We remain onboard the Asia train and see better days ahead.

iFAST Macro Research Team Published on 04 Jun 2021

  • With strengthening export growth, the drag from recent pandemic challenges might be cushioned and economic momentum may pick up again in 3Q/4Q. Our positive growth outlook remains intact and we expect a supportive macro backdrop for Asian equities in 2H21.
  • We see scope for further earnings upgrade in 2021, which will be a key equity driver in the near-term. Beyond that, strong double-digit earnings growth should be a core driver. We project EPS growth of 33.3% (2021) and 14.9% (2022).
  • Asian equities are looking attractively priced compared to its 5-year average forward PE ratio and our in-house fair PE ratio. It is also trading at a steep discount to DM peers. Valuation will provide strong support for Asian equity upside, especially in the medium-term.
  • Unlike last year, the balance of risks has shifted in 2021. Headwinds such as Asian tech uncertainties and Covid resurgence have become roadblocks challenging the region’s near-term equity outlook.
  • Overall, near-term equity drivers for Asia are mixed, with a lack of catalysts to shift the balance of risk in either direction. However, an improvement in sentiments regarding China tech may be the likely catalyst to tilt the direction of Asian equities upwards.
  • Beyond the near-term, medium and long-term equity drivers are skewed positively and we target 27% upside by end-‘23. We see better days ahead for Asian equities and maintain an optimistic view, particularly over the intermediate to longer-term.

After a spectacular run last year, the performance of Asian equities have seemingly mellowed. Uncertainties within the Asian tech space (IT, Comms, Con. Disc. sectors) and, more lately, the regional Covid resurgence were major drags on the region’s performance. The region (as gauged by MSCI Asia ex Japan index, chart 1) started the year on a high before surrendering much gains after mid-Feb ‘21, returning around 6.4% in the year-to-date (as of 2 Jun ‘21). Despite the lackluster performance, our strategical view on Asian equities remains constructive and we expect better days in 2H21 and beyond. 

Chart 1: Asian equities have had a bumpy year thus far

Strong export growth to cushion Covid impact and keep Asia’s recovery buoyed

While recent pandemic woes have hit service sectors and domestic demand, Asia’s export outlook remains solid and should drive the region’s recovery. With the value of Asia exports surpassing pre-Covid level, we are increasingly confident that export strength is durable and not just buoyed by base effects.
Firstly, we expect the low-base effect to spill over to 3Q21 as implied from Asia’s gapping export contraction (table 1) and poor manufacturing PMI readings (table 2) in 3Q20. With base-effect likely still in play next quarter, we expect stronger Asia export in the coming months. Secondly, we also observed a broad-based expansion in manufacturing sectors across Asia economies (table 2), which tends to precede strengthening export growth and ultimately, economic momentum. 
Last but certainly not least, US and China import demand – a predominant driver of Asia exports – remain very supportive. Forecasts for import growth of both countries suggest further positive growth for Asia exports till ’22 (chart 2), despite a moderation in magnitude. This is re-affirmed by consensus forecasts for China’s export growth (about 50% of Asia total export value) which projects positive growth for the next 2 years.
Given Asia’s strengthening export growth, we believe the drag from recent pandemic challenges might be cushioned. Should the scenario worsen, most Asian economies possess the fiscal ammunition to softened economic impacts. We, therefore, expect economic momentum to see a temporal moderation in 2Q before picking up in 3Q/4Q with re-opening, quicker vaccination, and more importantly, firm export growth. Hence,we retain our positive view on Asia’s growth for 2H21, and expect a supportive macro backdrop for Asian equities.

Table 1: Strong export growth driving Asia’s recovery this year; Base effect will support export growth in 3Q21

 Source: Bloomberg Finance L.P., iFAST compilations.Data as of Jun 2021. 

Table 2: Manufacturing PMI implies improving economic momentum; Similarly, base effect will support manufacturing/ exports sectors in 3Q21

 Source: Bloomberg Finance L.P., iFAST compilations.Data as of Jun 2021. 

Chart 2: US and CN import growth forecasts suggest positive export growth till ‘22

Scope for further earnings upgrade 
We expect positive EPS revision to be a key driver of Asian equities in the near-term, with higher relative revision being a driver of relative performance (vs other regional equity). Such a relationship is already evident across Asian markets whereby months with positive EPS revision were being rewarded by higher price gains. This dynamic will likely continue in our opinion as Asian equities are shifting from a re-rating-driven market to a fundamental-driven one, typical in the later stage of the recovery.
We see scope for further EPS estimates upgrades despite a +7.6% revision in the year-to-date (as of 1 Jun ’21). A look at historical consensus EPS estimates (chart 3) for Asian equities suggests more upward drift may materialise this year. EPS estimates tend to drift higher during the recovery and expansion phase. However, the current EPS drift (’21 and ’22) is still conservative compared to prior episodes, such as in 2009 and 2017. 
Additionally, when comparing the current and previous EPS upgrade cycles, we find the current cycle’s magnitude and duration of upgrade (+13% over 8 months) to be relatively conservative (chart 4). History shows that prior upgrade cycles have lasted at least 9 months, with upgrades between 10% – 38% after EPS has bottomed.

Chart 3: Historical upwards drift (green) suggests that EPS estimates for ’21 and ’22 may drift higher

Chart 4: Current EPS upgrade cycle is milder than previous episodes; Likely room for further upgrade within subsequent months

Strong earnings outlook for 2021 and 2022

Beyond the near-term, strong double-digit earnings growth will likely be a core driver of Asian equities. We project EPS growth of 33.3% (2021) and 14.9% (2022) (table 3) and our constructive earnings view is underpinned by i) strong cyclical and growth sector EPS rebound, ii) positive macro factors, and iii) margin expansion. 
Earnings growth should come in above trend in 2021, typical of a post-crisis recovery. Asian equities’ diverse exposure to Cyclicals (Fin, Ind, Mat, and Ene sectors, around 31%) and Growth (IT, Con D., Comms, around 52%) means that the region will benefit from big cyclical rebounds from the former and above-trend growth rates from the latter (table 3).
Macro factors are also favourable for stronger earnings growth. The four variables – (improving) Asia export, (improving) global and Asia growth, and a USD downtrend – which are typically good gauges for Asia’s earnings strength, are supportive of higher EPS growth. Collectively, these four variables may offset the negative EPS impact from a moderating China credit impulse.
Margins for Asian equities, which are an inflection point, are also starting to turn higher with gross margin leading the charge (chart 5). In recent quarters, pressure on margins has alleviated while drivers such as low inventory buildup, operating leverage, and rising sales are aligning.  All this points to margin expansion in 2H21 and beyond, thereby supporting stronger earnings for the region.   

Table 3: MSCI Asia ex Japan EPS projection (’20 – ’23); Strong EPS contribution from both Cyclical and Growth sectors.

 Source: Bloomberg Finance L.P., iFAST compilations.Data as of Jun 2021. 

Chart 5: Margins at an inflection point; Start of new cycle with margin expansion in 2H21

Valuation is looking cheap again

Multiples for Asian equities have corrected dramatically with the forward PE ratio seeing a massive de-rating from a 3 s.d. peak (20.2X) to a 1 s.d. level (16.1X) (chart 6). Considering such extreme valuation adjustment (of 5+ points, within a span of four to five months), we think Asian equities are once again looking attractively priced.
Despite current multiple hovering above the long-term average of 13.4x, Asian equities are reasonably priced when compared to i) its 5-year average forward PE ratio of 14.1x, which (the higher PE ratio) factors in the growing concentration of growth stocks, and ii) our in-house fair PE of 16.0X for the region – our expected ‘fair value’ multiple. 
Amidst a backdrop of overvalued regional equity markets, Asian equity demonstrates some measure of discount against its developed market (DM) peers. It is currently trading at a wide discount of 21% to the latter, compared to a long-term average of 12% (chart 7). This is despite having stronger economic and earnings growth rates. At such an extreme level – close to the historical lows – we see great relative value from Asian equities and thus, the potential to outperform when multiples re-rate. 
At current multiples, Asian equities are looking attractively priced and valuation should provide strong support for Asian equity upside, especially in the medium-term. We further expect limited de-rating risk given current valuation as macro and earnings backdrop need to worsen significantly – which we think is unlikely- for further downside.

Chart 6: Asian equities have de-rated significantly from a +3 standard deviation peak

Chart 7: Asian equities trading at a steep discount to DM peers

Headwinds mostly in the shorter-term

Unlike last year where tailwinds outweighed headwinds, the balance of risks for Asian equities has shifted in 2021. Headwinds such as Asian tech uncertainties and Covid resurgence have become roadblocks challenging the region’s near-term equity outlook.
As we outlined in our recent EM update, the primary causes of Asia tech uncertainties are two-fold, from a potentially higher US treasury yield (hence implications the longer-duration growth sectors) and the tightening of China’s tech regulation. We think the latter is the wildcard moving ahead as further degradation in sentiments may bring back volatility and choppy movements that may impact Asian equities.
That said, we think it is not all doom and gloom in the Asian tech space as earnings fundamentals are strong and will likely remain so this year, in line with consensus expectation. Valuation, in terms of forward PE ratio, has also massively de-rated, from a 3 s.d. to a 1 s.d. level, pricing in much uncertainties. Consequently, both factors suggest that downside risk in Asia tech is increasingly limited and max pessimism may have passed. 
The other major equity headwind is the region’s recent pandemic woes, which manifested as growth uncertainties for affected economies (Taiwan, India, Singapore etc.). This thereby translated to weakness in Asian equities as the growth outlook re-priced to reflect current realities.
Nonetheless,given that the resurgence was a big story in early May and widely known, we believe much of it is priced in (Asian equities). We further expect such headwind to be short-lived, dissolving as soon as the situation improves. Markets are likely to look past this episode, as it did in India (where equities have rebounded), considering Asia’s track record in dealing with Covid outbreaks. 
Also, it is worthwhile highlighting that the Citi economic surprise index remained positive after the 3rd wave outbreak (as most data are surprising positively) implying that macro data are no longer catching consensus by surprise on the downside, as compared to the 1st and 2nd Covid wave (chart 8). We, therefore, expect milder likelihood of future negative price shocks for Asian equities as well.

Chart 8: Consensus is less surprise from negative impacts of the 3rd wave; Asia’s Macro data are also coming in strong. 

Optimistic outlook with better days ahead

Overall, near-term equity drivers for Asia are mixed, with a lack of catalysts to shift the balance of risk in either direction. We see a tug of war between headwinds such as tech uncertainties and Covid resurgence against tailwinds such as positive earnings and economic momentum. 
Asian equities have reflected this reality with range-bound movements. However, our bias remains tilted to the upside as we think improving China tech sentiment – from softening regulations and/or from being seen as a “bargain”- may be a likely catalyst to tilt the direction of Asian equities upwards.
Beyond the near-term, medium and long-term equity drivers are clearly skewed positively in our opinion. The macro backdrop should remain positive while valuations and robust expected earnings growth provide strong support for equity upside. We, therefore, target 27% upside by end ’23 (table 4) driven by both re-rating (valuation) gains and EPS growth. In sum, we see better days ahead for Asian equities and maintain an optimistic view, particularly over the intermediate to longer-term.

Chart 9: MSCI Asia ex Japan index EPS forecast