Sector Watch: The sun is shining in Asia-Pacific markets

“Hong Kong has seen some higher gross domestic product (GDP) growth, which is supported by a more stable outlook for economic growth in Mainland China. That’s based on a strong housing market and fiscal stimulus,” says Eileen Dibb, portfolio manager with Fidelity Institutional Asset Management (a unit of FMR LLC) in Smithfield, R.I., who oversees Fidelity AsiaStar Fund.

“China has been a market laggard for a few years and now is benefiting from government policies that are supportive of [economic] growth and loose credit,” says Dibb. “That helps Hong Kong, too, because they are closely tied. There is a lot of overlap between Hong Kong and the mainland.”

After a period of double-digit economic growth in the 1990s and early 2000s, China sought to buffer the impact of the 2008-09 global financial crisis with a US$500-billion fiscal-stimulus package.

However, Dibb notes, that strategy had an adverse effect because it resulted in excess supply, including massive overcapacity in the steel-making industry, for example.

“Over the past couple of years, that supply has [dropped] and pricing for commodities and industrial products, which had been very weak, has begun to rebound,” says Dibb.

“Along with a strong housing market and some additional government support to stabilize the economy, pricing [in China] is starting to look better. That helps growth in the economy.”

China’s economy, which is expected to grow by around 6.5% this year, is on a more solid footing because authorities are working to stabilize the so-called “shadow banking system” (non-banks that lend money, but are not subject to banking regulations) in order to control the excessive use of leverage.

“[China’s regulators] also have begun to deregulate some of the state-owned enterprises – and that can help private industries to grow,” says Dibb. “And [policy-makers] continue to focus on infrastructure and fiscal spending to ensure the economy grows at a reasonable pace.”

Still, China is under pressure, as some industries have been moving to other countries. This indicates a lack of trained workers within China, but “that’s not a huge negative, in my view. Labour shortages usually are a sign of strength,” says Dibb, adding that wages have been rising rapidly in China.

“If those wage increases are sustainable, then it means you have a growing consumer culture and can support your housing market. That should be positive for domestic demand.”

Dibb, a bottom-up, “growth at a reasonable price” investor, has allocated an underweighted 40% of the Fidelity fund’s assets under management (AUM) to Japan (the benchmark MSCI all country Asia Pacific index allocates 42% in Japan), plus a neutral 29% to the so-called Greater China Region (which includes China, Hong Kong and Taiwan), 11.6% to Australia, 6.4% to South Korea and 5.5% to India, with smaller weightings in countries such as the Philippines.

On a sector basis, the Fidelity fund holds 22.3% in information technology, 19.9% in consumer discretionary, 19% in financials and 9.3% in industrials, with smaller holdings in sectors such as materials and consumer staples.

One favourite name in the 105-holding Fidelity fund is HDFC Bank Ltd., the largest private bank in India.

“HDFC also has a very healthy loan book, which protects it from impairment,” says Dibb. “This allows HDFC to grow loans while other banks are shrinking because there’s been a fair amount of impairment to loans throughout India’s market. This will allow HDFC to grow its market share.”

HDFC stock trades at about 1,435 INR ($29.55) a share, or about 23 times 2017 earnings. There is no stated target.

Another top holding is AIA Group Ltd., a leading Hong Kong-based life insurance firm.

“AIA’s agents are top-rated and they have very good systems that help them do their jobs,” says Dibb, adding that the firm benefits from rising consumer wealth, which is causing more people to buy insurance to protect their families and maintain their standard of living.

AIA stock trades at about HKG$49.40 ($8) a share, or 18 times trailing earnings.

One of the main drivers behind the market recovery is that regional markets are in a “catchup” phase, says Chuk Wong, vice president at Toronto-based 1832 Asset Management LP and lead portfolio manager of Dynamic Far East Value Fund.

“Global investors are beginning to question the implementation of Trump’s economic policies. At the same time, the U.S. dollar has rolled over. In fact, it peaked in early January, and [now] is down by about 5% against the Japanese yen, Korean won and Indian rupee,” says Wong. “A weakening dollar, combined with a sharp rebound in [China’s] economy, has set the stage for the emerging markets and Asia to do very well this year.”

From a macro perspective, Wong notes, China’s economic growth slowed in 2015 and early 2016, largely because of excess capacity in some primary industries, such as steel-making.

“There was almost no growth [in 2015]. But 2016 saw a sharp rebound,” says Wong. “The government introduced reforms to strengthen the capacity of those industries. [It] also responded with stimulus packages and put less emphasis on anti-speculative measures in the housing market.”

In the past, China’s policy-makers had brought in anti-speculative measures to cool overheated property markets in major urban centres.

“This time, they did the opposite. That led to a construction boom last year,” says Wong, adding that he expects China’s GDP growth this year to come in at 6.5%-7%. “The trend [in housing] is very likely to continue in 2017, although not be as strong as in 2016.”

Meanwhile, Wong also is bullish on India because it benefited from policy reforms by the three-year-old federal government of Narendra Modi. “Inflation has come down from [more than] 6% to about 3.5%, mainly because of the central bank’s tightening monetary policy,” says Wong.

In addition, this past winter’s so-called “demonetization” of the economy – a process whereby Indians were forced to turn in large-denomination bills – has largely succeeded. “Ninety-five per cent of transactions last year were in cash. This initiative was designed to fight corruption and tax evasion,” says Wong. “At the same time, [demonetization] was an opportunity to promote the use of financial instruments such as credit and debit cards.”

Pointing to the victory by Modi’s party in elections in the state of Uttar Pradesh (the largest state in India), Wong says: “People welcomed this initiative to fight so-called ‘black money.’ [The election result] was a vote of confidence.”

Wong, a bottom-up, value investor, has allocated about 65% of the Dynamic fund’s AUM to holdings in emerging Asia, distributed across holdings in China, Taiwan, South Korea, India, Indonesia and Vietnam. About 30% is spread through holdings in Japan, Hong Kong, Australia and New Zealand, and about 5% held in cash.

From a sector standpoint, there is 29% in financials (mostly banks), 19% in industrials, 15% in consumer discretionary, 13% in technology and 10% in consumer staples, with smaller holdings in industries such as communication services.

One top holding in the 53-name Dynamic fund is LIC Housing Finance Ltd., a provider of home mortgages in India that holds a 10% market share.

“There is a very compelling secular story,” says Wong. “Mortgage penetration in India is 9%, 18% in China and 68% in the U.S. China has a long way to go, but India is way, way behind. The good thing is that housing prices in India still are very affordable.”

LIC stock trades at 625 INR ($12.90) a share, or 12.5 times earnings.

Another favourite is Vietnam Dairy Products Joint Stock Co., also known informally as Vinamilk and the largest dairy-products maker in that country.

“[Vinamilk] has no debt and a return on equity of [more than] 35%,” says Wong, noting that the firm has a market cap of US$9 billion. “[The company] has the most extensive distribution network in Vietnam and the most comprehensive lineup of offerings, from milk powder and liquid milk to yogurt and ice cream.”

Vietnam Dairy Products stock trades at VND140,000 ($8.25) a share, or about 22 times forward earnings.

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