Investors, confounded with a growing list of uncertainties, are not in a gambling mood. Many prefer to stay on the sidelines and let the volatile and uncertain mix of geopolitics, pandemic, surging inflation, supply chain woes and the likes wear themselves out before they risk additional capital.
According to Credit Suisse, market sentiment is now “highly depressed”, and the bank has turned “structurally more cautious” on equities.
Nevertheless, Credit Suisse is still broadly positive about prospects for Asia. For one, it recently upgraded its rating on China from “market weight” to “overweight”.
While many Chinese companies face uncomfortably high debt pressures, thereby clouding long-term prospects, Credit Suisse still likes China for reasons including its low oil import bill, which will help keep costs checked, relative to other economies that are more oil-dependent. China’s 2021 net crude oil and petroleum product imports as a percentage of GDP was estimated to be less than 2%, whereas for Japan it was closer to 3%. Thailand — which led the pack, according to figures compiled by Credit Suisse — imported more than 5% of its GDP (see Chart 1).
Also, China enjoys “insulation” from the US Federal Reserve’s rate hikes, due to its largely closed capital account. As such, Fed rate hikes affect China less than most other Asian markets. China stands out globally in being in an easing cycle.
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Another plus factor for China is its limited export dependence. Its 2021 exports as a percentage of GDP stands at around 20%, versus 80% in the case of Malaysia and around 60% for Taiwan.
Citing historical performance during the global financial crisis of 2008- 2009, as well as the pandemic-induced market panic of early 2020, Credit Suisse notes that China typically outperforms when investors are in a “risk-off” mode.
China’s recent 2022 GDP target of 5.5% is also a source of possible cheer. This forecast is higher than expected by the consensus, including Credit Suisse. Again, if the historical track record is used as a reference, this means China’s GDP might end up at a higher growth rate than 5.5%. David Wang, the bank’s China economist, notes that China almost always meets or beats its targets (see Chart 2).
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Other factors in China’s favour include its range of effective strong short-term policy tools that can be deployed relative to other Asian governments. “In a pinch, increased infrastructure spending and more forceful window guidance for lenders can be rolled out again,” notes Credit Suisse.
Last but not least, despite the trade war with the US, China remains “fiercely” competitive, according to Credit Suisse. Last year, its share of global exports increased for the second consecutive year. The amount of foreign direct investment it was able to attract similarly surged to more than US$300 billion ($406.5 billion).
Nevertheless, Credit Suisse says a few factors are restraining it from becoming more bullish on China. Firstly, in the wake of restrictive policies over the past year or so, earnings growth among many China companies, across multiple sectors, remains weak, leading to ongoing cuts in earnings estimates. “Macro stabilisation should help earnings at some point, but it might take several months more,” notes Credit Suisse.
Furthermore, many property developers, saddled with mountains of debt, are still struggling. Credit Suisse notes that while housing prices appear to be stabilising, developer sales and land acquisitions remain weak. “As with earnings, we expect the real estate market to eventually respond to loosening measures, but the lag might unsettle markets.”
Last but not least, China as a whole remains an economy with a relatively high credit intensity — which refers to the amount of credit extended relative to gain in revenue. “Structurally, we remain concerned that China has yet to reduce the credit intensity of the economy,” states Credit Suisse.
Credit Suisse’s view is not unique. China equities have undergone substantial derating since early 2021 and the sector is now trading at a 37% discount to global equities on a forward P/E basis, versus a long-term average of a 23% discount. “Everything has a price. At current levels, we believe the rewards outweigh the risks,” says DBS’ chief investment officer Hou Wey Fook in the bank’s 2Q2022 outlook.
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Jason Liu, head of CIO Office Asia, Deutsche Bank International Private Bank, notes that year to date, more than 100 Hong Kong-listed companies have launched share buyback programmes, some of them up to a few billion US dollars.
Liu says that as the China Securities Regulatory Commission is explicitly encouraging listed companies to conduct share buybacks, this trend will probably continue in the coming months. This will provide upside potential for Hong Kong-listed Chinese companies. “Although, in the foreseeable future, a return to consistently massive outperformance seems unlikely, risk-conscious investors could take advantage of low valuations as well as of possible future temporary setbacks to gradually rebuild their China positions,” says Liu.
Credit Suisse recently too upgraded Australia to “overweight”, citing positive revisions to earnings estimates of Australian corporates. Australia is also seen to occupy a “neutral” position in energy, which insulates its economy from surging fuel prices which are in turn pushing up inflation in other energy importers.
The Swiss bank, too, likes Malaysia, given how the country is a key exporter of various commodities ranging from palm oil to rubber to energy, and is a clear beneficiary of rising prices. Companies listed in Malaysia tend to trade at relatively low valuation multiples while enjoying a somewhat “safe haven” status.
Downgrades
On the other hand, Credit Suisse recommends that investors trim their exposure to Korea due to the high proportion of oil imports, which will drive up costs. It has turned cautious on Singapore too, given the open economy’s exposure to US rate hikes. Thailand, meanwhile, is seen to take a hit from higher oil prices, as well as a further drop in tourist numbers from Europe because of the conflict between Ukraine and Russia.
Credit Suisse has also called for a “tactical downgrade” of India from “overweight” to “underweight” as higher oil prices have hurt its current account, added to inflationary pressures, and increased the market’s sensitivity to Fed rate hikes. The market’s big P/E ratio premium also magnifies risks.
Credit Suisse is keeping a lookout for opportunities to re-enter the Indian market due to its “strong structural prospects, positive positioning in credit and property cycles, and robust EPS momentum”.
From a broader perspective, Dan Fineman, Credit Suisse’s co-head of equity strategy for the Asia Pacific region, recommends that investors stay positive on Asia relative to the US.
In the past nine years, Asia outperformed the US only in 2017. However, Fineman, speaking at the recently held 25th Credit Suisse Asian Investment Conference, says that Asia will finally see a “better year” in 2022 compared to the US.
Firstly, valuations are cheaper, while the earnings cycle for corporations is “superior”, thanks to lower-wage pressures.
In contrast, the US is at the peak of an earnings cycle and is undergoing inflationary pressures that have spilt over to wages, which are now increasing at a pace that is “unsustainably high” relative to economic fundamentals.
Fineman explains that the US had mild wage pressures leading up to the years immediately before the pandemic, and this has helped boost earnings in the corporate sector. However, wage pressures spiked during the height of the pandemic, which caused compressed margins for companies, especially so when productivity is negatively affected.
On the other hand, the wage pressures in most Asian economies are not as stiff, says Andrew Garthwaite, head of global equity strategy at Credit Suisse.
While wage pressures have risen more sharply in the region before the pandemic, in the “high single-digit to double-digit range”, the pressure has since eased off, the analysts say.
Garthwaite goes as far as to describe the US labour market as overheating, which will compel the Fed to raise rates until growth slows below trend. He estimates that 60% of costs incurred by businesses come from labour and this component is growing at 4.5%, outpacing productivity growth.
While the US may be enjoying its upbeat moments, the same cannot be said for other markets elsewhere. Europe is currently downbeat at this point, largely due to the Russia-Ukraine conflict. Garthwaite thinks that the supply-side shock to commodities, financial markets, Russia and corporate confidence is being underestimated in Europe.
Europe will also face rising interest rates as the European Central Bank (ECB) tapers its asset purchases due to worries about inflation, which hit a record 5.8% in February, according to a report from Reuters. Credit Suisse expects Europe to grow at just 1%-2% this year — a significantly slower pace versus the ECB’s forecast of 3.7%.
