Is it time for Asian equities to shine in 2022?

We’re going to be a little cheeky: before discussing Asian equity markets, we are going to examine the setup for global equities, in particular the US, which dominates global equity indices. 

Simply put, we have never seen markets so vulnerable to a correction in our decades of investing. We have a strong view that caution is required – especially in the ‘safest’ stocks.

A fragile setup globally

US households have record exposure to equities, taking out the prior all-time high in 1999 in recent months. Margin debt recently posted explosive growth of 70% year-on-year – a rate only recorded in 1999 and 2007 previously.

Meanwhile, concentration in markets is high – the five largest companies by market cap in the MSCI All Country World Index make up a higher proportion of that index than at any time in at least 25 years.

And market indices are staggeringly expensive – equity markets are approximately as expensive as they have ever been in human history:

Source: Minack Associates, Bianco Research LLC. Total market cap used for market cap to GDP; S&P 500 used for CAPE; as of September 2021.

Let’s sum that up:

• Markets are very expensive
• Retail investors have come to the party late in the cycle, as always
• Retail investors have more exposure to equities than ever before on record in the US
• Retail investors are more geared into markets than ever on record in the US
• That level of gearing into US markets just grew at the fastest rate on record
• Investors are crowding into more concentrated positions than at any time in decades. 

To us, this looks much more like the late 1990s or the late 1920s.

The case for Asia, especially China

With that backdrop, it is worth reiterating the investment case for China, which dominates Asian equity markets excluding Japan. Here, we see an equity market that is the polar opposite of the crowded and expensive US market. 

In 2007, the Chinese equity market was the most expensive major market in the world on a PE basis, at 27x forward earnings (1). Its economy was lauded for growing at staggering rates – 12% that year. And the country’s economic model seemed unassailable. The Shanghai Composite Index was on the verge of falling 67.5% in a matter of months. And it remains approximately 40% lower than its 2007 peak 14 years later (2). The MSCI AC World China Index has de-rated to 11x earnings at the time of writing (3). 

Hence our view that, in equity market terms, China does not look like a country that is about to have a financial crisis – it looks like a country that has already had one.

However, readers may harbour reservations given fears of a housing crisis. China’s residential property price appreciation has been entirely unremarkable by global standards, its interest rates are among the highest of any major economy globally, first-home buyers require ~30% deposits and debt to GDP has been falling for 10 years. This latter point does not get reported remotely enough: since the post-GFC debt binge ending in 2010, credit growth in China has been below nominal GDP (4).

Late November and early December 2021 have seen large moves in markets and significant increases in volatility globally. In that context, it is interesting to note the muted reaction in China, with the Shanghai Composite Index up for the month of November and seeing no significant sell-off nor increase in volatility in the wake of the emergence of the Omicron variant. 

It is likely that China will see cases of Omicron, and it is likely that this will test the country’s zero COVID policy – but for now, it appears that having underperformed in 2021, China’s equity market may be viewed as “cheap enough”.

Ongoing regulatory pressure has seen China’s internet giants Tencent and Alibaba sell off heavily in recent months. 

These were among our biggest holdings until late 2020, when we sold due to investor crowding and clear signals of the regulatory risk that was building. 

We have used the sell-off in late 2020 to renew sizeable positions in these still-outstanding businesses. 

Regulatory risk is a fact of life for dominant platform businesses globally – recall the travails of Facebook and Google. 

This likely robs some of the dynamism and earnings power from such businesses. However, what remains are regulated social utilities, which can still grow earnings solidly, have enormous returns on capital and market power. 

Chinese regulation: have some perspective

Recent coverage of policy reforms in China has bordered on hysterical at times (5). This is unhelpful for investors. China has a very different form of government, which many in the West see as “undemocratic”. 

We would gently remind those commentators that this is not unusual in Asia, and not at all equivalent to poor social or economic outcomes – see for example Singapore, South Korea and Japan. Each of these Asian economic success stories display political regimes that scarcely resemble the liberal democracies of the West.

Moreover, Europe clearly has a greater penchant for regulation than the anglophone West. All global finance firms now have to comply with the Markets in Financial Instruments Directive (MiFID) and the General Data Protection Regulation (GDPR) for instance, while Margrethe Vestager has sought to hold global tech firms accountable for data practices and anti-competitive behaviour in her capacity as competition commissioner of the European Commission (6). 

Moreover, many European corporate governance nuances are unfamiliar to most investors in the US or Australia, notably Germany’s system of “codetermination” whereby corporate boards include worker or union representatives (7).

We provide this context by way of reinforcing that one simply cannot expect the same regulation and culture of corporate governance to apply globally. 

China has a different system to the anglophone West – this should hardly be a shock to seasoned investors. Further, it is the second-largest equity market in the world, among the chepeast, and regulations limiting property speculation, tech market abuses, and time spent gaming are far from senseless nor incompatible with the functioning of markets, in our view.

All in all, Asia is well-placed to benefit from ongoing global reopening and reinvigoration of CAPEX and trade following the trade war and COVID-19. Many markets in the region are cheap and earnings growth expectations are high. 

Investors globally have crowded into expensive equities in the US, and we see Asian equities as being relatively resilient to the inevitable unwind of market excesses in the West. In 2022 and beyond, we think investors will do very well by having the diversity of returns that Asian equities bring. 

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Footnotes

1. Credit Suisse, using the MSCI AC China Index.

2. Factset

3. Credit Suisse

4. Bloomberg, Platinum Investment Management Ltd

5. See for example: (VIEW LINK)

6. Time

7. The New York Times