♦ Asian economies slowed down in 2012, however the picture for 2013 has many positives
♦ China's economy appears to be reaching a sustainable level with retail sales continuing to grow at double-digit rates
♦ Signs that Chinese exports and infrastructure spending picked up towards the end of 2012
♦ Reform programme in China need to be pushed through to ensure long-term growth of the economy is not impeded
♦ Attractive valuations with Asian corporate earnings expected to grow at 10% in 2013, along with a 3% dividend yield
Asian economies slowed down in 2012, however the picture for 2013 has many positives.
Although Asian economies slowed down last year we have seen positive equity market returns. This was something we predicted, so performance over the last 12 months1 has not been much of a surprise, although it has been volatile.
There are three main reasons behind this strong performance. Expectations were very low at the start of the year, with the market trading at around 11 times 2012 earnings. Secondly, the European backdrop has been more stable than many feared and, finally, earnings of Asian companies have been resilient, with rates of growth higher than elsewhere.
Growth slow down
However we cannot ignore the drop off in economic growth and the causes behind this. To start with, monetary policy has remained tight in much of the region, with China in particular being slow to lower interest rates in spite of low inflationary pressures.
Asian exports have also fallen with less demand from developed economies as a result of stilted growth in the US and some remaining uncertainty in the eurozone. Finally, the uncertain global economic backdrop has held back investment growth in the region.
But what has caught some people by surprise has been how quickly growth has slowed. Weakness in the Chinese and Indian economies has played a large part in this; nonetheless it should be emphasised that growth remains robust by global standards.
China
China's economy slowed last year, but it has not collapsed. Its economy is rebalancing and the composition of growth is arguably becoming much more sustainable. Consumption has contributed more than investment to GDP growth this year; retail sales have continued to grow at double-digit rates, with the most recent year-on-year growth rate above 14% 1.
While there is still growth in fixed asset investment, it has definitely slowed, largely due to the reluctance of the Chinese authorities to stimulate the economy through investment spending. There is a desire to avoid overheating the economy again as occurred after the 2008 financial crisis. The government is also conscious of the risks of unproductive investment and bad debts in the banking system.
Exports are also contributing less to overall growth in the Chinese economy, although there are signs that these, along with infrastructure spending, picked up towards the end of the year. The new administration is unlikely to see the need to make wholesale changes.
What next for China?
These are all issues that aren't likely to disappear in 2013.
Property in selected areas of China is still very overvalued in our view, and we think there are likely to be growing bad debts in the banking system. But these will not be enough to slow the economy substantially.
The Chinese authorities continue to keep a close eye on the property market, and policy in this area remains high.
China is an economy with enormous advantages: labour is still relatively cheap, savings rates are high and it is an efficient place to produce manufactured goods.
Asia
Asia remains really dependent upon what happens globally. If we saw renewed problems in the eurozone or, indeed, the US going back into a recession, it would plainly be very bad for Asian equity markets.
On the Asian front, the potential problems really revolve around China. If the Chinese do not move forward with their reform programme, I think we would have a situation where the imbalances in the economy would just continue to grow. The market would be very uncomfortable with that and we would expect to see continued valuation contraction in China. There are a number of measures that need to be moved forward, including capital account reforms and the introduction of a market-driven banking system to support privately owned small and medium sized enterprises. If reform measures are not pushed through, the long-term growth of the economy will be impeded in our view. There may also be an increase in inflationary pressures, such as we have seen in India, if supply-side bottlenecks are not addressed.
At the regional level, I think that what we desperately need is for corporate earnings to be improved by increased productivity. One of the reasons why Asia does not translate its economic growth into market growth is that earnings growth is not sufficiently propelled by productivity improvement on the part of corporates.
We really need Asian corporates to do more for their own balance sheets and profit and loss accounts by cutting cost and giving that back to shareholders in the form of dividend.
Valuations
We have already seen two years of earnings downgrades, so analysts' expectations are, in our view, now a lot more reasonable, but many companies face further downgrades - although these are unlikely to be as large as in 2011 or 2012.
We believe companies are still cheap and although economic growth is not robust, earnings growth of around 10% in 2013 should be supportive of positive equity market returns. Valuation levels are still low historically, suggesting that the market has come to terms with the lower growth environment and this to my mind offers a good opportunity for long term investment.
In a generally low yield world, the dividend yield of Asian equities - currently around 3%2 - is also supportive.
There are lots of things wrong with the world and there is lots of uncertainty. Even within Asia, people just do not know what is going to happen in China, but I think that a lot of this uncertainty is already reflected in valuations. We are talking about markets which traded around 11 times this year's earnings. That is pretty cheap. You also have the fact that there has been some economic growth. Asian corporate earnings are in my opinion probably going to grow at 10% in 2013, along with a 3% dividend yield.
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