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In this podcast we are joined by Pruksa Iamthongthong, manager of Asia Dragon Trust, James Thom, manager of Aberdeen New Dawn Investment Trust, and Gabriel Sacks, manager of Aberdeen Standard Asia Focus, as they discuss the year ahead for Asia. They explore the macro-economic picture and give their views on what the strongest influences will be on markets in 2022.
 
Recorded on 29 November 2021

The outlook for Asia in 2022

Cherry Reynard: Hello and welcome to this Asia Outlook podcast. 2021 was a decidedly mixed year for Asian investors. It was a tough year in China as a regulatory clampdown hit its internet stocks and sentiment in general, while India went from strength to strength.

The year ahead is tough to call. China appears to be tightening policy, but the region is still buoyed by global economic recovery. Today we're talking to Pruksa Iamthongthong, co-manager of Asia Dragon, James Thom, lead manager of Aberdeen New Dawn, and Gabriel Sacks, co-manager of Aberdeen Standard Asia Focus about the year ahead - welcome, everyone. I’m wondering if we could start with the macro-economic picture. So, James, how do you view the strength of the Chinese economy today? Do you think some of the fears have been overdone perhaps?

James: Well, growth is certainly slowing, we are seeing that, both at sort of macro-economic level in China and at a sort of corporate earnings level. And, you know, there's no surprises there really. If you think about the headwinds that the economy is battling against currently, I mean, you mentioned the regulatory clamp down, there's the new common prosperity kind of policy agenda, China's still pursuing its zero COVID policy, but battling new waves of infections. And then we've had concerns around power supply and the property sector more recently, and all of that is having an impact. Is it overdone? Possibly, certainly the market has been very poorly performing this year. And our view is that if you step back and reflect on these issues, most if not all of them are actually kind of self-imposed and a function of policy at their core, whether it's restrictions around the property sector, or environmental policy impacting the power supply sector. And what that means is that the Chinese authorities have the wherewithal to relax policy, or slow down the implementation if they need to. And that aside, they still have plenty of other kind of levers, policy and macro-economic levers at their disposal to kind of buoy the economy, should things start to get really tough. So our base case is that China's going to be okay, and that there is no real systematic risk.

Cherry: Gabriel, do you see any looming political threats? I mean, Taiwan is the obvious one, but are any others?

Gabriel: Yeah so thank you for the question. I think ultimately, the rise of China as a dominant economic and military force is going to be the biggest challenge of the century, you could say, perhaps alongside something like climate change. So it's, it's quite likely we'll see political tensions and flare ups every now and then in the region. You know, not just with the US, but Japan, Australia, India, as China sort of flexes its muscles. And as James highlighted, you know, the fact that Xi is embarking on quite deep structural reforms at home, it does raise the risk of policy mistakes. So that's something we need to watch. You know, so far, China has been very good and strategic and deliberate in the way they manage these things. But it's something to watch alongside the Taiwan issue, you know, that's not something that China is going to let go. So hopefully, Xi doesn't become increasingly erratic around that issue, and some sort of status quo can remain to be the case.

But beyond China, I think most of the issues are now domestic, you know, COVID, has brought significant challenges for politicians and central bankers, in terms of managing that balance between public safety and economic growth, and inflation as well, a big issue at the moment. So these domestic challenges have been more important this year, and probably into next year as well, rather than the international issues aside from China.

Cherry: Pruksa, if we could bring you in here. To what extent do you see the fortunes of the wider Asia region as tied to those of China? Or could other major economies such as India pick up some of the slack perhaps?

Pruksa: Yeah, I would say that China is important to Asia, and I think this is given the context of how the intra Asia trade as well as trade with China has been growing over the last few years. And more specifically, if you look at the greater China trade, it accounts for around half of total Asia trade. So I don't think it's an understatement, you know, when you hear people say that when China sneezes, Asia also catches a cold. But as James highlighted just now, China is not facing a systematic risk, not from our point of view. We are probably going to see a slower level of growth, but we also believe that it will be a higher quality of growth.

Turning to the next big economy, we certainly think that India can pick up some of the slack. I mean, in itself, it is a large economy and this is certainly where the growth is as well for the region. And if you were to look at things from a stock market perspective, this year, India has certainly been picking up the slack in China. Just to give you some figures to go by, it is the best performing market year to date as of end October. And in GDP terms, India has risen about 25%, while China has fallen by 14%. So I think more than picking up the slack, actually, there's a few things going on for India. It has favourable population demographics, a young and growing educated labour force. And coming up as well we are seeing that mortgage rates in India are at close to 15 years low, while household incomes have risen on a year on year basis. So this has resulted in, you know, a record levels of housing affordability in the major cities in India. And you think about digital adoption, as well, as part of what's happening with COVID. We are seeing an acceleration of digital adoption in India, and this is expected to get close to 70% by 2025. So we are seeing lots of investment opportunities in this as well. Very, very exciting years ahead.

Cherry: James, what do you see happening across Asia more broadly? I mean, how do the ASEAN economies for example, look today.

James: So I'm quite positive on the ASEAN economies looking into 2022. I mean, they've been as a region, you know, so out of favour for so many years now, and sadly got hit, were amongst the hardest hit by the COVID pandemic, if you look to Indonesia, or the Philippines, for example. But that means that they're now amongst the best positioned for kind of a reopening play. And we've seen the sort of V shaped type recoveries elsewhere in the region in the world. And the expectation and hope is that the Southeast Asian markets will stage a similar kind of V shaped recovery as COVID restrictions ease and they get the pandemic under control. So, so I'm pretty positive from that perspective.

Having been out of favour for so long, there's also quite a bit of value, I think, in the Southeast Asian markets. So we're sort of hunting around for opportunities there. And there's some really great quality companies to and not dissimilar to India, though, perhaps not quite the same scale, rather than there are also some really interesting kind of tech and internet plays emerging within the region to.

Cherry: And Gabriel, does the virus continue to exert a significant influence? Or do you think its impact will ebb from here?

Gabriel: No, I think it certainly does still play a part in terms of the direction of the recovery. And clearly different countries have different approaches at the moment. So you know, Asia generally has been more cautious in, in opening up. So you see, you know, James referenced the zero COVID policy in China. So things are quite restrictive there in terms of mobility. And that does put some pressure on growth, particularly as the base effect for China had been higher during sort of the first wave of COVID, and then they managed that very well. You know, Singapore, has been quite tough on border restrictions and lockdowns until very recently, as well. So how long this policy is maintained for will be interesting to see and it will affect markets. I think there's also a risk of perhaps some complacency coming in as people sort of move on from the virus, people sort of don't want to get a booster shot or a second dose. And in a big market like India, that can that could potentially, you know, bring a third wave.

But generally speaking, I think we we've seen very good progress with vaccination rates in most of Asian markets. So the outlook for next year, certainly much improved. And we feel the stage is set for recovery. You know, I think I think COVID will remain the risk in terms of any sort of negative surprises. But generally speaking, we do expect as James also highlighted, a more V shaped recovery in Southeast Asia. So that's an area that we are starting to allocate more capital to, as you see a recovery there.

Cherry: Pruksa, obviously, inflation has been a big consideration for Western economies and to what extent are you seeing it have an influence across Asia.

Pruksa: Yes, it is a concern globally, but I think the picture in Asia is slightly different, but maybe we should expect that when we look at the Western economies headline inflation is expected to continue to pick up over the next few months. And I think things are getting slightly stickier than what previously, the central banks have predicted as well.

But as far as Asia is concerned, it really stands out relative to the rest of the world from an inflation perspective. And we haven't really seen a big surge in inflation in Asia as well. So as a result, from rates and monetary response perspective, is going to be quite limited, especially if you want to take a comparison with Western economies, we are not seeing the same pressure at all.

Perhaps one country that we might want to watch out for in Asia, in terms of inflationary pressure is in India. So far, it does look manageable. And the Central Bank of India has also indicated that it could actually adopt a slower pace of policy normalisation and will not be too perturbed if inflation exceeded his target range. So I think as economies start to open up for India and inflation pressure remains relatively manageable. I think rates and monetary policy should remain pretty supportive for growth into Asia next year.

Cherry: If we could turn to stock markets now. It's obviously been a tough year for Asian markets. But James has that less valuations looking more attractive would you say?

James: As a whole, yes, I think they have. So my perspective is that Asian valuations are looking pretty undemanding at this point in time, they are broadly in line with their long term average, depending on what kind of metric you look at. And to your point around Asia having sort of disappointed versus some other global markets, there is now a widening gap in terms of valuations between Asia and say, the US, for example. So Asia is now trading at approximately a 30% discount to the S&P 500. So I think valuations look quite attractive in aggregate, as always, the devils in the detail. And of course, there are pockets of, you know, markets and sectors that remain expensive and look a little bit stretched. But that's why, you know, we maintain our bottom up approach to selecting stocks

Cherry: And have Asian markets seen that same strong performance from value as other markets, or is that kind of recovery rally, still to come? Pruksa I’ll put that to you.

Pruksa: I will say it’s a combination of both, actually. So yes to both of your question. I think in terms of the value rally, we have seen some of that, and we are seeing this from a field perspective as well. So if you were to look at things from a sectorial perspective, we actually see that through this year, energy, materials, capital goods and banks, and these are typically cyclical and value sectors, they have actually delivered double digit increase in terms of stock performance, again in GDB terms, and this is a huge outperformance against the broader Asia ex Japan index, which fell 2% during the same period. And we are seeing this strength, more particularly so during the third quarter as well for banks and energy. So I think overall, it's quite clear from the sectoral perspective that there is a rebound from a value angle. And from a country perspective, it is quite interesting that, again, back to the optimism that James talked about with regard to ASEAN economies, we already start to see some of that playing out that third quarter Asian economies, sorry, ASEAN economies have actually outperformed the broader Asian market, and a special call out for Indonesia, which jumped 23% within just one quarter as well. So from a characteristic standpoint, Indonesia is smalling to the commodity cycle, and so has a large financial heavy as part of that index as well. So I think from that you do see some evidence that underpins the valuation - the value angle – within, within Asia. But then, I think it's also worth highlighting that we think that this rally has more legs to go. And this is tied pretty much to the vaccination rates improvement as it comes through - and we are going through that phase at the moment as well. And as more economies start to reopen up an economic activity resumes in Asia in a more sustainable way, we should continue to see this recovery rally playing out further on into next year.

Cherry: And Gabriel, what do you think are likely to be the strongest influences on markets in the year ahead? You know, might it be interest rates or global growth or possibly earnings for individual companies?

Gabriel: I think all those factors will be important. I’d probably bucket it into three things. The first is the pace of reopening that we see in the region, and how much recovery do we see in growth. So, you know, referencing Southeast Asia, you know, does that really materialise? How damaged are the sort of small and medium sized enterprises in in the region? And thinking, for example, in Thailand with the impact of tourism, you know, has that has that led to pretty significant structural issues? Or is it a case of, you know, once you see a reopening that comes back, so that will be important to track.

The second point is really, around liquidity in markets, we've seen a huge wave pretty unprecedented support to the economy via fiscal and monetary policy. So how quickly the Fed and other central banks start tapering and raising rates that will drive stock markets and have an impact on sentiment or what you call animal spirits. So that is a key question really for markets globally.

I'd say the third bucket is inflation. I think that's very topical at the moment. Pruksa mentioned that in Asia at the moment, it's less of an issue, because, you know, Asia is on the producer side of things. I think inflation is ticking up more aggressively in the US and in Europe. But it's something that we have to keep an eye on, you know, how long supply chain bottlenecks remain in place and the spike in energy prices that we're seeing, you know, that that is potentially a structural issue, particularly as you see capital, fleeing fossil fuels and the transition to renewable energy, you know, how we manage that transition, and the impact on inflation will be important. But maybe that's a bit more of a long term issue rather than a than a very short, short term one.

I’d just add one, in the specific case of China, I think regulation will remain pretty key. So whether we see some easing next year, you know, there is an expectation that with a slowdown that we've seen in growth and significant tightening across several sectors and regulatory crackdown, will there be a bit a bit more sort of relaxation in regulation and easing of policy and property in particular, that could move China and then it's important to bear in mind as well.

And finally, if we could zero in on the trust themselves, I wonder if I could turn to each of you individually to talk about your trust positioning today, you know, key themes, stock ideas. Pruksa, if we could start with you.

Pruksa: Yeah, so starting with Asia Dragon, we are positioned to capture long term structural growth opportunities in Asia.

So, if you were to think about the five broad themes that we see running through Asia, for the longer term, it will be aspiration - so that's more about consumption, it will be things like building Asia, digital, health, green and technology.

Today, we don't really have time to go into all but I thought, it's quite timely, to actually expand a bit more on the green side, which is more of a energy transition story.

And within that energy transition story, I'll say that there are there are three main layers to that.

The first one would be the renewables layer. And here we prefer upstream companies, companies that are making the components in solar farms, for example, and this would be components like solar modules and solar wafers. And our preference here is really because the industry, the whole industry is in a growth phase, and we want to benefit from the rapid growth of the whole industry. And the consolidated nature of the industry structure also means that companies within these areas do have good profitability. So here we have companies that do solar wafer manufacturing, companies that does, you know, inverters, energy storage systems, we even have smart grid and grid automation company, for example - so very exciting opportunities here.

Apart from the renewables layer, the second layer is the electrification layer. And this layer is really about increasing EV penetration, largely in China, but also elsewhere around the world. And the opportunity set here within north Asia, so you have Chinese companies within the battery space, as well as the Korean companies and both are globally leading in their own ways. We have the component companies as well, something like you know, a separator, which is part of a battery. And there are companies that do the onboard charging infrastructure, for example, in Taiwan.

And the last and third layer would be the energy efficiency layer. This layer may not be the most obvious to everyone, but it also represents the broadest in terms of opportunity set for us. It will actually involve companies in advanced semiconductor supply chain and that's really because more advanced semiconductors are more energy efficient. It will involve companies like you know, data centres in China, as well as machinery and automation companies. And all this together will be very well placed to help their customers to meet the increasingly tough energy efficiency targets set by the Chinese government and many governments around the world.

Cherry: And James, same question to you

Well, New Dawn shares many of the same structural growth themes that Pruksa has just talked about there, including the going green theme, but perhaps just to provide a slightly different perspective on how we're positioned. So at the moment, were underweight China, but have been selectively adding to China on weakness. In contrast we’re overweight India, and are still constructive on that market, despite the strong run this year. We're positive also on the tech hardware sector going into next year. And so maintaining a pretty large, absolute exposure to that sector. And we also like healthcare, mainly on the sort of services and equipment side, which is a sort of clear structural growth story as well. And then consistent with the comments we've already made, we've been looking for more opportunities in Southeast Asia and kind of hunting for value with a with an eye on what rates may or may not do, going into next year.

Cherry: And Gabriel, if we could turn to you about your Trust as well.

Gabriel: Yeh, I think the first thing to say is that Asia Focus has much more of a small cap slant. And, and just on, on that, relative to the performance of Asian markets this year, I think it is worth highlighting that small caps have actually done pretty well and are sort of back in vogue, with the index up 20% or so. So even though the large cap index fell 2%, small caps have been outperforming which is which is great to see from an Asia focus perspective, and over two years, you know, the differential in performance from the index is now 30%. So there is quite a differentiated exposure here in terms of the size of these companies.

In terms of the positioning, it's quite balanced portfolio in terms of country and sector. And what I'd say between sort of old economy and new economy stocks, a notable point is that we're comparatively low on China, China is a smaller part of the small cap universe anyway. So if you look at the index, it's less than 10% versus 40% or so in the large cap. So we have very little in China, we are underweight the index, we'd like to have more. But that has been beneficial this year, given the regulatory crackdown, as well.

We have a large allocation to India, Taiwan, as well, increasingly, and Southeast Asia. And then we have a reasonable position in countries like Korea and Vietnam. And by sector, as I said, it's very, it's very balanced tech is now the largest sector in the portfolio at around 20%. But tech is really now quite pervasive. So we do have tech in other sectors. The clear one I can think of is Momo, which is the largest position in the trust that around 5%, and that comes under consumer discretionary, but is an Amazon equivalent in Taiwan.

And then we have a chunk in other sectors like industrials, more consumer oriented industries and financials. We have decent allocation to healthcare and real estate as well. But where we're very light on is, is in more cyclical areas, such as materials and energy. And we also have very little I think nothing in utilities actually.

Cherry: Pruksa, so what do you see as the key characteristics for stocks in the year ahead? You know, will it be kind of pricing power, for example?

Pruksa: Yeah, I would say if there's anything that we learn from the COVID lessons and the disruptions that we are seeing this year, in the market, it will be resilience. And, and I think I'll come to this with different angles of resilience.

So look for you know, resilience of margins. And here you can talk about the company's ability to hike prices. So this links to that pricing power as cost increase comes through. And we talk about that the threat of inflation as well, so resilience of margins will be important.

The second resilience would be in terms of resilience of energy supply, and we would all recall the huge power shortage situation in China recently. And I think it's to see how the companies are reacting to that and strategically making some changes whether they should think harder about diversifying their power supply from just reliance on the grid, should they have backup power or installation of solar panels, for example, or even factor this into the longer term expansion plan as to whether, you know, how do they actually diversify their production risk, perhaps away from China into somewhere that is more stable from a power supply point of view as well. So that's something to think about.

The third area will be resilience of supply chain. And again, a big issue this year is in the semiconductor supply chain. So and that's really because it's a long and global one. So the ability to get sufficient supply, not just for yourself, but also for people on your upstream and people and your downstream will be very critical to have sufficient supply security for, for us to be able to sell that goods on as well. So resilience of supply chain is important.

And the last bit perhaps might seem longer term, but resilience to climate change, this will be important. And I think people might not realise that this is impacting our companies sooner than most of us think, because a business decision today has implications for longer term returns as well, especially if it's capital heavy. So having a good understanding of how the company is positioned for climate change in terms of the risks and opportunities, will be extremely important and will have significant impact on financial returns.

Cherry: Gabriel, I wonder if we could talk about, you know, the most interesting areas of structural growth across the region?

Gabriel: Yeah, sure, you know, this is an exciting question. And I could go on for a long time. I think one of the we've referenced quite a few of these in the conversation already. But I think one of the most obvious areas where I think Asia is very dominant, and there is structural growth is in the semiconductor supply chain, which Pruksa was talking about, just now, where you're seeing shortages. You know, this is an area where Asia has deep expertise. And you'll continue to see strong demand for complex chips as we move into an age of you know, connected devices, smart manufacturing, and just the prevalence of software applications in everything we do. So we think that that is an area that is pretty exciting. And I think in most of our portfolios, we have a decent allocation to the semiconductor supply chain.

The other one that was referenced earlier in the conversation is Internet penetration, and digitalization in India and Southeast Asia. So until recently, it was all about China and Alibaba and Tencent, but we are seeing a wave of IPOs in India. And it's not just you know, ecommerce companies, but gaming, FinTech, EdTech. So it is a really thriving area. And in the case of India, specifically, you know, you already have a pretty vibrant tech cluster, around Bangalore, where you've had these IT services companies doing outsourcing work for multinationals for a very long time, you know, two or three decades at least. So it is quite an exciting opportunity for India and again, for Southeast Asia as well, where I think Internet penetration and, and these business models are now starting to grow more than they have in in in China, or comparing to China's just a few years before.

And then, you know, I don't want to elaborate too much, I think the other one would be the emerging green energy theme, which Pruksa was highlighting, that's also going to be beneficial to some miners in Australia, you know, lithium and copper, for example. And then generally, the rising affluence and strong consumer theme is still very much alive in Asia. And we're positive on several areas there, you know, property in India, health and wellness in China and premiumization, generally.

Cherry: And finally, James, what do you see as the key risks in the in the year ahead? And how are you navigating those in your portfolio?

James: Yeah. So I mean, I think we've probably covered all the key risks already in the discussion. For me, you know, there are three main ones that really stand out, as we look into next year.

There's the, you know, the China balancing act for one of a better term. And Gabriel spoke about the potential for missteps there for on a sort of policy front. I mean, it's not our base case, we think that China will kind of navigate its way through this, but certainly, there is scope for error there. I think from a portfolio perspective, you know, ultimately, the sort of direction is to try and not go against the grain of policy, and kind of align yourself as best you can. So that's been what we've been trying to do in China.

I think the second big risk is COVID. And Gabriel's talked extensively there already. Obviously, if we see a new variant emerge, that will again act as a major setback. And so we from a portfolio perspective continued to take an approach of diversification. It's a positioning in some defensive sectors and stocks, but also positioning in the number of reopening plays that would benefit should that risk not come through.

And then the third big one is inflation and rising rates which Pruksa’s spoken to already and from a portfolio standpoint there I think, you know, Pruksa has talked about focusing on quality companies and those with pricing power, the ability to sort of pass on some of the inflationary impact, so that's key. Certain sectors and companies will actually benefit from rising rates so we've been looking at those, and meanwhile being a little bit more cautious on some of the sort of longer duration stocks where cash flows are kind of longer dated, and perhaps favouring value over those kinds of stocks.

Cherry: Great. Okay, we'll wrap up there. Thanks to Pruksa, James and Gabriel for those insights today and thank you to our listeners for tuning in. If you have any further questions, please do take a look at the abrdn Investment Trust website, which is www.invtrusts.co.uk. Many thanks.