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Why YOU are the greatest risk in markets right now

10 December 2018

Matthews Asia’s Robert Horrocks makes the case for patient investing and highlights the structural drivers of long-term growth in Asia.

By Maitane Sardon,

Reporter, FE Trusntet

As clichéd as it may sound, investors who allow themselves to be swayed by headlines, sentiment and short-term momentum are probably the greatest risks in markets right now, according to Matthews Asia’s Robert Horrocks.

Horrocks (pictured), who co-manages the Matthews Asia - Asia ex Japan Dividend fund alongside FE Alpha Manager Yu Zhang, said that as 2019 approaches investors should stop and think about the future as well as reflect on the structural long-term drivers in Asia. 

“Conventional wisdom is always right – until it isn't,” said Horrocks. “The question is: when is it right to disagree?

“The investment herd is thinking: trade wars, tight money, fractious politics and a falling stock market in the US, banking systems in distress in Europe and the splitting of the EU. A weak credit and profit cycle in Asia, slow earnings growth, and a Chinese state determined to assert political control.”

He added: “Can you continue to be impartial and thoughtful amid falling equity prices and depressing headlines? Trading is an emotional game; investment is a thoughtful analysis of contradictory evidence. At times like this, the two can conflict.”

However, as share prices have fallen and Asia has continued to lag other markets, Horrocks – who is also chief investment officer at Matthews Asia – said his view on the region has become increasingly optimistic.

“For patient capital, the present is an exciting time to capture a larger share of the wallet from Asia's rising middle class,” he said.

“Consumer spending could soften a bit over the short term, but over the long term, consumers have behaved with remarkable consistency.

“As incomes rise, spending usually grows. This trend still appears solidly on track across Asia and should continue to make Asia a key driver of global growth over the coming decade.”

Performance of indices YTD

 

Source: FE Analytics

As the above chart shows, 2018 hasn’t been an easy year for Asian markets. While the S&P 500 has delivered a gain of 4.42 per cent in sterling terms, the MSCI AC Asia ex Japan index is down by 8.09 per cent year-to-date.

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Over the course of 2018, concerns over US-China trade relations have remained at the fore, taking a severe toll on investor sentiment.

But fears of additional equity market declines stemming from trade impacts have been driven more by sentiment than calculus, Horrocks noted.

“The irony is trade protectionism, if it ever makes sense in the short run, it is only really useful during times of depressed demand,” he explained. “Today, protectionism is unequivocally damaging, but not to the extent that breathless headlines would have us believe.”

Rather than trade tariffs being the major factor behind market declines, Horrocks said tightening monetary policy has brought the bull market to an end.

“The US Federal Reserve has been raising rates and looks set to continue. The fact that the market falls in October were accompanied by declines in bond yields suggests that fears were growing over US economic growth. After all, no expansion lasts forever,” the Matthews Asia CIO said.

Horrocks, who is also deputy manager of the $455m Matthews Asia Asia Dividend fund, said what surprised him in 2018 were Chinese policymakers and the tightening of domestic policy seen over the last months despite a lower inflation rate.

Inflation (CPI) in China since 2010

 

Source: OECD

“I thought they would be quite happy to see inflation in a range between 2 per cent and 3 per cent and that working through debt and financial system issues would be done within this kind of context, but his has proven to be wrong.”

Having peaked at 2.5 per cent in February this year as markets were topping out, China's core inflation declined to 1.7 per cent at the end of September.

“Money is tighter in China than I expected and fiscal policy is too,” the fund manager said. “While trade concerns exacerbated equity price declines in some businesses, I think the woes that befell Chinese stocks were a mixture of domestic policy tightening and some high valuations in certain sectors.”

Layered on top of this, he said was the fact that domestic Chinese retail investors are by nature “skittish” and many have pulled their money out of the market due to the slower growth environment.

Although earnings didn’t post the same kind of growth across the region that was seen in the US or the rest of the world, he noted that global leadership in trade, economic growth and market performance may be on the cusp of change.

As we enter 2019, Horrocks said he believes the US will tighten and that monetary policy in Asia ought to be heading in the opposite direction.

However, he doesn’t think this will cause pressure on Asia's currencies to the extent that many fear, as Asia's currencies have already been weak against the dollar (as have all global currencies).

“What's more, Asia's economies are disinflating when they should be inflating. A bit more robust nominal growth in Asia may even spur better growth and offset some devaluation pressure,” the manager pointed out.

Given that sentiment changes at extremes, he noted valuations are the aspect that is worth a look, with many of the Matthews Asia strategies now taking advantage of low valuations to add to existing high-quality names in their portfolios.

“How panicked investors are in the short run is directly measurable by how cheaply they are prepared to part with equity, representing their long-term claims on Asia's growth,” he said.

“As long-term investors, we know that markets move in cycles, not straight lines. And the current cycle among Asian markets indicates that a lot of pain has already been priced-in.

“The way we sleep well at night is by knowing what's in the portfolios and knowing what's likely to hold up well over time, when the dust settles and security prices realise their long-term growth potential.”

He added: “Valuations are much cheaper than they were at the start of the year. If I look at enterprise value and earnings before interest and taxes multiples in Asia relative to their own history, I see Asia ex Japan looking inexpensive relative to Europe, the US, Japan, and Latin America.

“Asia's stock markets seem to be the only ones really factoring in a tough macroeconomic environment in 2019.”

Performance of fund vs sector and index since launch

 

Source: FE Analytics

Since launch in 2015, the Matthews Asia - Asia ex Japan Dividend fund has delivered a 63.06 per cent total return compared with a 46.37 per cent gain for the average fund in the IA Asia Pacific sector and a 52.11 per cent rise in the MSCI AC Asia ex Japan. It has an ongoing charges figure (OCF) of 2 per cent and a yield of 3.58 per cent.

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.