First Sentier Investor

While Asian Credit fundamentals have remained stable, demand-supply technicals was the bigger driver of year-to-date performance. In line with broad expectations, the scarcity in bond supply has also rendered new issuance premium to be increasingly small. At this juncture, First Sentier Investor Asian Fixed Income team (“FSI team”) remain constructive in Asian investment grade (IG) credit as high all-in yields well above 5% does makes this asset class attractive from an income carry perspective.

Whereas in the Asian Equity markets, overall conditions in China remain rather challenging. China’s economic model seems intently supply-side focused. Consumption is likely to remain weak, even in the increasingly unlikely event that specific pro-spending policy initiatives emerge. The scale of the residential property bust and its share of household wealth are that overwhelming. From a policy perspective, geopolitical tensions appear to be ratcheting upwards as well, even before there is any change in the White House. On the other hand, technology, Taiwan and India have been the things to have owned, with everything else adding up to a rounding error. But, looking out, First Sentier Investors’ Asia equities specialist team - FSSA Investment Managers (“FSSA”) believes there were reasons to be optimistic.

Political noise ramps up

With uncertainties and cracks in economic indicators getting more pronounced over the past year, FSI team thinks there is a good possibility that the first cuts could commence by September. Downside risks to the base case include further increases in US treasury issuance, a US debt crisis, and a re-acceleration in inflation, any of which could challenge the long US duration positioning. Should any of these scenarios pan out, the sanguine outlook that markets have priced in for credit spreads could also be at risk. That said, the crescendo in election rhetoric and geopolitical events remain wildcards that would warrant a dynamic approach to managing our duration exposures.

Economic tensions between the US and China ratcheted up a notch as election rhetoric increased in momentum. President Biden announced sweeping tariffs on Chinese electric vehicles (EV) imports that will quadruple tariffs to 102.5% from 27.5%, a move that came in tandem with the nearly $ 81 billion from the EU and the US in semiconductor spending. Likewise, there were reports of China’s government telling technology firms including Alibaba (BABA), Baidu (BIDU), Tencent (TCEHY) and TikTok’s parent ByteDance to cut back on their purchase of foreign made AI chips from Nvidia (NVDA) and other companies in favour of purchasing more domestically made chips. Chinese TMT issuers — Baba, JD.com and Lenovo came to the market with convertible bonds, with some proceeds going to equity buy-backs. Outside of China, S&P revised India’s sovereign rating to positive (from stable) with expectations that pro-growth policies, infrastructure investment and commitment to fiscal consolidation would continue. Price action was relatively quiet but trended towards better buying sentiments in the market.

Asian Credit: economies remain resilient

Asian economies have been resilient thus far.  Within the Asian region, countries with a stronger domestic story, such as India and Indonesia, are likely to fare better. Most Asian central banks have paused interest rate hikes as inflation moderated and shifted attention to supporting growth. FSSA remains constructive on the region’s longer-term growth prospects as Asian economies continue to move up the value chain in the global economy.

Asian central banks have held off easing monetary policy due to currency pressure and a bumpy disinflation process. The Bank of Korea (BOK) kept its policy interest rate unchanged for the 11th consecutive month as stubborn inflation and strong export growth gave policymakers reasons to hold off easing policy. The BOK stated that it needs to see more progress on prices to gain confidence that they are moving towards the central bank's 2% target before lowering borrowing costs. Elsewhere, Bank Negara Malaysia (BNM) kept the policy rate unchanged. BNM's statement showed that the current interest rate level remains supportive of the economy and is consistent with the current assessment of the inflation and growth prospects. BNM also mentioned that the ringgit currently does not reflect Malaysia’s economic fundamentals and growth prospects and that it will continue to manage risks arising from heightened financial market volatility.

China’s policies have been highly accommodative and recent policy measures aimed at destocking excessive property inventory have seemed to gain positive traction. In undertaking an ambitious growth target of 5% for 2024, allowing a continued budget deficit of 3%, and issuing special treasury bonds, FSI team believes that China is sending a strong signal in committing to growth. The property sector and weak consumer sentiment will remain weak links that need to be addressed. Nevertheless, FSI team expects that the Chinese economy will emerge much stronger from this consolidation process and maintain a positive long-term outlook for the economy.

The premiumisation trend and the soaring manufacturing sector in India

20 years ago in India, it was very easy to make a case for under-penetration in any consumer category. The companies who were market leaders generate tons of cash, high return on capital, and built significant moats around themselves. However, FSSA believes that penetration story is largely complete for most categories as incomes have risen. From here on, it will be more about premiumisation. Taking financial products as an example - previously a large part of the savings would go into bank deposits; whereas now people are moving from basic bank deposits to more discretionary financial products. FSSA believes that in most aspect of the consumption categories, people are consuming differently and will continue to consume differently over the next decade.

In the next 20 years, FSSA thinks manufacturing will become an important part of the economy. Blue Star, for example, one of the leading domestic air conditioner companies - they import most of the components, then assemble and sell the products. They don't manufacture much; but as they keep growing quickly, they are investing more to develop their manufacturing capabilities. As that manufacturing base increases, because of a large domestic market^[1], that will increase the scale of the manufacturing for these companies. And with that, the benefits of scale will start accruing to them. They can also start looking at export opportunities.

The global multi-national companies are also looking to diversify their supply chain away from China, and India has become one of the alternatives. The Indian government has also taken some steps to incentivise more manufacturing in India and here will be more opportunities in that space.

Unveiling artificial intelligence (AI) Investment potential

In terms of AI’s potential, it is a big debate. FSSA believes it would need to expand into more day-to-day applications. We favour companies like MediaTek or Samsung because for AI to be sustainable, there needs to be more applications which can increase profits for companies, such as smartphones or automobiles which use AI. AI will help us become more connected, becoming ingrained in consumer interfaces and used in more applications.

One area it could impact is general productivity. Before AI happened, it made communication much easier with 5G. And with that, it became easier to control a robot compared to 3G and 4G. So I think AI would be another catalyst for automation as the world is running short of labour, and companies like Keyence and Advantech would benefit from this.

Investing in Japan

Since the collapse of the asset price bubble in the early 1990s, Japan had been stuck in a prolonged deflationary environment – the so-called “Lost Decades”, when consumer prices stagnated, and average annual gross domestic product (GDP) growth was just 0.7%.^[2]  Then, in 2023 inflation finally picked up but real wage growth declined, implying that Japanese household consumption power had weakened. From this perspective, it seems only natural that Japanese consumers have been downgrading their spending behaviour. FSSA expects this to be an ongoing structural trend in Japan over the long term.

FSSA thinks Japan is interesting because the economy has been bad for so long. For any companies to have survived three decades of recession or deflation, that speaks to the management ability and balance sheet strength. Another interesting aspect of Japan is that there are many niche companies which focus on very specific products. For example, SMC is a leader in pneumatic components and has this singular focus. Likewise, one of FSSA’s first investments into Japan was a company called Pigeon, which focuses on infant milk bottles and related products. Automation is another major areas and Keyence has been strong in optical sensors in the automation space and has a very strong track record and financial performance. FSSA considers Japan as a good complementary in a regional portfolio, because if investors believe in China’s automation, they may find the leading automation companies are actually Japanese, and better-positioned to benefit from the trend. Similarly, looking for leaders in hardware, TSMC in Taiwan might be the choice. Same as in wanting to find a leader in content or intellectual property (IP), one could consider Nintendo in Japan. FSSA also highlighted Sony Group, which has Sony Music, Sony PlayStation games, and is a leader in complementary metal–oxide–semiconductor (CMOS) image sensors.

From the credit market perspective, the Bank of Japan’s (BoJ) exit from its Negative Interest Rate Policy (NIRP) and Yield Curve Control(YCC) policy has not come easy after 17 years in a negative interest rate environment. FSI team expects monetary conditions to remain very accommodative in Japan as the BoJ monitors the long anticipated virtuous cycle — for higher wages to translate into higher spending, for the economy’s ability to sustain inflation at its 2% target. In the meantime, FSI team expects the course of the dollar’s strength remains largely driven by the Fed’s monetary policy. When the first interest rate cuts are implemented, Asian local currency bonds may perform well, and this will likely lead to further dollar weakness versus Asian currencies, further boosting Asian local bond returns.

_{Source: First Sentier Investors,  company data retrieved from company annual reports or other such investor reports. Financial metrics and valuations are from FactSet and Bloomberg. As at June 2024 or otherwise noted.}

_{^[1] There are 7 million air conditioners sold a year for a population of 1.4 billion people, versus 70 million air conditioners in China for a similar-sized population. Source: Jefferies and Euromonitor, as of fiscal year 2023.}

_{^[2] World Bank national accounts data, average annual percentage growth rate of GDP at market prices based on constant local currency, from 1992-2022. https://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG?locations=JP}