China’s influence dominates region

But latest figures from the Chinese National Bureau of Statistics show second quarter GDP growth remained steady at 6.7 per cent year on year, the same as the first quarter. As the Chinese government aims to target growth of between 6.5 and 7 per cent a year, the country is currently on track – but is this data enough to boost Asian equities?

In sterling terms, the MSCI AC Asia index has delivered a gain of 12.3 per cent in the year to July 14 – ahead of the MSCI AC Europe index’s increase of 8.2 per cent, data from FE Analytics shows. But the region still lags both the MSCI North America index, which gained 18.5 per cent, and the resurging MSCI Emerging Markets index, which has risen 22.4 per cent.

Craig Botham, emerging markets economist at Schroders, says while second quarter Chinese GDP growth was better than expected, it appears overly reliant on fiscal stimulus.

“The reading surprised us, and would suggest stimulus efforts have successfully supported growth. A sector breakdown of the data shows acceleration coming through the primary and secondary industries, or ‘old’ China, with the tertiary sector slowing marginally. This is counter to the narrative of a China transitioning to a new growth model and suggests that growth and stability for now trump the need to reform the economy.”

Chris Kushlis, fixed income sovereign analyst at T Rowe Price, highlights China’s influence both regionally and globally: “China’s influence is apparent in the significant credit expansion seen in Asia since 2009. In response to the global financial crisis, all the Asian countries followed China’s lead by letting domestic credit expand rapidly to support domestic demand. Hong Kong, Singapore, Thailand, Malaysia and Korea – all have seen a massive credit expansion. This is significant as it is going to be hard to keep growing credit, leading to a modest outlook for Asian domestic demand growth.”

China’s influence is apparent in the significant credit expansion seen in Asia since 2009 Chris Kushlis, T Rowe Price

Joep Huntjens, lead portfolio manager, Asian Debt Hard Currency at NN Investment Partners, suggests overcapacity in China is high, especially in industries that have seen limited bond defaults because of state support.

He says: “China cannot continue supporting companies in such industries, especially in light of its reforms. The default rate in the Chinese onshore bond market has been 0 per cent for years, which is not natural. In the coming years there will be more defaults, which is the only way to get a healthy credit environment where investors start to demand a compensation for credit risk.”

On the equity side, Robin Hepworth, manager of the EdenTree Amity International fund, suggests Asian equities can offer investors “compelling long-term value”, particularly in markets such as Hong Kong and Singapore.

“Both markets are displaying strong growth and also offer a range of companies with direct and indirect exposure to China. Both rank highly for free trade, open markets, lack of corruption and a competitive tax regime.

“Equities in Asia have significantly de-rated and now trade at a material discount to overall global equities. The reason for this continues to be pessimism surrounding China, which we believe is divorced from the facts. While there is a slowdown in the heavy industry areas of China, the service sectors are now a strong driving force behind economic growth.”

In terms of other areas, John Yakas, manager of the Polar Capital Asian Financials fund, notes the real estate sector has outperformed in the past month helped by potential interest rate cuts in the region and a lower likelihood of rate rises in those markets linked to the US dollar.

But he adds: “Domestic rate cuts could start proving a negative for the bank sector since margins will be difficult to sustain in the face of falling interest rates and increased intervention by regulators to ensure cuts are passed on to borrowers. However, interest rates in emerging markets remain well above the levels seen in the developed world and with ample room for banks to still charge enviable spreads. Added to which, central banks will be cautious in cutting rates to avoid pressure on their currencies.”

In Asia, once again, China is the driving force in terms of economic growth and investment opportunities. In the past 12 months, UK retail investors have steered clear of Asia and Japan, but with elections in the US this year and in some parts of Europe, it is possible Asia could see a similar improvement in investor sentiment to that which has helped the broader emerging markets sector rebound in 2016.

Nyree Stewart is features editor at Investment Adviser