Equity markets ended the year on an upbeat note, shrugging off concerns over the impending “fiscal cliff” while focusing on better economic data from the U.S. and China. In Japan, expectations of a higher inflation target and a depreciating yen brought some overseas investors back to the Tokyo stock market. The MSCI AC Asia Pacific Free Index including Japan gained 5.6%, while the MSCI AC Asia Pacific ex Japan Free Index also closed 5.6% higher in the October-December quarter of 2012.
The Tokyo Stock Price Index (TOPIX) posted a quarterly gain of 16.73% in local currency terms during the October-December 2012 review period, boosted by a strong 10.14% rally in December. While many markets appeared apprehensive about the “fiscal cliff” threat facing the U.S. economy, expectations of a shift in Japan’s monetary and fiscal policies triggered a rapid decline in the Japanese yen that helped to lift the Tokyo stock market and fuel a strong rally in the latter half of the review quarter. Progress in the European Union’s bailout plans for Greece also improved global investor sentiment, which hastened the euro’s rise against the yen.
Prime Minister Noda announced a surprise dissolution of the National Diet’s lower house and called a general election for December 16th. Given the poor approval ratings for the Noda cabinet and the Democratic Party of Japan (DPJ), the election resulted in a landslide victory for the Liberal Democratic Party (LDP), which had pledged to introduce reflationary economic policies to boost growth and tackle chronic deflation. Consequently, LDP leader Shinzo Abe became the new Prime Minister at the end of December, heightening expectations of an aggressively pro-growth economic policy. Prime Minister Abe has urged the Bank of Japan (BOJ) to raise its inflation target from the current 1% to 2% and has also stated that he would seek to amend the law governing the BOJ so that the central bank would be required to implement aggressive monetary policies aimed at realizing a positive Consumer Price Index (CPI) trend and driving down the value of the yen. He has also hinted that he would be prepared to postpone the scheduled implementation of a hike in the consumption tax and revealed plans to expand fiscal spending.
Tepid global economic activity and negative sentiment toward Japan in China dampened Japanese export and production activity during this review period as exports declined continuously in value terms. Industrial production declined again in October, decreasing by -1.7% month-over-month (mom). Nevertheless, positive production forecasts for the next two months suggest that industrial activity might be bottoming out. Domestic demand appears to be stabilizing lately, as the unemployment rate gradually improved to 4.1% in November from 4.2% in August, although CPI has failed to rise as the figure continued to decline for six consecutive months.
Estimated changes in government policies seem to have driven the market during the review period. Construction and Real Estate sub-sectors rallied due to an expected increase in public spending on construction projects that led the Infrastructure sector to outperform. A rapid decline in the yen exchange rate also supported export oriented sectors including Electronics, Automobiles, and Capital Goods, while securities companies responded to the equity price rally and were the best performers in the Financials sector.
The MSCI China Index (+12.8%) was the 4th quarter’s strongest market as macroeconomic data pointed towards a recovery. A-shares experienced such a sharp turnaround in December that they managed to record a positive return for the full year 2012. Consumer Discretionary (+21.7%) was the best performing sector as automobile related stocks outperformed. Chinese joint venture brands gained on recovering sales. Financials (+19.5%) also outperformed with all stocks (ranging from real estate to banks) recording gains. The worst performing sectors were the defensive Healthcare (-5.8%) and Information Technology (-0.9%). In the MSCI Hong Kong Index (+5.2%), gains were seen across all sectors, with Telecommunication Services (+11.5%) and Consumer Discretionary (+10.9%) posting the strongest rallies.
The MSCI India Index underperformed the region (+0.3%) in the quarter, largely due to losses from the Information Technology (-8.3%), Utilities (-7.7%) and Energy (-4.5%) sectors. The Telecommunication Services sector was the top performing sector in. In the MSCI Australia Index (+5.8%), Healthcare (+14.0) and Telecommunication Services (+11.3%) led the gains while Energy (+0.2%) was the worst performer.
The MSCI Korea Index (+4.8%) underperformed the rest of the region slightly, largely due to the Consumer Discretionary (-4.4%) sector including automobile companies. The appreciating Korean won could have an impact on the competitiveness of the Korean automobile manufacturers vis-à-vis their Japanese competitors, which are benefiting from a depreciating Japanese yen. The MSCI Taiwan Index also underperformed the region with Materials (-1.8%) being the weakest sector while Information Technology (+2.6%) was the strongest.
ASEAN (Association of Southeast Asian Nations) regional markets ended higher, with the Philippines (+11.4%) being the best performer, followed by Thailand (+5.8%), Malaysia (+3.1%), Singapore (+2.7%), and Indonesia (+0.7%). Consumer Staples (+22.4%) and Financials (+16.7%) in the Philippines were the best performing sectors. In Singapore, stocks related to China real estate performed well based on recovery expectations. Indonesia’s underperformance was attributed to weakness in the Industrials (-6.0%), Telecommunication Services (-4.9%) and Energy (-3.7%) sectors.
Market Outlook and Strategy
The New Year has brought renewed optimism to the outlook for the global economy, igniting a sharp rally in Asian stock markets. However, our broad view remains that de-leveraging of individual and government balance sheets in the OECD (Organization of Economic Co-operation and Development) countries is a structural phenomenon that will lead to a sub-par recovery. Growth may likely rebound from 2012 levels providing an environment for well-managed companies to post better profit growth numbers. More crucially, the highly accommodative monetary policies of the Federal Reserve, European Central Bank (ECB) and latterly the BOJ too may continue to provide market participants with plentiful and cheap liquidity. As the year progresses, investors may begin to discount an unwinding of this monetary stimulus. We can then expect the yield curve to steepen and long bond yields to rise sharply. This could have a temporary impact on sentiment, but the subsequent redemption of bond funds and a shift into equities could then provide further stimulus to the stock markets.
Asian economies are likely to again demonstrate superior growth rates. Anemic export performances will be more than offset by buoyant domestic demand as strong wage growth and negative real interest rates fuel consumption growth and rising property prices.
One major change we have made recently is to reduce the extent of our deep underweight China position. Economic conditions are improving, although the pace of the rebound lags behind similar periods due to a weaker external picture and less government stimulus cash than is normally apparent. We expect the recovery to broaden as we move into 2013. Of probably more importance is the new government’s determination to accelerate the pace of economic reforms, to crack down on corruption and to reduce the income gap.
Meanwhile, we reduced our extent of overweight exposure to Indonesia. Whilst the macroeconomic environment is still supportive, we are less impressed by the more populist and erratic policies being adopted by the government in the lead up to next year’s elections. Many of these could work against corporate profitability. Valuations also look a little stretched especially for the larger companies.
We also took some profits in the Philippines. This has been an outstanding market recently and the structural outlook remains favorable. However, we believe it is now appropriate to take advantage of the increased foreign investor interest to scale back our position slightly.
We have also lowered the Korea weighting. The dramatic shift in the Korean won exchange rate against the Japanese yen could hurt profits for the automobile and technology stocks.
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.
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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.
A-shares are shares in mainland China-based companies that trade on Chinese stock exchanges such as the Shanghai Stock Exchange and the Shenzhen Stock Exchange. A-shares are generally only available for purchase by mainland citizens; foreign investment is only allowed through a tightly-regulated structure known as the Qualified Foreign Institutional Investor (QFII) system.
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