Emerging Asia has disappointed equity investors during the past seven years. The MSCI Non-Japan Asia Index has gained just 34%, and remains below its 2015 peak, while the S&P 500 rose by about 230%. Asian stocks outperformed during 2017 to date, to be sure, but the performance gap remains enormous.
There are several reasons to expect Asian stocks to outperform the S&P during the next couple of years.
The first is economic growth. The revival of world trade is concentrated in emerging Asia. As of March, year-on-year growth in world export volume was just 3% for advanced economies, but 11% for emerging Asia.
Economic growth translates into higher revenues. Earnings before interest and taxes (EBIT) for the MSCI non-Japan Asia Index is expected to grow by 34% this year, according to the Bloomberg consensus of equity analysts. Revenue growth, moreover, is well distributed among the members of the universe.
The second reason is that perception of China risk — the bogeyman of world markets since the Chinese equity bubble popped in 2016 — has diminished. Asia Times has been confident about Chinese economic management all along, and we are pleased to see that the consensus has moved in our direction.
Strong nominal GDP growth and higher corporate revenues mitigate the high debt levels of Chinese companies. For example, Goldman Sachs analysts wrote May 31, “We recently updated our credit analysis for listed Chinese non-financial companies, and we found that the median levels for gross debt/EBITDA (2.1x) and net debt/EBITDA (-0.2x) ratio improved in 2016 from the previous year.
Also improved was the percentage of debt issued by companies with an interest coverage ratio below 1x, falling to 9% from 14% in 2015. The improvements were mostly due to better earnings in upstream sectors in 2H16, coinciding with PPI inflation turning positive and a rebound in commodity prices. With leverage having improved over the past year, we see room for policies to tighten without resulting in widespread corporate distress.”
The third reason is the regional impact of China’s $1 trillion infrastructure spending plan, the One Belt, One Road initiative. Enormous gains in efficiency are feasible. Perhaps the single most transformative investment the Chinese will make is in broadband, which opens China’s periphery to cashless payments, e-commerce and e-finance.
Vast amounts of human effort are wasted in the emerging world, and the smartphone with wireless Internet access will be the catalyst for entrepreneurship and efficiency. Fast rail and maritime connections will open entirely new markets. Thailand will become China’s truck garden once it can ship fresh produce by high-speed rail to southern China.
E-commerce will allow the most efficient consumer businesses to replace the vast number of unproductive small firms that service rural populations in the region, with a quantum leap in labor productivity. As China’s workforce begins to shrink over the next several years, China will export manufacturing employment to its periphery, as it is already doing in Indonesia and Vietnam.