Monday, August 8

Asean: A region of reopenings and recovery

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ASEAN is reopening its borders to tourism, which will be a strong boost to Asean GDP and employment. This in turn should support equity prices.

Asean equities earnings should be supported by multiple factors, such as Asean equities’ pro-cyclical tilt, an improving situation in China, and a sustainable earnings rebound from historical lows.

While Asean central banks are expected to normalise policy quicker than expected due to rising inflation, we believe the pace of tightening in Asean will unlikely be as urgent as the US.

As a whole, we remain cautiously optimistic on Asean equities. Valuations are marginally expensive at the moment, but multiples should look more palatable over time if our earnings forecasts materialise. Using our target P/E ratio of 16.0X, we forecast an attractive upside potential of 21 per cent by end-2024.

Investors looking to gain exposure to Asean equities can consider our two recommended products: Premia Dow Jones EM Asean Titans 100 ETF and Principal Asean Dynamic Fund – MYR.

Asean equities (gauged by the MSCI AC Asean Index) broadly comprise equities from Asean-5, namely Singapore, Indonesia, Thailand, Malaysia, and Philippines. While equities have generally done poorly in 2022, Asean equities have managed to remain relatively resilient, falling by just nine per cent year-to-date, compared to its global equity peers which have fallen almost 20 per cent year-to-date (in US dollar terms).

In this article, we reiterate our cautiously optimistic view on Asean equities as a whole, particularly as Asean reopens itself to the world.

MSCI AC Asean Index contains equities from Asean-5 countries.

Reopening will be shot in the arm for Asean

While Asean had an initially slow vaccination rollout, many key Asean countries now have vaccination rates above the global average, with Singapore leading the pack. As a result, Asean is now on the cusp of a full reopening, and the number of hotel searches already far surpasses pre-pandemic levels. Even though a complete tourism rebound is unlikely due to China’s strict border controls, the low pandemic-era base should still contribute to strong growth in tourism revenues.

The improvement in tourism outlook will be a significant boost to the region’s growth momentum in 2H22. Based on World Travel & Tourism Council data, in 2019 (pre-pandemic), the travel and tourism industry contributed a notable 12 per cent of Asean’s GDP and hired 42.6 million workers which represented 13 per cent of total employment.

In other words, the expected rebound in tourism should not only have a direct effect on GDP but also an indirect effect through higher employment rates within Asean.

Thus, we expect the region’s growth to see a steady rebound from 2H22 onwards, which is in line with Asian Development Bank estimates of around five per cent GDP growth in 2022 and 2023. Historically, Asean equity prices have generally tracked the region’s economic momentum, and we expect the improving macro backdrop in 2H22 should support equity prices.

 

Asean equities have held up relatively well compared to peers.

Asean equities likely to see solid earnings rebound

We expect Asean equities to see a solid earnings rebound of six per cent in 2022 and 13 per cent in 2023, buoyed by the improving macro outlook. Across its 10-year history, this is relatively high as positive year-on-year EPS growth averages around 10 per cent.

On a relative basis, Asean equities are also expected to generate stronger earnings growth than most global and EM peers. Even though global earnings are starting to see profit headwinds due to rising input costs and moderating global growth, we see sufficient support for Asean equity earnings arising from factors like Asean equities’ pro-cyclical tilt; improving situation in China; and for a sustainable earnings rebound from historical lows.

First, Asean equities have heavy allocations into traditionally cyclical sectors like financials (37 per cent), which are highly levered to economic growth. When growth momentum in the region improves, earnings tend to pick up as well.

Thus, with our view of an improving macro backdrop, we expect greater earnings upside given Asean equities’ pro-cyclical tilt. From the bottom up, we expect the Asean Financials sector to form the backbone of the region’s EPS strength.

The major banks are expected to generate above long-term average EPS growth, supporting earnings for the broader index.

In addition, a positive turn in China on lockdowns and government policy could become a big upside to the Asean equities, especially as many negative factors have already been priced in through lower equity prices and reflected in weaker economic data.

This should then lead to positive spillover effects on the Asean economy and equities in a variety of ways, such as greater tourism revenue from Chinese tourists (which make up 20 per cent of Asean tourist arrivals); stronger demand for Asean exports (China is the largest single-country trading partner of Asean); and easing of supply-chain bottlenecks and shipping delays.

While the Chinese pandemic situation remains very fluid, we reiterate that the risk-reward remains very much tilted towards a positive outcome for China. With these earnings tailwinds in mind, we believe it may finally be time for Asean equity earnings to see a stronger recovery. In 2020, we saw their largest YoY EPS decline in history (minus 34 per cent), resulting in an unprecedented EPS collapse to 10-year lows across many Asean equity indices.

The subsequent EPS rebound in 2021 was relatively lacklustre on an absolute and relative basis, and Asean continues to be one of the few exceptions where EPS has not fully recovered from 2019 to 2021.

The slow recovery in Asean equity earnings was due to the severity of Covid-19, which led to significant earnings uncertainties in the region. However, as we have highlighted above, pandemic uncertainties are easing while earnings tailwinds are present. Thus, we no longer expect earnings to lag behind and see a sustainable rebound over the next two years.

 

Most Asean countries have above-average full-vaccination rates.

Key risk – inflation and monetary policy

Despite our optimism over the growth recovery, we note that soaring inflation and tighter monetary policy within Asean will pose as key equity risks. Inflation amongst several Asean-5 countries has picked up significantly this year and is on track to exceed medium-term inflation targets set by their respective central banks.

Central banks have already begun to tighten policy (e.g. BNM’s [Malaysia] surprise rate hike in May), while others are feeling the increased pressure to hike rates, including Philippines which has signalled two rate hikes of 25bps each by Aug 2022.

However, while we expect Asean central banks to normalise policy quicker than expected, we believe the pace of tightening will unlikely be as urgent as the US. The Asean economic recovery remains fragile, unlike the US, and that means that Asean policymakers will likely be more mindful to not derail the positive growth momentum. Furthermore, Asean-5 CPI inflation remains far from record highs unlike in the US (Chart 10), and this is partially helped by a large number of price controls on food and energy prices as well as lower services inflation within Asean-5.

 

Cautiously optimistic on Asean equities especially as a reopening play

To summarise, we remain cautiously optimistic on Asean equities, especially as a play on the reopening theme observed across the region. We believe the reopening will have a notable effect on Asean equities due to the latter’s pro-cyclical tilt, while our expectation of the China situation improving should also have positive spillover effects on the Asean economy and equities.

Coupled with the fact that earnings have thus far only seen a lacklustre rebound from historical lows, we believe there is further room for a stronger and more sustainable rebound over the next two years.

With that in mind, investors should note that valuations for Asean equities are marginally expensive at the moment, trading at about a three per cent premium to its 10-year historical average.

These elevated valuations were the result of the historic earnings collapse described previously, but we expect multiples to look more palatable over time if our earnings forecasts materialise. Using our target PE ratio of 16 times, we forecast an upside potential of 21 per cent by end-2024.