Supportive U.S. economic data drove most markets higher during the first quarter of 2013. China underperformed the region amid concerns that the economic recovery may not be as robust as previously expected, while the National People’s Congress in March failed to provide any incentives to the equity market given the absence of pro-growth policies. The MSCI AC Asia Pacific Free Index including Japan gained 5.5% while the MSCI AC Asia Pacific ex Japan Free Index closed 2.0% higher during the quarter. (All performance figures are based on MSCI indices in U.S. dollar terms with dividends included unless otherwise stated.)
The Tokyo Stock Price Index (TOPIX) extended its rally during the first quarter with a strong 20.34% surge, and capped by a further 6.05% gain in March. Despite fresh credit concerns in the European Union triggered by the banking crisis in Cyprus, the Yen continued to depreciate steadily against the U.S. dollar and the Japanese equity market remained solid in anticipation of aggressive monetary easing policies from the new administration of the Bank of Japan (BOJ). The steady recovery of the U.S. economy and a robust performance in the U.S. equity market also appear to have supported investor sentiment in Japan.
The appointment of the new BOJ governor, Mr. Haruhiko Kuroda, was approved by the National Diet in March. Mr. Kuroda has been known as a critic of the BOJ for its failure to take a sufficiently accommodative monetary stance, and he reiterated his call to “do whatever it takes” to defeat the current deflationary conditions at his confirmation hearing.
Domestic economic data have yet to demonstrate signs of a full-fledged recovery, as we observe mixed results from the latest macroeconomic numbers. While the survey of manufacturers' production forecasts suggest that output could recover, February’s Industrial Production Index actually declined by 0.1% month-over-month (mom), falling far short of the consensus estimate of 2.5%. In contrast to weak production activities, domestic demand gradually improved. The Household Survey revealed that core consumption had increased for a third consecutive month in February. However, deflationary conditions still prevail in the domestic economy as the Consumer Price Index (CPI) in February was -0.7% year-over-year (yoy) and remained in negative territory.
On the back of improved domestic demand and expectations for further monetary easing policies, domestic sectors including Consumption and Infrastructure have led recently. In contrast, manufacturing sectors such as Capital Goods, Automobiles, and Electronics failed to catch up with the market as global demand has not shown any clear recovery signs yet. The Commodities sector also underperformed, dragged lower by steel producers. They met with a sell-off due to the disappointingly tepid recovery in global steel demand.
The MSCI China Index (-4.5%) was the region’s worst performing stock market, held back by some unexpectedly weak economic numbers. Consumer Discretionary (-9.9%) was the worst hit sector with large cap stocks declining amid disappointingly weak retail sales. Telecommunication Services suffered a 9.4% decline despite the sector’s normally defensive characteristics. The Materials sector (-8.0%) underperformed too, largely due by weak cement prices that caused investors to take profits after a strong fourth quarter in 2012. On the other hand, sectors such as Utilities (+22%) and Healthcare (+3.6%) outperformed. Clean energy stocks such as gas distributors and wind farms were re-rated in the wake of government plans to tackle the country’s chronic pollution problems. Similarly, Utilities (+7.5%) were the best performers in the MSCI Hong Kong Index (+3.5%). Lagging sectors included Information Technology (-9.7%) and Real Estate (-6.8%). Real estate stocks were weak as the government imposed further tightening measures to curb property demand.
The MSCI India Index has (-2.6%) also underperformed the region since the start of this year on the back of poor corporate earnings, the absence of government reform policies, and pressure on the fiscal and current account deficit. The Industrials sector (-17.3%) led the decline during the period. Information Technology, on the other hand, bucked the downtrend with a 24.6% surge over the same period.
The MSCI Australia Index (+9.1%) outperformed the region during this review period, with all sectors except Materials (-8.2%) closing higher. Financials were the strongest performers for the period as bank dividend yields remained attractive and the Australian dollar remained stable. Consumer and Industrial sectors also posted double-digit gains for the quarter.
The MSCI Korea Index underperformed (-3.4%) during the quarter, chiefly due to concerns that a depreciating Japanese Yen will make Korean exporters less competitive. The Material sector was the weakest, declining by 14.7%. Energy (-12%) names were weak due to concerns about fluctuating crude oil prices, weakening petrochemical spreads and deteriorating base oil margins, which outweighed stronger gross refining margins. Defensive sectors such as Telecommunication Services (+4%) and Healthcare (+1.5%) outperformed in Korea. Similarly in the MSCI Taiwan Index (-0.2%), Energy (-12.4%) and Materials (-8.5%) were the two weakest sectors. The Financial sector saw the biggest gains and logged an 8.9% return during the quarter as news of cross strait-talks with China resurfaced.
Market returns in the ASEAN (Association of Southeast Asian Nations) region were mixed, with the Philippines (+18.6%) the strongest country, followed by Indonesia (+13.2%), Thailand (+10.1%) and Singapore (+3.1%). Malaysia underperformed the region, closing 0.9% lower. Consumer stocks in Philippines led the gains with expectations of sustained domestic consumption even beyond the May’s mid-term elections. Telecommunication Services in Malaysia was the weakest sector.
Market Outlook and Strategy
With the global economy steadily recovering, led by the U.S. and emerging economies, the outlook for the Asia Pacific equity markets remains broadly positive. Risk asset prices are finding support from the sustained aggressive monetary easing policies from virtually all developed world Central Banks. Remaining uncertainty, however, means that equity markets may be volatile, particularly in regards to the health of peripheral Europe and the potential negative economic consequences of the mandated U.S. budget cuts.
Most regional markets could maintain their upward trajectory, not only due to this abundant and cheap liquidity but also because EPS (earnings-per-share) forecasts are starting to be ratcheted higher in an environment where valuations are still reasonable.
A pleasing development for stock selection focused investors is that stock to stock correlations have dropped to their historical average. Therefore, this may be an environment where buying the right stocks can be adequately rewarded.
In terms of our country allocation, we will increase our overweight exposure to Indonesia. This market disappointed in 2012 amid concerns about economic growth prospects, the exchange rate, and Government policies – all of which encouraged profit taking. However, the positive secular story remains unchanged. In addition, some of the macroeconomic concerns have dissipated, the currency has stabilized, and the risk of domestic overheating has diminished.
Meanwhile, we will fund this purchase by extending the underweight China position. Growth in the first two months of 2013 has disappointed and the latest Consumer Price Index figure was higher than expected. However, we believe there are several factors that can explain these disappointing numbers. Instead, we are reducing the exposure for the same micro and technical reasons that we have espoused over the last few years: poor corporate governance, a potentially huge supply of equity, rising wage costs, and general over-capacity. However, from a long-term perspective, we believe Chinese growth may slow sharply as the impact of a shrinking workforce, a relative fall in fixed-asset investments and the need to spend considerable amounts to alleviate pollution will all have an adverse impact on gross domestic product growth. Under this scenario, many companies, especially State Owned Enterprises, could find it difficult to sustain their relatively high ROEs (return-on-equity).
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.
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