The US-China trade dispute appears to be most prominent concern on investors’ minds this year. Indeed, further deterioration of the current trade spat between China and the US will potentially impact economic growth in China. However, one must remember that both governments support free trade and the conflict is a means to force negotiation in areas where imbalances exist.
Fears of a trade war
There is certainly risk to the China market from the current ongoing trade tariff issue. The team’s view is that this will not be resolved in the short term and market volatility will result well into Q4 2018.
It’s probable that the mid-term elections in the US will accelerate some tangible progress towards a resolution, at which point, we expect the China market to respond very positively. The issue will, however, remain complicated and firmly on the political agenda for some time to come.
It is more accurate to describe the scenario as an ‘economic war’ rather than a ‘trade war’. The reason for this remains that US primary concerns are actually around intellectual property/technology transfer and the ‘Made in China 2025’ initiative, both of which they feel threatens the future of US corporates.
This will take longer to settle but a strong showing for Trump in the mid-term elections will force China to compromise, knowing that the administration has more political capital to continue its fight. Meanwhile, China can utilise a variety of tools available to address weakness. The recent cut in reserve requirement rations and fiscal stimulus are examples of China responding to concerns of a slow-down.
If the issue has not reached any point of compromise/negotiation by the mid-term elections then we would need to reassess the scenario. However at this point the likelihood of a recession is low and current indicators in China do not show this is a realistic proposition here.
Deleveraging could take a back seat in an environment where further stimulus, most likely from an expansionary fiscal policy, will be used to offset external pressure. Deleveraging is a key focus for the Chinese government and will remain so. However, the near-term pressure to loosen the liquidity environment will likely pause the recent momentum. There is some evidence of this already.
Naturally, we expect ripples from a trade war to be felt in markets such as Korea and Taiwan, both of which boast large high tech sectors which are susceptible to the ongoing tumult.
Korean names are dominated by the well-known chip and memory makers. We consider their technology leadership, industry dominance and strong balance sheets sufficient for providing protection in this environment. Their valuations are also attractive.
The Taiwanese technology supply chain names, however, are more vulnerable. While some of these names have high dividend yields and strong balance sheets, we have not been tempted to add here and have instead focused on financials, chemicals and domestic consumer names in Taiwan. These names have performed well and should continue to outperform as investors seek more defensive plays. The lack of a major product cycle in Q3 has also negatively impacted the Taiwan technology names and there is still not sufficient valuation upside to consider these names here, further weakness is required before they become attractive.
It is crucial that investors avoid countries in Asia where macro-economic indicators are deteriorating especially where fiscal and current account positions and valuations are expensive alongside currency volatility. Rising oil prices and general pick-up in inflation is also hurting the credibility of central banks in these countries as they have reacted too slowly to the rising risks. We observe these factors evident in markets like India, Indonesia and the Philippines.
It’s not all gloom and doom, however. We believe a majority of Asian companies are valued quite attractively. Additionally, many of these companies are increasing dividends at a significant rate, with the MSCI AC Asia Pac ex Japan High Dividend Yield Index already yielding 4.7%1 and the region having grown dividends 14%2 CAGR over last 15 years. With record cash on balance sheets, rising FCF and falling capital expenditure, there is great potential for this trend to continue at least in line with historical levels.
Why dividend growth? Rising dividends*
Asia leading the way in dividend growth
MSCI indexed dividend over the past 15 years
MSCI regions and markets: dividend CAGR
(last 15 years)
Source: CLSA Research, as at 30 April 2018
Note: *Rising dividends refers to yoy increase in dividends by 5% or more
With Asian dividend payout ratios some of the lowest globally, the upside potential is significant. An improving Asia economic outlook and corporate governance spurs more confidence in releasing strong cash flow and cash on balance sheets to minority shareholders. Further domestic reforms and improving corporate governance will continue to drive this trend, further benefiting the strategy.
This trend is expected to continue despite the volatility from the external environment. With attractive valuations and decent earnings growth this year, any toning down of the trade tariff issue could see a sharp rally back in Asia Pacific led by China. We think high-yielding defensive assets together with domestically-focused, cyclical names with high dividend growth makes for a compelling combination in the current environment.
When it comes to China, we maintain an overall positive view on the market. While the recent volatility has been unfavourable to the market, the underlying economics of the businesses we own has been unaffected. The strategy has minimal exposure to sectors such as technology and other export-led names which are likely to continue to be out of favour in this environment.
Source: 1. Bloomberg, October 2018; 2. CLSA, as of 31 July 2018.
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