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Russell Asian Barometer: near term caution warranted for Asian markets but China stands out as most attractive

Report says Asia now looks reasonable value in its own right but is still expensive compared to the rest of the world.

SINGAPORE, AUGUST 28, 2008–– Russell Investments, in its second quarterly Asian Market Barometer, says that  while Asian economies have so far shown remarkable resilience to the global downturn, slower growth, rising inflation and stretched relative equity market valuations suggest Asia might underperform global developed markets over the near term.

Andrew Pease, Russell’s Asia-Pacific Investment Strategist and the author of the Asian Market Barometer says “Investors in Asia have felt the full force of the global equity bear market so far this year.  As at mid-August, the MSCI Asia ex Japan share price had fallen 27% from the beginning of the year compared to the 12% decline in the S&P 500 and the 19% decline in the developed world excluding the US.  After outperforming in the early stages of the sub-prime crisis, Asia has now caught up to the United States with around a 15% fall since the middle of 2007.”

Pease explains that while Asia’s economies have mostly weathered the global storm, they are battling weaker exports and rising inflation. In addition, high equity market valuations relative to the rest of the world means that regional markets will be vulnerable to earnings disappointment over the remainder of 2008 and may underperform developed markets through 2009.

Relative valuation handicap
The Russell Barometer explains that the price-to-earnings (PE) ratio for the MSCI Asia ex-Japan (based on one-year ahead consensus earnings forecasts) stood at 12.0 times since August.  This is down from a peak of nearly 17 times in October last year and is below the 12.5 times average for the past 10 years. Global developed equity markets have also been de-rated and the forward PE ratio for the MSCI World Index is near a 20-year low at 11.9 times.

 “Put simply this means that even though Asia might look reasonable value in its own right, it is still expensive compared to the rest of the world.  Over the past 20 years, Asia has on average traded at a 20% PE ratio discount to global developed markets,” says Pease.

Valuation race: China looks attractive
Pease says that simple valuation measures presently give a mixed picture.  Countries with low PE ratios (Singapore, Malaysia, Taiwan) have poor earnings outlooks while those with robust earning-per-share (EPS) mostly have relatively high PE ratios (India, Indonesia and China). 
Pease adds that “On balance China looks the most attractive as its forward PE of 11.7 times in August has retreated from the overheated 24.3 times of last October.  China’s economy has been the most resilient to the global slowdown with the consensus slightly upgrading forecasting GDP growth in recent months.  The inflation rate fell to 6.3% in July from a peak of 8.5% in April calming fears that more aggressive central bank tightening would be required”.

Additional highlights of the report:

• India is expected to achieve EPS growth of over 30% over the next 12 months but this looks fully priced given the PE ratio of 14.6 times in August.
• Singapore, Malaysia and Hong Kong are the three markets most closely linked to the US slowdown through their export exposure. All are attractively priced on a PE ratio basis but have poor EPS growth outlooks.
• Taiwan continues to look attractive on a relative PE ration but forecasts for EPS growth are trending lower. However an improved political situation and closer relations with China have eased some of the political tensions that has  held the market back.
• Korea has been the worst performing market losing 22% in the year to July.  Consensus EPS growth forecasts for 2008 have fallen from 16% at the beginning of the year to 8% in August. In addition Korea’s inflation rate has more than doubled over the past year to 5.9%. Investors should stay on the sidelines until the global upturn is confirmed and the extent of further Bank of Korea rate rises is known.

In summary Pease says that economic growth in Asia has so far shown remarkable resilience to the global downturn which is a strong argument for the bullish long-term structural growth story.

The structural story focuses on the budget and current account surpluses across the region, improved corporate governance and balance sheets as well as strong long-term growth prospects delivered by urbanisation. This view holds that Asia is less prone to boom/bust cycles and has decoupled from large developed countries. The consensus expects that Asia will grow at a slower pace than last year, but will still expand at a faster rate than the 10-year average, both this year and next.

For more information:

Russell Investments Asian Barometer
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Andrew Pease is an investment strategist for the Russell Investment group. In his role Andrew conducts research on the economy, capital markets, portfolio strategist as well as investor behaviour. He has extensive financial industry experience as an economist, investment strategist, fund manager and central banker.

Russell Investments is the owner of the trademarks, service marks and copyrights related to its indexes. Russell’s indexes are unmanaged and cannot be invested in directly.