Large Asia markets unloved, but for how long?
ReutersA statue of a bull stands outside the Hong Kong Stock Exchange. The bourse's blue-chip benchmark Hang Seng Index is down 8.5% over the past three months, as losses for it and other large-market indexes underperform their smaller rivals elsewhere in Asia. This may be set to change, however.
HONG KONG (MarketWatch) -- Within Asia, large equity markets appear to have taken the brunt of investor concerns about Europe and global growth in recent months, perhaps to an excessive degree.
That compares with a 1.1% drop for Thailand's SET index and a 3.2% gain for Malaysia's FTSE Bursa Malaysia KLCI index over the same timeframe.
Valuations on Chinese stocks have fallen to extreme levels, for example, with the Hong Kong market trading at an average price of between 8 and 8.5 times earnings, compared to a historic price-to-earnings ratio of between 12 and 13 times. And the South Korean market's P/E ratio is forecast to fall to 8.3 next year, according to FactSet.
"When the market is trading at 8 times price-to-earnings, it's saying that something's wrong," said Khiem Do, head of Asia multi-asset investment at Barings Asset Management.
Partly, markets are reflecting developments remote from the Asian region.
"We have a positive view on Asia, but it's still in the crossfire of Europe and the U.S.," said Yonghao Pu, Hong Kong-based chief investment officer for UBS Wealth Management Asia Pacific.
"What I normally do when I open my computer is look at the dollar and peripheral [European] bond yields," he said, in an example of how far Europe's troubles have spread across the global investing landscape.
Europe has been battling with its debt crisis for more than two years, while the U.S. has struggled to kick start its economy after the financial crisis in 2008-2009.
"Our exports to Europe have been under some headwinds," said Pu at UBS. Also, "European banks tend to have a big balance sheet and provide a lot of the credit to other regions. If they are repatriating capital back to Europe, this puts some stress on the funding markets."
"On the U.S. front, we are not so worried, but the momentum is not so good," he said. "I'm not betting on China suffering another crisis but I'm really concerned about Europe."
Do at Barings said that equity investors are craving a larger-scale effort to fix the world's economic problems.
"Investors want the big-bazooka fixes in China, in the U.S. and in Europe. They haven't had it -- that's why the markets have been very sluggish, unloved, with very low turnover, not much interest," he said.
In particular, Do said, "people hate BRIC at the moment. Every one of them has a specific issue. It's now just a brick," he said, referring to the major emerging markets of Brazil, Russia India and China.
Some of the concerns about China include its property market, off-balance-sheet bank lending and possible bad debts from local authorities, Do said. There's also uncertainly ahead of China's leadership transition set for November of this year.
Some investors "think that Chinese banks have not provisioned sufficiently. It's a lack of confidence, a lack of trust," he said, noting that Chinese bank P/E ratios have fallen to 5 to 6 times earnings, which is far below even the extremely low level of the broader market.
Meanwhile, growth has slowed in China, with gross domestic product expanding 7.6% from a year earlier in the second quarter, down from 8.1% in the first quarter.
India's growth has also slowed this year, with first-quarter GDP rising 5.3% its slowest pace since 2004.
The Indian economy has its own troubles, not least that the markets have lost confidence in the government, according to Dominic Bryant, a Hong Kong-based economist covering Asia for BNP Paribas.
That lack of confidence has been reflected in the steep drop in the Indian rupee, he said.
"Things were going well, then they stalled," Bryant said. "Fiscal policy has been too loose."
He also flagged a protectionist attitude by the Indian government, as well as a lack of investment spending, as current negatives for the Indian economy.
So, with two of the biggest economies in the region grappling with such issues, it's not surprising that Western investor interest in Asia -- already regarded as cyclical and therefore more risky -- has waned.
Tide of money ebbs
Bryant at BNP Paribas said that, while Western investors are keen to invest in Asia for higher returns, "money comes in and tends to exit quite quickly in times of stress."
For instance, Morningstar data show that European investors withdrew 2 billion euros ($2.46 billion) from Asia ex-Japan equities in the second quarter, while the same group added €1.2 billion in investment in the first quarter.
This volatility, which impacts the major markets more than their smaller rivals, has fed variation in performance between the larger and smaller bourse, with the smaller ones as the outperformers.
Regional Asian fund managers are "hiding in stable stocks and stable markets -- the Philippines, Indonesia, Malaysia, Thailand and other [smaller] emerging nations," said Barings' Do.
But, if and when, foreign investors want to come back to Asia, the bigger markets will benefit the most, he said, as their liquidity provides ease of entry and exit.
He named Korea, Taiwan and Hong Kong -- as well as mainland China, despite restrictions on some foreign investment there -- as examples of markets that would likely see a V-shape performance in such a scenario.
Valuations would be expected to play a key role in any such market turnaround.
"The one market we should like is China. On [a P/E ratio of] 8.5 times, you should like it. [However] We think that maybe the time for China is the last quarter of this year, when we know who is in charge," said Do of the mainland markets.
Some fund managers are already taking a more positive view on China.
"Our conviction market at the moment is China as it has underperformed for more than two years. We have started to see value," said Adrian Zuercher, Hong Kong-based senior investment strategist at Credit Suisse Asset Management.
"On the fiscal side, China has started to step up measures. We definitely expect a soft landing scenario. In the third quarter of 2012, or maybe in the fourth quarter, there could even be an acceleration of growth," he said.
"We have become more positive on equities in general. We think a lot is priced in. From a contrarian perspective, equities are very attractive," he said.
Valuations don't appear to be so compelling in India, however, according to Bank of America Merrill Lynch's Indian analysts.
"We think the market trades at 14 times fiscal-year 2013 earnings, in line with historic averages," they said. "For many investors, investing in India was the counter to their China view."
"Most investors we spoke to were neutral India, and conviction levels on the markets were low either way. There was practically no debate on our view that, overall, markets would be range-bound," they said.