Asian Insights: Profitability, Policy and the Reflation myth

2017 so far has seen equity markets in Asia off to a positive start, and as a result, global investors are gaining more confidence in their outlooks.

Apr 23, 2017 | Invesco Asian Investment team

Along with global markets, Asian equities have moved forward in parallel led by economic sensitive sectors, while dragged by defensive sectors.

As the year progresses, we believe three key areas may have an impact on Asian equity markets: an improvement in profitability for Asian corporations, spurred by growth in certain sectors; global policy uncertainties impact to Asia will not be as significant and has been exaggerated by the market; and the myth of reflation, at least for the case of Asia.

Asian Corporations Improve Profitability

We believe one of the biggest drivers in Asian equities in 2017 will stem from a return of profitability to the region. Compared to 2016, during which Asia ex-Japan earnings were largely flat-lining, the region is expected to see meaningful improvement with a 15% growth in earnings in 2017. We are particularly excited to see an upward revision in earnings already this year, as compared to previous years’ ongoing downward revisions from the first quarter.

We predict broad-based earnings growth this year across most sectors, particularly within information technology (IT), the second biggest sector behind financials. This sector accounts for almost 25% of aggregate earnings in MSCI China in absolute terms. It experienced a doubling in earnings growth from 12% (2016) to 24% (2017), driven by the addition of US-listed franchises as American depositary receipts (ADRs) to MSCI indexes via two tranches from late 2015. Most notably in China, several industry leaders are active in their own areas, such as Alibaba, an e-commerce business, and Ctrip.com, an online travel agency. In our view, these franchises will enjoy robust growth in the years ahead as consumer behavior in China shifts to mobile internet. Superior scale, established logistics networks and a high barrier of entry for these industries will leave growth intact.

Asia ex-Japan earnings are further lifted by improvements in the financials sector, which is expected to see a turnaround in earnings from -3% (2016) to +6% (2017). Prior monetary easing and accommodative liquidity across Asia has stabilized overall asset quality and lowered the required provision of non-performing loans (NPLs) expected for 2017. It is worth noting that the financials sector is the largest earnings contributor and may therefore be a swinging factor - any slight downturn in bank earnings growth could have an impact on the market earnings growth result or estimate overall. After the recent Fed rate hike, a rising US interest rate would be positive for Asian banks, such as Hong Kong and Singapore, with expanding net interest margins (NIMs) and high US dollar loan exposure.

Finally, the energy sector has seen the sharpest rise in growth from 18% (2016) to 33% (2017), with crude oil trading at more than $50 compared to approximately $30 a year ago. Unless oil prices correct sharply from their current level, earnings for upstream companies will be relatively secure in 2017 (year-on-year basis). The energy sector stands out with the biggest sequential earnings improvement; however, its contribution to Asia ex-Japan earnings is not as significant at less than 5%.

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