Ian Hargreaves, Invesco
Updated 09 Mar 2021
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This is a non-independent marketing communication commissioned by Invesco. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.

Asian equity markets have enjoyed a v-shaped recovery since their March 2020 lows, but recent market strength suggest markets are up with the events. Looking forward, Ian Hargreaves, manager of Invesco Asia Trust plc, believes this offers a notable amount of scope to drive outperformance by capitalising on valuation differences within different areas of the market.

2020 was a challenging year for Asian equity markets. The Covid-19 pandemic saw widespread lockdowns and a significant contraction in global economic activity, with considerable uncertainty over the timing and pace of a recovery. However, Asia fared relatively well compared to other regions, particularly North Asian economies such as Taiwan, Korea and China given their lower infection rates, fewer deaths and less economic damage. However there has been a divergence in performance between sectors, with internet and technology companies faring far better than financials, energy and travel-related companies.

Markets have recovered strongly since their March lows, with recent positive news on a vaccine triggering a significant improvement in sentiment towards the worst hit Covid-sensitive service sectors that had lagged the broader rally. However, markets appear up with events and it is possible that we have seen most (or all) of the rebound at the market level. Looking forward, we believe there are still opportunities to buy shares in businesses for less than they are worth, and that this remains the most sustainable way to make money for shareholders.

Given the divergence in performance and valuation between different areas of the market we have been able to find opportunities in selected economically-sensitive businesses that have scope for earnings to recover quickly as economic conditions normalise. We have been able to find what we consider to be deep discounts to fair value in these areas, with conviction levels supported by the strong balance sheets that some of these companies have. However, we feel it is right to have a balanced Invesco Asia Trust at the current time, and our portfolio continues to have significant exposure to tech and internet names given their strong fundamentals and attractive growth prospects.

Opportunities among economically-sensitive stocks

The companies that interest us most tend to be Covid-sensitive industrials where the pandemic is unlikely to have materially changed fundamentals, but earnings can recover quicker than the market expects as conditions normalise. For example, some auto-related companies are trading at valuation levels close to the levels they were trading at during the Global Financial Crisis (GFC). Astra International in Indonesia has interests in a wide range of market leading auto-related businesses, including: 4-wheeler manufacturing for Toyota; 2-wheeler manufacturing for Honda; auto dealerships and auto financing. Having struggled with slower growth in recent years, the shares have suffered even further given Covid-related demand uncertainty. While the fundamentals of the Indonesian economy are weak in the near-term, we believe that auto demand should eventually grow as GDP per capita rises.

Attractive good quality businesses in India

India has probably had the worst pandemic experience in Asia in terms of impact on its population’s health and the sharp shock felt by the economy as a result of what was an unsuccessful lockdown strategy. The Indian government was swift to abandon this strategy and has instead focussed attention on support for the economy, which appears to be working. Domestically driven, India’s economy is open for business again and with infection and death rates falling there is less concern about having to protect a Covid ‘clean sheet’.

We believe this country offers one of the best structural growth stories in Asia for a number of reasons. Firstly, it is supported by the government’s reform momentum which we expect will bear fruit within the medium term. For example, we expect the recent new labour codes (new labour laws) is likely to help incentivise investment and small business creation. Secondly, debt levels are low in India compared to historical levels and this provides scope for credit growth and business expansion, particularly as the banks have been strengthening their balance sheets for several years which increases their capacity to lend.

We added exposure to Indian private banks in Q3(2020), which are still taking market share from the dominant, less well-run state-owned banks. We are also comfortable owning other economically sensitive stocks in India given the large structural growth opportunities. In 2020, we’ve seen some solid and well-managed companies suffer from the lack of economic activity, which has allowed us to take positions at historically attractive valuations. For example, we had added to Larsen & Toubro (L&T) which is not only a leading construction and infrastructure business with a strong balance sheet – a characteristic we value in these uncertain times – but is a potential beneficiary of a return to normality.

Tech companies capitalising on the new tech cycle and trends in consumer behaviour

A number of technology and internet companies are likely to emerge from this period stronger, particularly those that continue to invest and innovate. Chinese internet companies have benefited from an acceleration in the trend towards online shopping, social connectivity and gaming, while demonstrating a willingness to focus on core profitability. Elsewhere, the rollout of 5G and the growth of artificial intelligence and the ‘internet of things’ have only been temporarily interrupted by the Covid-19 outbreak while, at the same time, working from home has increased demand for PC-related equipment and cloud capacity. We continue to be attracted to companies benefiting from these enduring themes and will remain so for as long as valuation levels permit.

US-China relations

Turning to the US-China trade war, the relationship between the US and China is unlikely to improve dramatically due to a change of President. While we expect US policy under Joe Biden to be handled more diplomatically, and less haphazardly, it is prudent to assume that Biden will be slow to roll back the Trump administration’s measures targeting trade, technology or financial markets. While we need to consider the potential impact of trends such as de-globalisation, as companies seek to ensure that their supply-chains are less reliant on China, we are also aware that there is likely to be a greater level of government investment in technology development by both countries and a desire for self-sufficiency. While this may create uncertainty within supply chains, we believe that innovative companies stand to benefit.

Outlook

The global economy is gradually getting back to normal, supported by a demand recovery in the US and Europe. In the near-term, supportive economic policies should provide a tailwind to economic activity, with policymakers unlikely to repeat the mistakes of the recent past in trying to withdraw support too early. However, once normality has returned, governments in developed markets will be forced to begin to chart a course back to policy orthodoxy, in our view. This is likely to be a riskier point for markets.

Most Asian countries went into the Covid-19 crisis with relatively low levels of government debt, which has enabled them to loosen taxation and increase spending and means they may not need to revert to austerity once the crisis is over. Furthermore, economic growth in China is recovering without the authorities having to rely on the same level of policy support which is taking place in developed economies.

While the market currently has policy and vaccine tailwinds behind it, we feel it important not to exaggerate the likely positive impact of economic normalisation. Markets have done very well since they bottomed in March but valuation levels still compare favourably relative to developed markets. Given the wide divergence in performance and valuation between sectors and countries, opportunities are still available, particularly in undervalued economically sensitive stocks. However, we feel the need to be selective and maintain a balanced portfolio.

Finally, while these are clearly challenging times, Asia remains the biggest driver of global growth, with solid economic and corporate fundamentals. We continue to be impressed by the greater capital discipline being displayed by companies across the region, with strong balance sheets and improving free cash flow generation. The challenge has been how to better allocate that capital, with management facing growing pressure from minority shareholders to pay better dividends. While valuations and positive surprises in earnings are less likely to drive equity returns in the near term, there is an increasingly good dividend growth story in Asia.

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