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Forget Chinapocalypse and focus on Asia's 'cash flow torrent'

Forget Chinapocalypse and focus on Asia's 'cash flow torrent'

In a world which seems united in its uncertainty about Asia, reader polling by Wealth Manager offers this statistically improbable but oddly appropriate factoid: for the nine months up to end-January, private client managers were exactly split between those over and underweight emerging market (EM) equity.

While the numbers for benchmark-neutral dipped in the Q1 2017 survey, from 50% to 41%, those taking a positive or negative view remained mirror-images of the other on 29.4% apiece. The wisdom of the crowd, on this particular occasion, appears to be a collective shrug of mystification.

On the one hand, recent upgrades to global growth – with the International Monetary Fund (IMF) in January upping its 2017 forecast from 2.3% to 3.1% – have delivered a jolt of optimism to the region’s exporters, with some credible spectators suggesting the risk to full year earnings-per-share forecasts of between 12%-14% are, if anything, to the upside.

On the other, Donald Trump. And underlying the most recent unwelcome outbreak of anxiety about a potential retreat from globalisation, there is still the reasonable fear that China’s opaque and over-leveraged economy, a regional bellwether, may be about to fall over. So how to walk the line?      

‘An aggressive directional bet on regional equities should be avoided until we have some clarity about Trump’s trade policies and/or the likely magnitude of China’s economic slowdown,’ said Adam Wolfe, Asia specialist at global asset analyst the Macro Research Board. 

‘There are two major reasons to hesitate. President Trump could still upend global supply chains by pursuing anti-trade policies, and China’s economy is likely to slow more than investors appear to expect over the next six months. Either outcome would weigh on regional earnings and investor sentiment.

‘Still, we recommend overweighting financials in most trade-oriented economies and those in which the government is pursuing structural reforms. Defensives should likewise be held at neutral until there is more clarity about the risks to global growth.’

The reluctance to fully bail on regional exposure looks justified by the fair amount of bad news already priced in. Compared to the global benchmark, a relative 20% discount to Asian forward PE multiples provides some cushion against headwinds, as does a 30% discount on price-to-book, despite offering broadly similar returns on equity. Wolfe tipped the non-China dependent economies of India, Indonesia, Korea and Taiwan as safest bets, held on moderate overweights.

While attempting to accurately divine the various conflicting tides bubbling beneath the Chinese economy is beyond the scope of this column, it is also worth noting that the country may not be as precariously balanced as the most reflexively negative assessments suggest. 

Recent rapid credit expansion has suggested that policymakers are tweaking rather than tightening with UBS saying in a recent note the immediate outlook was one of limited ‘policy calibration’.

While the Chinapocalypse remains pending, portfolio positioning remains accommodative to an upward revision of risk assessment.

A total of $1 trillion in global equity funds cut their underweight position in Asian equity to the lowest point in two years in February, according to Bank of America Merrill Lynch’s quant analysis team, but their $8 billion in regional equity purchases recorded since early December still leaves them $24 billion below a benchmark weighting.

‘From a top-down view, we are more confident than any point in the past five years that Asian and EM earnings growth is likely to surprise the consensus’ 12-14% growth substantially positively in 2017,’ said BoAML Hong Kong-based equity strategist Ajay Singh Kapur. 

‘We have been sceptical of the usual 10-15% EPS growth projection in the prior five years. Not so for 2017. Our own leading indicators suggest around 20% EPS growth this year for Asia ex-Japan. 

‘In the next two years, both national capex/GDP and the listed private sector’s capex/sales ratios are projected to fall simultaneously. This is important. The decline in National capex/GDP should boost EBIT [earnings before interest and tax] margins, the projected decline in private sector capex/sales should directly increase free cash flow available to shareholders (and creditors).

‘We expect free cash flow in Asia ex-Japan to more than double from an estimated $157 billion in 2016 to $339 billion in 2018. Operating cash flow should rise from $611 billion to $752 billion, while capex is projected to drop from $454 billion to $413 billion.

‘Industrials, utilities, telcos, energy and technology lead the projected free cash flow torrent, with the Philippines, China and India in the lead.’

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