FUNDSUPERMART RESEARCH / Pic By BLOOMBERG

Are Asian and China equity markets a good buy despite the recent rally?

Looking at the earnings growth estimates for Asia ex-Japan to 2020, and recent developments in the trade talks between the US and China, there is too much pessimism over how Asia ex-Japan will perform.

Last year, the main factors that dragged global equities, especially Asian and China equities, was the strengthening of US dollar, a hawkish US Federal Reserve (Fed) and the unsettling US-China trade disputes.

However, moving into 2019, most of the market headwinds have started to turn into tailwinds.

At this juncture, we believe the Fed tightening cycle is almost approaching the end, given chairman Jerome Powell has again reiterated that the central bank is now more flexible and patient, and would change the policy stance on a dime if the economic outlook worsens.

US economic growth is expected to moderate as the tax cut effect would fade this year. Hence, the likelihood of a slower economic growth in the US would warrant a pause from the Fed in tightening the monetary policy.

Hence, the probabilities of interest-rate hike in 2019 has dropped significantly over the past few months, while the probability of no hikes has surged together with the probability of interest-rate cut since the end of 2018.

The dovish US Fed coupled with the moderating economic growth is expected to translate into a weakening US dollar which would ease the pressure on Asian currencies.

This provides breathing space for Asian central banks, especially those who have aggressively increased interest rates last year to adopt a supportive monetary policy and lead to a rebound in Asian equities and fixed income markets.

Last year, as trade tensions rose, consensus priced-in the effect of trade tariffs by revising earnings’ estimates downwards.

Despite the current progress in trade talks, the market has not priced in any of the positives.

Although the chances of a complete breakthrough in US-China trade talks remain relatively low, we believe that any positive developments will trigger a reversal in the earnings revision trend.

For the Chinese equities, on top of the supportive fiscal and monetary policies, we believe the expectation of an increased foreign fund inflows and attractive valuation with limited downside risk should convince investors to take advantage on the current weakness.

The 5% initial inclusion of China A shares into the MSCI indices was successfully implemented in May and August last year.

Thus far, the inclusion has attracted more than 300 billion yuan (RM180 billion) of net foreign inflows into the Chinese stock market.

According to the vice chairman of the China Securities Regulatory Commission, the estimated inflow in 2019 is likely to be double that of 2018 as MSCI is expected to further increase the inclusion factor of China A large-cap securities from 5% to 20% in two phases, May 2019 and August 2019 respectively.

Hence, we should see more foreign investors actively or passively allocating more of their capital into the Chinese equities for portfolio diversification, as well as to gain exposure in companies that are more heavily exposed to China’s “new economy”.

Despite the year-to-date rally, the valuations for both the CSI 300 and HSML 100 indices are at an attractive level, indicating lucrative upside potential from both the onshore and offshore China equity markets.

The valuation for Chinese equities rarely drops to such an attractive level except in 2014 (Taper Tantrum), as well as 2016 (Chinese Circuit Breaker Meltdown).

All in all, given the attractive valuations and the above mentioned elements, we believe the Asia ex-Japan and the Chinese equities would be able to deliver investors with lucrative upside potential.