Asset Allocation Q1 2020

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2020 vision

We arrive at year end with a (very basic) trade deal apparently done and Brexit about to follow suit. Removing the two principal worries for global markets ought to allow markets to refocus on the fundamentals. So what do they look like? Not great, after the battering of 2019, but really not bad either.

In ASEAN, the region is starting a new cycle. After a period of rather tricky elections, which were drawn out for a variety of reasons, the consumers of Thailand, Malaysia and Indonesia are regaining their confidence and governments are re-starting major infrastructure and stimulus programmes. Most ASEAN countries also find themselves the destination of choice for a diaspora of manufacturing from China which is reaching unprecedented proportions, helped by growing integration of the ASEAN Economic Community. In general, Vietnam is attracting mid-skilled electronic assembly; Thailand auto-part production and mid-high-level skilled production in less labour-intensive industries (Thai workers are not expensive, but unemployment at just 1% lessens the availability of labour). In Malaysia, they come for the semiconductor test and packaging supply chain and for energy-intensive production needing highly skilled workers, whilst Singapore is drawing R&D, software, and electronic design needing ultra-high-end skilled workers. Indonesia has seen less of this trade, with companies looking for more domestic sales when they set up there. More stable politics and the giant RCEP trade treaty on the verge of signature paint a rosy backdrop for ASEAN, where valuations appear to be cheap against their historic ranges and versus the region as a whole.

Taiwan and Korea are also seeing the start of a new economic cycle, but here the catalyst is semiconductors. The trade wars have reduced finely honed supply chains to dust and many manufacturers now find themselves short of components to make that next widget. Inventory has thinned out to almost nothing and low capex, halted by indecision and fear, has removed all thoughts of oversupply in future. Taiwan looks expensive, but if less trade war tension and potential European stimulus persuade companies to reinstate their capex programmes, it could remain well placed in 2020, although elections early in the year look likely to exacerbate an already poor relationship with the Mainland.

India too is starting a new cycle – or so the Modi government hopes. Having thrown everything at an exceptionally weak economy and ultra-low public confidence in the last six months, the government now has to wait to see if its labour will bear fruit. Tourism (9% of GDP) is lifting and companies are starting to beat consensus expectations.

China is a different story, with Services now well over half of GDP, the decline in manufacturing ought to have less impact. However, the older, manufacturing sector (just 26% of GDP now) is in an exceptionally poor place at present and the quantity and complexity of China’s debt is weighing on the entire economy and leaving Beijing walking a tightrope (plank?) between total collapse of the financial system and rejuvenation via newer, cleaner industries. 2020 will be a critical year for China’s debt repayment and the auguries do not look encouraging at the moment, with the debt repayment burden now exceeding 42% of GDP per annum. This is undoubtedly the major risk for the Asian region and the world in 2020, but it also offers opportunity. With its fiscal deficit already maxxed out, there is no room for further fiscal stimulus, unless the country starts to divest some of its vast holdings in State Owned Enterprises (SOEs). We find evidence that it is doing that, with a substantial programme of IPOs already lined up and more to come, so we remain optimistic about China’s future in the long run, but getting there may be a bumpy ride. Its new, much larger Services-focused economy, whilst not starting a new cycle (it has been expanding at an extraordinary pace for years already) should benefit from accommodative monetary and fiscal policy for years to come.

2019 was a tough year in Asian politics and has left Hong Kong battered and bruised. Sadly, we do not see a satisfactory resolution to the problems there in the short term.

It is easy to look at difficulties in China and extrapolate them to the rest of Asia, but Asia ex China now represents almost the same contribution to global GDP as China itself and the ASEAN Economic Community is just starting (finally) to pull together. Catalysed by the manufacturing diaspora from China and with its politics now stable, this is a new and important engine of growth for the region. Despite the threat from China’s complex debt problems, we see 2020 as a strong year for Asian markets and one in which Asian earnings should exceed those of the rest of the world.

This quarter, we have chosen to highlight Indonesia, which is rapidly becoming the core of ASEAN now, although it is not a principal recipient of the diaspora of Chinese manufacturers.

Indonesia Economics

After almost a year of pause over the time of the election and its aftermath, the Indonesian economy is showing signs of reaccelerating again. The infrastructure stimulus packages put in place by President Jokowi in his first term in office are starting to pay off and, with a focus on outside Jakarta and Java generally, that growth is strongest in the regions and outlying islands. This has left the Indonesian consumer with confidence accelerating to levels only slightly below all-time highs.

The Rupiah is rebounding, which is keeping inflation (and therefore fuel and living costs) under control, and unemployment, whilst a fraction higher than it was in March, remains at historically low levels, further reinforcing the feel-good effect for Indonesians.

The residential property market, which has seen a substantial over-supply in residential housing for many years, has also returned to equilibrium (except in Balikpapan, where immediate speculation has started ahead of the move of the administrative capital there) and the office market, which has been chronically oversupplied for several years, is also improving. Take-up rates for new residential launches have soared in H2 2019, despite a much deeper product offering from the developers.

The commercial and retail property markets remain heavily oversupplied, leaving Jakarta-focused office developers gloomy and querying whether the rate of GDP is really real (see below). Interest rates remain low and BI has run a careful process of reform, which is stabilising the economy generally. Indonesia is unusual in the Asian region, in that it has very low household debt to GDP (just 17%, of which mortgages are only 2%) and mortgage growth is returning again, after deleveraging throughout 2013-14.

Questions have been raised as to why businesses based in and around Jakarta do not seem to be feeling the 5% rate of GDP growth currently being reported by the government, but we feel that this is explicable by a) stable oil, which supports offshore growth b) rebounding palm oil, which is felt most in the rural and outlying areas and c) growth in businesses and regions remote from Jakarta, now served by better infrastructure. Companies with nationwide businesses are also reporting a rise in economic activity in the second and third tier cities across Indonesia and what data is available seems to support a substantial narrowing of overhang outside central Jakarta and in shop-houses and apartments. Foreign competition in the property market, especially from the Chinese, seems to have calmed down, after a series of ill-advised Chinese-style multi-tower block style developments by Country Garden and China Construction failed to sell well (Indonesians prefer landed property).

The need to upgrade housing remains acute in many areas – the only things lacking in recent years have been political stability, wages and confidence. Now all these seem to be coinciding and Indonesia looks to be on the verge of a consumer-led rebound. To help further, Finance Minister Sri Mulyani has also reduced taxes for higher end housing with effect of June 2019.

Consumer staples companies are reporting unexpected improvements to demand in every area, whether basic food stuffs like flour and noodles, snack-foods like pizza and bready treats, or personal care products. The better sentiment looks likely to have been catalysed by the stabilisation of the oil price globally (oil, gas and refining together account for 9% of Indonesian GDP), a sharp rebound in palm oil prices, caused by an increase in tree stress and inventory drawdown and a 9% increase in minimum wages. Consumers are also reported to feel much happier about the political backdrop, now that the election is over.

The anti-corruption drive of 2014-15 was successful in cutting levels of ultra-low-value corruption (that $1 for submitting a form), when it pushed government forms online. That took a lot of money out of the pockets of the lower middle class, who now seem to have recovered. In doing so, the move seems to have underpinned the shift to the internet amongst the wider population. This in turn is driving the same trend seen elsewhere globally – for retailers to lose business to online operators and consumers to stay at home, ordering in their food and entertainment, rather than travelling to malls, which we feel explains some of the retailer gloom in Jakarta.

What might puncture this positive sentiment is the removal of subsidies on fuel and electricity and the tax rise on cigarettes (just under 50% of the population smoke), which are due in 2020.

Private consumption has lifted marginally from its c 4.92% yoy growth in 2015 to +5.01% now, but the improvement is very small and may still be somewhat fragile.

We feel that these factors are key to the poor business sentiment currently being reported in Jakarta. Coal, palm oil and mining businesses are finding themselves crimped by environmental considerations, whilst relatively capricious changes in laws on exports of unrefined ore have interrupted other extractive industries (most notably nickel), leading to a sharp fall in PMI.

Indonesia is a significant exporter of cars (mainly to ASEAN), as well, and this has not been immune to the drop in demand globally. Finally, the re-orientation of the regional supply chain due to the trade wars has also slowed exports this year.

Indonesia has not been a favoured destination (so far) for the relocation of businesses leaving China, but is starting to pick up enquiries from businesses interested in playing the ASEAN integration theme (the Japanese are especially interested), as the AEC begins to get going in earnest and every company we spoke to on a recent trip reported starting new divisions in other ASEAN countries. It is not a typical location for exporters, due to its archipelagic nature, but with the largest population in ASEAN, many regional consumer-facing or infrastructure companies want to expand there and the recent reforms and stability of the currency increase that attraction. Its consumption as a percentage of GDP is large and its consumers youthful by comparison to Thailand, Singapore and Malaysia.

GDP make-up of ASEAN countries

President Jokowi is highly focused on this and has put in place a slew of reforms to improve the country’s standing in the Ease of Doing Business surveys.

The creation of the ASEAN Economic Community (AEC) in 2015 has set dramatic targets for tariff reductions, which are now starting to come through, but some are also being negated by new non-tariff barriers. Nevertheless, we would see the steady improvement in terms of trade between the countries as underpinning exports within the region.

What the country is seeing in FDI is investment in the EV car and battery supply chain, as it seeks to restrict exports of nickel ore. This offers strong potential growth in the heavy industries around these sectors, with some (small % of GDP) already moving.

Corporate taxes are to be cut by 3ppt in 2021 to 22% and then to 20% in 2022, which may accelerate inward FDI.

Fiscal policy in 2020 should be neutral to slightly expansionary. The 2019-20 target is -1.76% of GDP and is currently running at -2.2%, but the government are currently proposing a relaxation of the annual cap (currently -3%) to an average of -3% over five years. The bond market took this proposal well, weakening by only 4 bps. We are slightly more optimistic on the outlook for GDP than consensus, which currently predicts the same rate of growth (5%) in 2020 as 2019. We expect an increase to 5.2-5.4%, as the infrastructure projects begin to fire up, AEC trade deepens and the consumer gains more confidence, giving a positive backdrop to the stock market in 2020.

Disclaimer: The stocks and ideas mentioned in this report should not be construed as a recommendation to buy or sell anything. This document is intended only as an illustration of the investment themes likely to prevail in Asia over the coming months and is based on our views at the time of writing. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situations or needs of individual investors.

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