pre-pandemic levels as Asian economies reopened. “For China, given that full reopening materialised only early this year, the consumption recovery will also follow the same profile as the rest of the region did, albeit with a lag of a few months,” notes Ahya.
He explains that strengthened end demand will translate to a pick-up in investment activity — first in consumption-related segments and subsequently in externally-linked segments. With external demand conditions experiencing a boom cycle in 2021 followed by a bust in 2022, Ahya believes the adjustment in global demand is already “largely complete”.
“Early signs of sequential improvement are evident in the trade data for Korea, which we think provides a good read across for the rest of the region,” he notes.
Asian landscape growing ‘multipolar’
The slowdown in the US and Eurozone also coincides with a purchasing power parity-weighted increase in favour of three of Asia largest economies, namely Japan, India and Indonesia, which have all seen tailwinds in their favour year-to-date.
Cyclically, strong corporate and banking system balance sheets in Asian economies have meant that regional borrowers and lenders have a healthier risk appetite. Structural reforms have also allowed entrepreneurs — both domestic and foreign — to increase private investment, says Ahya.
Speaking at the same webinar, chief Asia and emerging markets equity strategist Jonathan Garner says that Morgan Stanley remains bullish on Asia and emerging market equity, noting that the investment banking firm turned its focus towards North Asia in late 2022.
According to him, the Asian and emerging market landscape has grown “even more complex and multipolar” since the 2023 outlook in October was shared last year. Looking ahead to 2H2023 amid economic disruption, Garner says Morgan Stanley has increased its structural conviction on Japan’s return on equity (ROE) turnaround, followed by Korea and Taiwan, while holding on to cyclical positioning for a recovery and new semiconductor hardware product cycles.
The investment banking firm has raised its Tokyo Price Index (Topix) target by some 19% to 2,400 points, retaining preference for Japanese equities compared to their peers in other developed markets.
Garner points out that tailwinds for Japanese equities could arrive from both macro and micro levels, with inflation and wages moving to a “sweet spot” for corporate returns and corporate reforms driving the ROE journey.
Meanwhile, the trend towards a multipolar investment landscape will also provide revenue opportunities in sectors where Japan is strong, such as semiconductor capital equipment. Global supply chain de-risking increases demand for Japanese capital goods, precision instruments and wafer fabrication equipment, while its deep capital markets are benefiting from investors’ shift in focus away from China, he explains.
According to Garner, Morgan Stanley has retained its overweight position on technology given supply cuts and a structural upswing from artificial intelligence (AI)-related demand. While the “trailing” price-to-book value ratio of semiconductor hardware has moved towards its 10-year average, he expects further outperformance into a “likely strong” 2024 earnings rebound for the segment.
In China — where initial recovery momentum waned visibly in April and May, with services continuing to outperform manufacturing and limited recovery in the property sector — Garner says he now expects a weaker Chinese yuan profile through the second half of the year, which will add to a delayed earnings recovery for MSCI China.
While the Chinese outlook remains challenging, Garner says that these “interim setbacks” have now been priced in to a “large degree” with MSCI China de-rating to a forward price-to-earnings ratio of 9.3x — a 20% discount to emerging markets overall. Morgan Stanley maintains an overweight recommendation on China in anticipation of further policy easing and help from state-owned enterprise policy reform, but has reduced target prices for the offshore China equity and further reduced its active position to 25 basis points.
Elsewhere, although incrementally more constructive on India following Morgan Stanley’s upgrade on the economy in late March, Garner remains “broadly neutral” on other large markets in the Asia Pacific region, including Australia, India and Indonesia, and underweight on smaller markets in Asean.
