Europe’s inability to find a solution for its current fiscal problems and the weakening macroeconomic outlook sent equity markets into a downward spiral during the July-September quarter. In Asia, concerns about the risk of a hard landing in China resurfaced as well. All country and regional indices declined, with the MSCI AC Asia Pacific Free Index including Japan and the MSCI AC Asia Pacific ex Japan Free Index declining 16.35% and 21.28%, respectively, for the quarter.

China was the worst performing market in Asia, as the MSCI Index suffered a 25.67% slide during the quarter. The Financial sector was in focus, underperforming the market due to bad debt worries surrounding property developers and small and medium enterprises that have lately plagued investors. The severity of the problems in the shadow banking sector were highlighted by reports of wealthy entrepreneurs absconding after not fulfilling their debt obligations. Other sectors that led the declines were Materials (-40.9%) and Industrials (-35.1%). Cement stocks underperformed too despite China National Building Materials raising its average selling price twice in September. The situation clearly reflects the negative sentiment towards the property market and the slowdown in fixed-asset investment. MSCI Hong Kong showed a similar trend with the index declining 20.56%.

With no sign of a resolution to the sovereign debt problems in Europe and mounting concerns about an economic slowdown in the U.S., the Japanese equity market extended its losses and The Tokyo Stock Price Index (TOPIX) decreased by 2.8% in local currency terms in September, capping a loss of 13.8% during the third quarter.

Amid deepening unease about the U.S. economy along with persistently high unemployment figures, the U.S. Federal Reserve has lengthened the maturity profile of its Treasury holdings to force down long-term bond yields and lower borrowing costs. Although the new measures failed to give an immediate boost to market sentiment, a joint effort by the world’s central banks to prevent a liquidity crisis in Europe by providing funds to the commercial banking system helped to boost market confidence to a limited degree.  These measures ultimately failed to outweigh the growing anxiety over a possible sovereign debt default by Greece, and the yen remained strong against both the U.S. dollar and increasingly the Euro too. The Japanese equity market rebounded towards the end of the quarter, again partly due to events in Europe, led by expectations that the European Financial Stability Facility would be expanded.

Japanese economic data released in September indicated a recovery in output from the supply-chain disruption since the March earthquake, though the softening of overseas demand could impede the production recovery. Industrial production in August decelerated to a 0.8% month-over-month (mom) growth rate from 3.9% (mom) growth in June. Waning external demand began to sap the recovery momentum, while the survey of production forecasts indicated an uneven recovery in production activity with output projections cut to -2.5% (mom) in September followed by an expected growth rate of 3.8% in October. Trade figures suggested a much weaker recovery in exports than consensus forecasts had indicated. Nominal exports increased for the first time since March, rising by 2.8% year-over-year (yoy) in August, boosted by a large contribution from transport equipment. Looking at the negative aspects, exports of machinery and electrical goods and components declined partly due to falling demand from Asia. Lackluster domestic economic conditions persisted throughout the third quarter. Real consumer spending extended its 2.1% (yoy) decline in July, with a 4.1% (yoy) decline in August.

Faltering overseas demand and the yen’s persistent strength put pressure on the export-oriented sectors. The Capital Goods sector declined along with a sell off among stocks that have a large exposure to Chinese demand, as the risk of an economic slowdown in China grows. The Commodity sector underperformed too along with falling basic commodity prices in September. Conversely, defensive sectors such as Consumption and Medical outperformed amid the market weakness.

MSCI India decreased 20.3% but outperformed towards the end of the quarter (September: -1.1% in local currency terms) on the back of declining oil prices, which has been positive for the economy. The Consumer Discretionary sector, which largely consists of automobile stocks, was the biggest outperformer in India. In Australia, the MSCI Index suffered a 21.4% decrease, with Materials (-27%) and Energy (-25.3%) stocks taking the biggest hit.

Technology heavyweights Korea and Taiwan underperformed; their respective MSCI indices declined by 23.3% and 20.4%, respectively. In Korea, cyclical stocks declined due to a weakening order outlook and decreasing petrochemical demand.  Technology stocks in Taiwan declined 20% overall due to a weaker demand outlook. Domestic consumer stocks, on the other hand, outperformed given its strong earnings visibility.

In the ASEAN (Association of Southeast Asian Nations) region, all markets outperformed with the Philippines (-7.6%) being the most resilient, followed by Indonesia (-11.5%) and Thailand (-15.5%). Malaysia (-17.8%) and Singapore (-19.5%) also outperformed marginally. In Indonesia and Thailand, consumer related stocks outperformed along with resilient domestic demand.  For Malaysia, defensive stocks outperformed. In Singapore, telecommunication stocks (-5.1%) were the clear outperformers for the quarter while industrials such as offshore resource related stocks were hammered by the decreasing oil price.

 

 

Market Outlook and Strategy

 

We admit to being surprised by such a rapid turnaround in sentiment towards the Pacific Basin stock markets. Our best-case scenario had been that European countries would be able to cobble together some sort of bailout package for Greece. We also judged that even under a worst case scenario, the superior fundamentals of this region would provide a buffer. Both assumptions proved to be overly optimistic and the subsequent deterioration in regional sentiment was therefore unexpected.

Looking ahead, our best case scenario still maintains that the regional markets look enticing in terms of their historically very reasonable valuations. Weakening currencies will support the earnings of exporters, while the global growth slowdown will eventually alleviate the inflation pressures, which until recently, were the region’s overriding concern.

However, it is becoming increasingly evident that a forced de-leveraging process is underway in the developed economies. In the short term, the rush to raise cash could lead to further declines in markets. In the longer term, there is little doubt that an extended period of sub-par global growth is now a strong probability. This latter prognosis is not necessarily bad for the Pacific Basin region given that money remains plentiful and cheap. These funds will likely chase what little growth is available, and both the Asian economies and listed stocks stand out in this respect.

In terms of our portfolio structure, subject to valuations, we are likely to rebalance the portfolio more towards those companies better insulated from a global slowdown and a potential banking crisis.

In terms of our country allocation, we will keep overweight positions in the smaller ASEAN markets due to their greater domestic orientation, and underweight positions in China and Australia.

 

International investing involves certain risks and increased volatility not associated with investing solely in the U.S. These risks include currency fluctuations, economic or financial instability, lack of timely or reliable financial information or unfavorable political or legal developments. These risks are magnified in emerging markets. Securities focusing on limited geographic areas and/or sectors may result in greater market volatility. Investing in securities issued by smaller companies typically involves greater risk than investing in larger, more established companies.

 

Investors should carefully consider the investment objectives, risks, charges and expenses of each Fund before investing. This and other important information is contained in the Nomura Partners Funds, Inc. prospectus, which may be obtained by contacting your financial advisor, by calling Nomura Partners Funds at 1-800-535-2726, or visiting our website at nomurapartnersfunds.com. Please read the prospectus carefully before investing.

 

This material contains the current opinions of the author, which are subject to change without notice. This material has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information used to compile this report has been obtained by sources deemed to be reliable, but its accuracy and completeness are not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. Past performance is no guarantee of future results.

 

MSCI AC Asia Pacific ex Japan Index is an unmanaged free float-adjusted market capitalization index that is designed to measure the equity market performance in the Asia Pacific region excluding Japan. The Tokyo Stock Exchange Price Index (TOPIX) is an unmanaged capitalization weighted measure (adjusted in U.S. dollars) of all shares listed on the first section of the Tokyo Stock Exchange. One cannot invest directly in an index.

 

The MSCI information contained in this material may only be used for your internal use, may not be reproduced or redisseminated in any form and may not be used as a basis for or a component of any financial instruments or products or indices. None of the MSCI information is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such. Historical data and analysis should not be taken as an indication or guarantee of any future performance analysis, forecast or prediction. The MSCI information is provided on an “as is” basis and the user of this information assumes the entire risk of any use made of this information. MSCI, each of its affiliates and each other person involved in or related to compiling, computing or creating any MSCI information (collectively, the “MSCI Parties”) expressly disclaims all warranties (including, without limitation, any warranties of originality, accuracy, completeness, timeliness, non-infringement, merchantability and fitness for a particular purpose) with respect to this information. Without limiting any of the foregoing, in no event shall any MSCI Party have any liability for any direct, indirect, special, incidental, punitive, consequential (including, without limitation, lost profits) or any other damages.

 

Investments are not FDIC-insured, nor are they deposits or guaranteed by a bank or other entity.

 

Distributed by Foreside Fund Services, LLC.

 

 

 

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