Is Japan Asia's Germany

We are still confident about Asia excluding Japan

North Asia is the first region to bring the coronavirus under control

In North Asia (Greater China, Korea and Japan), the state health authorities have managed to bring the coronavirus under control. It seems that a severe second wave is less likely; However, it cannot be ruled out entirely. A local surge in the number of new infections in Beijing in June made the world aware of the risk of a second wave. Public health experts believe a second wave will be easier to contain than the first as it draws on China's extensive experience of fighting the coronavirus. Asian governments are fully aware of the risks of a new outbreak and remain on heightened alert. After the increase in new infections in a narrowly delimited area in May, all 10 million residents of the city of Wuhan were tested for the coronavirus within ten days - a real show of strength. Only a few new infections were found. All affected persons were asymptomatic and were classified as probably not contagious.

North Asia is the first region on the cusp of the "post-coronavirus" era and has lifted or eased restrictions. Thanks to the sharp decline in new cases, consumers and business people are now seeing light at the end of the tunnel. In previous pandemics, markets bottomed out at this point as well. In India, on the other hand, the coronavirus is still spreading rapidly - despite the country-wide lockdown, which is extremely sharp in a global comparison. The rating agency Fitch recently downgraded the outlook for India to negative, justifying this with the accelerated increase in new infections after the partial lifting of the lockdown. In the member states of the Association of Southeast Asian Nations (ASEAN), the Covid-19 curve is less steep, but there can still be no talk of flattening. In a comparison of the ASEAN countries, Indonesia lags behind, with around 1000 new infections per day and low test capacities.

North Asia has successfully flattened the Covid-19 curve

(Fig. 1) Total confirmed cases by country

As of July 9, 2020.
Source: Citi Research and EM Asia Economics & Strategy. Copyright Citigroup
2005-2020. All rights reserved.

China's powerful political response to shore up the recovery

The key to Beijing's efforts to get the Chinese economy going again after the lockdown is less monetary than fiscal policy. Monetary policy measures also responded to the crisis. This was reflected in faster growth in bank lending as well as overall social finance, which is a broad measure of credit volume. However, assuming the new annual bank lending and lending volume targets announced in June, growth is likely to be lower in the second half of the year. This is a sign that China is still holding back and does not want to turn on the money taps for credit just yet. The measures in 2020, which were of a fiscal policy nature in the broadest sense, correspond to around 5.5% of gross domestic product (GDP).1 That is significantly less than China's response to the financial crisis in 2008. At that time, the volume was over 12% of GDP, which, in retrospect, also caused many problems. The fiscal policy stimulus that China has given so far in 2020 also appears to be rather low compared to the measures that the USA and some other countries have announced and implemented. However, the lockdown in China was comparatively shorter and did not cause as much economic damage, so there is less need for extreme political support. Many of the big fiscal policy packages announced by other countries include loan guarantees and interest rate subsidies that, while inflating the total, have little impact on demand. In its fiscal response to the coronavirus, China is placing greater emphasis on traditional infrastructure spending, which has a significantly greater impact on domestic demand. With fiscal policy measures amounting to 5.5% of GDP, a lot can actually be achieved, which can already be seen in China's monthly economic data.

We believe that easing fiscal and monetary policy can contribute to a broader-based upswing for China in 2021, potentially boosting other Asian economies as well. At the same time, the economic recovery in Asia will also depend on global demand, which is not yet picking up again. The exporters in Asia are important employers; It will therefore also be decisive for recovery whether the gainfully employed keep their jobs or not. The global demand shock that rocked Asia as a result of the coronavirus outbreak remains a major risk and is only slowly becoming more noticeable.

Asia (ex Japan) - stronger integration with China

A return in Chinese domestic demand to trend growth is likely to be the most important growth driver for the region in 2021. In the long term, we assume that the integration of the Asian economy with China will be stronger rather than weaker. There is evidence that there is a regional factor driving economic growth in Asia, linked to China's rise and the impact on neighboring economies. In the beginning, the processing for export, i.e. the assembly of input products from Asia and other countries for re-export to the end markets in the USA and Europe, was the most important engine for China's export growth. As China climbed further up the value chain, China's share of added value in exports also increased. According to estimates by the OECD, it rose from 73% to 83% between 2005 and 2016 and was thus higher than in Germany, France or South Korea. As a result, more of the global industrial supply chain is located in China today than it used to be. Other Asian countries are still benefiting from growth in the Chinese domestic market and from Chinese tourists, but on the other hand they cover a smaller part of China's need and demand for intermediate products than in the past.

Immediate (re-) relocation of global supply chains from China unlikely

Turning away from globalization and taking steps to reduce dependency on global supply chains were lively discussed after the adverse effects and disruptions caused by the coronavirus. Some expect the supply chains from China to be relocated to other regions and countries in order to spread the risk and increase proximity to the end markets in the US and Europe. Some churn is expected in the medium to long term as multinationals appear to see the merits of greater diversification. But in the short term, there may be little change in global supply chains, as there are high sunk costs in many cases.

Fears of globalization may be exaggerated when it comes to Asia

(Fig. 2) Foreign direct investment (FDI) as a percentage of GDP (%)

As of May 29, 2020.
Source: HSBC Global Research.

For more complex goods with higher added value, only a few countries can compete with China in terms of size and highly developed production and logistics networks. The withdrawal of the supply chains for these products from China is likely to result in significantly higher short-term costs and a potential loss of competitiveness. With the swift resumption of economic activity after the coronavirus-related lockdown, China has also provided evidence of the quality and strength of the supply chain ecosystem. Labor-intensive, low-value industrial production, on the other hand, is a completely different story. As it has been for around ten years, it is increasingly being relocated from China to low-wage countries. A large part of this production is likely to remain in Asia and settle in Vietnam, Malaysia, Indonesia and, increasingly, in India. The net loss of industrial manufacturing capacity in the region from supply chains leaving China could be quite small.

Profits and ratings in Asia (ex Japan)

Analysts have quickly revised their earnings estimates downwards in response to the coronavirus. But there is probably still room for improvement. From January to May, consensus earnings growth estimates for the MSCI Asia ex-Japan for 2020 were lowered by 23%. In terms of momentum, the share of month-on-month earnings estimates fell to a low in April but has been gradually recovering since then, particularly in China, Taiwan and Korea. On a country-by-country basis, China, Taiwan and India are projected to achieve low single-digit earnings growth in 2020, while Hong Kong and the ASEAN countries will see declines of 16% to 25%. The 20% increase expected for Korea is an exception. This is due to the very low comparative value from 2019, which in turn is caused by the global slump in the semiconductor sector, which was followed by a cyclical recovery this year.

Earnings per share (EPS) for 2020 are very low and are suffering from the aftermath of the coronavirus pandemic. A price / earnings ratio based on realized profits could therefore be a more meaningful indicator for a valuation comparison. On the basis of this, the evaluation of the region is not far from its 10-year mean value and appears to be acceptable overall. Measured by the price-to-book ratio based on the figures realized, Asia (ex Japan), as shown by the MSCI AC Asia ex Japan Index, is currently valued at around one standard deviation below the ten-year average. China - a market that is less affected by the coronavirus - has a moderate premium by historical standards. In contrast, some markets in Southeast Asia (MSCI EM ASEAN) appeared cheap, trading at 25% to 35% below their 10-year average at the end of April. This is where we spotted some good investment opportunities as, from a bottom-up perspective, high quality companies were being sold indiscriminately and blindly during the coronavirus panic.

Investment Themes in Asia (ex Japan)

We are not making any changes to our strategic approach to investing in Asian equities due to the coronavirus. We will stick to our best practice and continue to look for quality companies with good cash generation and capable management teams that we want to retain over the long term to capitalize on their growth potential. As we focus on companies with the potential for sustainable earnings growth, the portfolio is consequently more focused on companies with solid balance sheets. We are convinced that we survived the difficult time during the sale in the first quarter so well because we pay so much attention to the solidity of the balance sheets.

Profits in Asia may be less affected by Covid-19

(Fig. 3) Consensus Estimates of Earnings Growth (EPS) by Region - 2020

As of June 30, 2020.
Sources: FTSE Russell / FactSet and HSBC (see “Additional Information”).
Asia excluding Japan = FTSE All-World Asia Pacific x JP AU NZ, emerging countries = FTSE All-World Emerging, Japan = FTSE Japan, USA = FTSE US, Welt = FTSE All-World, industrialized countries = FTSE All-World Developed, EMEA = FTSE All-World EMEA, EU = FTSE All-World Europe, Latin America = FTSE All-World Emerging Latin America.

The turmoil in the Asian markets in February and March gave us the rare opportunity to add positions in companies with good long-term prospects that were massively oversold by the panic in the markets and, in our opinion, very low valued. When the fear and panic caused by the coronavirus peaked, a brief moment arose as a good opportunity to collect high-quality Asian stocks at apparent bargain prices. As always, we were looking at bottom-up fundamentals for stocks rather than any very positive top-down views when building new positions. Chinese equity markets rallied faster than other Asian markets. This enabled us to sell some of our Chinese stocks that had performed very well and appeared reasonable to highly valued after the rebound in order to fund investment opportunities in other markets.

We found many of the best opportunities in Southeast Asia and, more recently, in Hong Kong. The really sharp market corrections in these markets came later than in China. In total, we bought 14 new positions in the first quarter, which is an exceptionally high number considering our style of investing in which we have a “buy-and-hold” strategy. Many of the new stocks were high-quality stocks that had been around for a long time, but were valued unattractively until the panic caused by the coronavirus pandemic led investors to sell indiscriminately. We also took this opportunity to acquire positions in oversold high-quality stocks from Hong Kong, one of the worst performing markets in the region and which had suffered not only from tensions between the US and China, but also from fear of renewed street protests and the coronavirus . The fact that the market in Hong Kong is oversold is indicated, among other things, by the fact that some large publicly traded companies have recently bought back their own shares.

As a result of the changes outlined above, the portfolio is currently overweight in the Philippines and Hong Kong. In terms of direct exposure in the country, China is no longer overweighted, but now moderately underweighted. However, given the positions in Hong Kong and some regional stocks with strong ties to China, including a large wine company listed in Australia, it would be more appropriate to describe the Greater China sub-region as neutrally weighted.


We remain optimistic about the long-term outlook for Asia (ex Japan). However, we believe that the world may only gradually recover from the upheavals and distortions caused by the coronavirus pandemic. The latest market correction gave us opportunities to take positions in a number of high quality names that were previously valued much higher. We are still finding companies that we believe are well positioned to weather the crisis more or less harmlessly and emerge stronger once the recovery takes hold. We believe that many good companies in Asia will offer value once global economic activity gradually normalizes over the next six to 12 months.

We will pay attention to this in the near future

We will keep an eye out for evidence that India and Southeast Asia are following the example of Northeast Asia, bringing coronavirus outbreaks under control. We will also continue to look for high quality Asian companies whose stocks we can buy at cheap valuations and which are led by savvy, capable management teams capable of generating consistent earnings growth.

Main Risks—The following risks are essential to the strategy outlined in this document:
Transactions in securities denominated in foreign currencies are subject to fluctuations in exchange rates, which can affect the value of an investment. Returns may fluctuate more than in other more developed markets due to changes in market, political and economic conditions.

1 According to the definition of the IMF, the broader figure for China's budget deficit includes some large, non-budgetary programs, for example special government bonds for infrastructure financing and net bond issues under the LGFV (“Local Government Financial Vehicle”) program.

Additional information

Financial data and analysis from FactSet. Copyright 2020 FactSet. All rights reserved.

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