CONTRIBUTION Reducing US concentration, rotating to Asia
Market statistics are displayed on a screen at the New York Stock Exchange, June 2. AFP-Yonhap
With the days of investing in few US single stocks gone, Asia ex Japan is good area to diversify into
Investors who have most of their equity positioning in U.S. exposures are facing a common dilemma. This year, their equity portfolio returns have been dragged by not only U.S. equity underperformance relative to the rest of the world, but also a slump in the U.S. dollar.
Will this double whammy persist for the rest of the year?
More selective US equity positioning
Raymond Cheng, chief investment officer for North Asia at Standard Chartered Bank's wealth solutions unit / Courtesy of Standard Chartered
We continue to see the merits of staying invested in U.S. equities as the earnings outlook remains supported and superior to other regions.
However, the earnings growth gap versus other regions is narrowing. Coupled with the twin pains of growing U.S. budget deficits and mounting debt concerns, it would be prudent to maintain a well-diversified portfolio across major regions, while becoming more selective in the U.S. equity market.
As an illustration, within the U.S. technology sector, we are locking in some profit in the semiconductor segment after an impressive 40 percent rally since April. At the same time, we remain bullish on the software segment, where earnings are more resilient against macro uncertainty and have a more defensive, less cyclical growth profile.
Asia equities to benefit from US dollar's weakness, policy stimulus
Intensifying geopolitical risks in the Middle East have reignited equity market volatility, denting the near-term upside potential. Despite this, we see mitigating factors for international equities.
First on the list is the U.S. dollar's expected weakness: In the past decade, every 1 percent drop in the U.S. dollar has resulted in 1-2 percent gains in Asia equities. In addition, we see domestic policy tailwinds across the region.
In China, the equity market has been a steady outperformer this year, and we expect monetary and fiscal policies to remain expansionary given persistent deflationary pressures and a weakening global outlook. We recommend a barbell strategy in China, balancing the growth-centric Hang Seng Technology Index and the defensive high-dividend state-owned enterprise shares listed in Hong Kong.
Korea is likely to be an outsized beneficiary of reform tailwinds. Recently elected President Lee Jae Myung is the pro-growth leader of the Democratic Party of Korea, which now also holds a majority of the seats in the National Assembly.
President Lee Jae Myung listens to a briefing on stock market trends and monitoring systems during his visit to the Korea Exchange in Seoul, June 11. Courtesy of the presidential office
Lee is widely expected to push forward a supplementary fiscal budget in excess of 30 trillion won ($21.9 billion) to revive economic growth. He should also be able to pass the revised Commercial Law, aimed at enhancing corporate governance and narrowing the "Korea discount."
It is worth noting that, notwithstanding its year-to-date outperformance, Korean equities still trade at an attractive 9x price-to-earnings ratio, with earnings growth expected to accelerate from the low teens this year to the high teens next year. This suggests ample room for a reexamination of the rating of Korea equities.
India is another market that has enjoyed incremental policy support. The Reserve Bank of India delivered a bigger-than-expected 50 basis point rate cut in June as moderating inflation pressures provided room to stimulate economic growth towards the 6.5 percent target.
The central bank also cut the cash reserve ratio requirement for banks by 100 basis points, potentially bolstering liquidity by 2.5 trillion rupees ($28.8 billion). More accommodative financial conditions and greater fiscal support than prior estimates are lifting India’s corporate earnings outlook.
Low investor positioning in Asia equities augurs well for re-rating
Low investor positioning in Asia sets a conducive backdrop for this year’s equity market momentum to continue. According to EPFR Global, U.S. equities attracted a net global fund inflow of $132.6 billion this year, despite concerns about the fading "U.S. exceptionalism."
On the other hand, Korea saw a net fund outflow of over 14 trillion won for the first five months of the year, with the flows only starting to reverse course after Lee won the election in June. Should we continue to see more self-help policy initiatives in the region, Asia equities will likely benefit from a resumption of net fund inflow and outperform other regions.
Diversify, diversify, diversify
We always talk about the need to avoid putting all our eggs in one basket. It is easier said than done, especially given that in the past few years, simply investing in U.S. equities or even a few single stocks could generate a spectacular return.
Times have changed, however. With the evolving policy and geopolitical landscape, it is crucial to diversify our equity portfolio across regions and sectors. Ongoing geopolitical risks reinforce our thesis for diversifying across asset classes, such as gold, quality bonds, alternative investments and safe haven currencies.
Raymond Cheng is the chief investment officer for North Asia at Standard Chartered Bank's wealth solutions unit.