It’s certainly difficult to imagine a more dramatic year for investors than the year 2020, with the Covid-19 pandemic sending markets worldwide on the wildest of rollercoaster rides.
In fact, what has become clear in the past few months is that even if investors had known a year ago that the world would be in the grips of one of the most severe pandemics of the century, very few would have accurately predicted where the market would end up.
Key Drivers to Stock Market Recovery
For much of 2020, Morningstar’s Asian coverage universe reflected a discount to their fair value estimate, and despite the fact that this discount had been narrowing since the March market bottom, it reflected a fairly wide gap between the Technology, Healthcare and Consumer sectors and the rest of the market.
According to Lorraine Tan, Director of Equity Research, Asia at Morningstar, that discount has narrowed in the equity markets with the rotation into the cyclical sectors since November, but the sectors that are still showing the largest discounts remain Energy and Real Estate.
“I think what this implies is that investors have already factored in an economy recovery from the pandemic but it’s still far from reflecting any market top. We think the rotation out of Tech and Consumer discretionary stocks that have outperformed will continue,” she tells Smart Investor.
“The pandemic recovery remains the key driver – we continue to have a base case view that the vaccine will be available by mid-2021 and activity to start normalising in the second half of 2021. Our valuations reflect this view. So, the main risk is obviously any delay because it could raise prolonged debt problems,” she continues.
“For the first half of 2021, we think holding onto some industrial automation companies for exposure to a manufacturing recovery makes sense,” says Tan.
She opines that the recovery in capital expenditure by companies is likely to take place only in late 2021 and into 2022, given the pandemic disruptions, so the positive news flow to drive the rotation should continue in 2022.
Being in Asia, another key driver to look out for is the Sino-US relations. According to Tan, outgoing US President Donald Trump’s penchant for executive orders has added uncertainty to the region, “but getting rid of him only solves half the equation” and “the question becomes how pragmatic President Xi Jinping is.”
“I would imagine that Biden would be keen to establish his China policy but with a greater multilateral approach and to be within the World Trade Organisation (WTO) and other global platform frameworks.
“We suspect that a clearer and consistent policy will help reduce market swings but the relationship, regardless, is
going to remain challenging. Policy clarity will undoubtedly help those companies impeded by the trade tariffs and exclusions,” she comments.
In any case, Tan’s long-term view on China’s economy is that growth will be on a slowing downtrend as much of the development is done, and with ageing demographics, the only growth driver in the country is likely to be consumption from wealth effect.
“Regardless of Sino-US relations, fixed asset investment growth is likely to be quite flat which implies slow growth for the infrastructure-related segments. In this regard, the longer-term view continues to favour companies dialled into domestic China consumption,” explains Tan, citing that companies like Alibaba and Tencent will be in their buying recommendation if they reach more attractive price levels.
On the broader investment themes, Morningstar’s Director of Manager Research Practice, EMEA & Asia, Wing Chan, favours China onshore markets and sustainable investing.
China Onshore Markets Opportunities
China currently ranks as the world’s second-largest equity market and second largest fixed income market.
Highlighting the immense opportunities for investors in the China onshore markets, Chan says, “The gradual opening of China’s financial markets means that its weighting in global equity and fixed income indices are rising, and this is likely to lead to continual and structural inflows into China onshore assets.
“Many asset managers have spent the last several years building their onshore investment capabilities and we are beginning to see compelling investment propositions that are well-equipped to take advantage of these mispricing opportunities,” Chan explains.
However, fund selection is critical, as the best fund managers can outperform mediocre ones by a meaningful margin, he reminds.
Sustainable Investing Turns Mainstream
Against the backdrop of what has been described as the worst recession since the Great Depression, interest in sustainable investing strategies and instruments continues to grow.
“We consider sustainable investing a structural theme that is turning mainstream as investors become increasingly aware of Environmental, Social and Governance (ESG) issues,” comments Chan.
Assets in sustainable funds globally hit a record high of US$1.3 trillion in the third quarter of 2020, up 23% from 2019-end, according to Morningstar data.
Asset managers, he adds, are ramping up their efforts in rolling out sustainable investment products, which are supported by continually positive and growing flows despite the pandemic’s impact on the broader fund market.
Meanwhile, regulatory developments are also gathering pace to support this structural shift. For perspective, over 170 ESG-related regulatory measures were proposed globally in 2018 – more than the last six years combined.
“In Europe, the wide-ranging Sustainable Finance Action Plan is actively seeking to change investing behaviour and direct more investments to long-term sustainable investment products – many of which are Undertakings for the Collective Investment in Transferable Securities (UCITS) that are widely distributed across Asia,” informs Chan.
“Locally in Asia, the Securities and Futures Commission in Hong Kong launched a website showing ESG-related funds that meet the necessary requirements,” Chan reveals.
Quest for Income to Continue
Meanwhile, global central banks’ commitment to keep interest rates low along with the return of quantitative easing implies that investors’ demand for income is set to continue despite unattractive yields from developed fixed-income markets.
“In comparison, Asian and emerging market bonds continue to offer a reasonable yield for income-seeking investors who are comfortable with taking slightly more risk,” he concludes.
By Bernie Yeo
