Mohammed Zaidi (MZ): Hi, my name is Mohammad Zaidi. I'm the director of research for Asian and Emerging Markets Equities here at Nikko Am. Looking back, the Asia ex-Japan equity market is up a respectable 13%*. And for all the negative news around China, that market is up 17%*, all in U.S. dollar terms. Not bad for a country attracting negative headlines around. The government not doing enough to promote consumption. Today to discuss the outlook for Asia ex-Japan and how investors can best prepare for the impending tariff war and key investment themes, we're joined by Peter Monson, Joint head of Asia and Emerging Markets Equities, and he's been with Nikko for 12 years.
* Source: Bloomberg, as of 12 Dec 2024. Past performance is not indicative of future performance.
MZ: So, Peter, you've seen the investor interest rise and then fall with the Chinese market. The consensus view is that tariffs are bad for everyone, Chinese and American. What's your thinking about Trump 2.0 and the impending tariff wars?
Peter Monson (PM): Yes, if I had a dollar for every time I've been asked that question this year, I'd be a rich man. I think what we know what we do know is there will be a lot of big headlines or bluster, but it's the final actions that really matter. And I think most people assume it's going to be very negative and very negative for China in particular. But if we look back at Trump 1.0, you might be surprised that your MSCI China outperformed the S&P. It outperformed all the perceived beneficiaries India, ASEAN, Mexico, etc.
So the lesson there is that there are other big fundamental changes out there that can be more dominating than, say, Trump. So domestic policy matters most in China and we really look to ascertain the real fundamental changes from the noise.
MZ: So speaking of that, you know, fundamental changes, China outperforming the first time around. So how do you go about separating the noise that we have every now and we both we rich from all the noise that we've heard from the fundamentals in China?
PM: Yeah, good question and we know there will be a lot of noise next year. I think for us, what's really important is having a sense in assessing where the risks are priced and where they maybe aren't priced. Chinese equities already priced in a lot of risk. They're not far off all-time low valuations relative to other emerging and Asian markets. And whether China outperforms or not, as we've mentioned, is really down to the domestic policy. Here we see there's greater efforts to stabilise the domestic economy and while this is welcome, what we really want to see is more specific support for consumption, services and backstopping the property market, which is key to confidence in the domestic market.
Some potential areas of volatility could be that isn't currently priced maybe in the hardware technology sector or some of those other beneficiaries the first time around who've really gained out of trade disruption. But in tricky markets such as this, that what we really try and do and what we're really trying to value is bottom-up stock selection and identifying real fundamental change at the company level. If you can find good quality companies with an investment thesis that is not geared towards geopolitical tension, it's going to be a much, much more productive endeavour than trying to guess what Trump is going to do next.
MZ: So in China, then, really, it is the domestic policy that will be driving market performance almost more so than the Trump tariffs, because, as you said, that could be going either way. It could be noise or basically overridden by domestic policy. Right?
PM: Yeah and it could be a reaction of the Chinese authorities to focus more on domestic support if exports are being compromised. And also, it is worth noting within the Chinese market, exporters are not a very high proportion of the overall equity indices. Much, much more is domestic orientated or new economy or Internet still. So again, that's another reason why domestic policy can matter more.
MZ: So that's on China. So now moving on to the other big cycle that started is the interest rate cuts at the Federal Reserve started back in September and Asia is a big beneficiary of interest rate cuts. What parts of the market do you think are going to be benefiting the most?
PM: Yeah. Okay. So rate cuts have started. I would caveat that with we're not sure how deep a rate cut cycle will be, but your traditional areas would be twin deficit economies which are more sensitive to the price of money, your rate sensitive or highly levered businesses perhaps, and then areas of the market that are a bit more sensitive to liquidity conditions.
From a country perspective, that's probably India, Indonesia, Philippines in our markets, but then elsewhere, more the interest sensitive subsegments are things like REITs and small capitalisation stocks. And REITs is particularly interesting because you have more than just an interest rate play there. You've got actually got some interesting growth opportunities in REITs, be it data centres or India or new constituents coming into the investment universe as small cap as well is very, very interesting.
Small caps1 actually outperformed large caps during the tightening cycle, which is a bit counterintuitive, but that was supported by a lot of good positive fundamental change in India and Taiwan, to name a couple. But looser rates should give us another tailwind. One other interesting point about small cap, which I don't think is well known for Asia in particular, is we've had the most amount of new companies come to list in public markets of any region globally the last 5 to 10 years. So it really does make it a more dynamic and interesting hunting ground for picking up small cap names.
MZ: So that the small cap part is very interesting and that it almost sounds like it's on a different cycle or different from what we think of as small caps in the US market or more developed markets where interest rates going up a positive and more companies are being listed. Is that a shift that you're seeing, which I think is structural?
PM: It would be structural in some places. The Indian market has been a big, big driver of new company formation and there's been almost one IPO a day in India this year and a lot of really, really interesting companies coming to market. It's also very interesting in that you have less of a private market developed in Asia. Companies are coming to public to list, so you can still access those opportunities in the public space. That's another big difference between the US and Asia.
MZ: And that's something I'd like to come back to, is that whole privatisation or selling of family-owned businesses almost into the public markets? And is that a theme that's stuck only for India, or is that also are you seeing that in Korea or other places as well?
PM: Mainly in terms of new company listings, it has been in India. You do see a bit of activity in Korea as well, although within Korea and a couple of other markets, there's been a lot more of a push towards what they call value up or governance improvement programmes. That's been happening for a number of years, but it's really gained a lot of momentum this year, at least until recently, for companies both paying out more, being more active with their capital management, but in the interests of minority shareholders. And that's a really welcome development.
MZ: That sets up a positive outlook for these investors anyway, that we can get different streams of return. Instead of just share prices going up, there's a capital return element to it as well. So what are the other some of the other key fundamental changes or themes that you think are going to play out in 2025?
PM: Yeah, we've only got a few minutes, but I would like to highlight, one is the question mark of whether we're going from Artificial Intelligence (AI) Act I to Act II. And what I mean by that is there's been a lot of attention and market rerating of infrastructure related stocks, NVIDIA* and TSMC* for example, but we're seeing increasing evidence of that moving towards maybe end applications. And we spent a lot of time this year researching where AI has the potential to change business models a lot and you'd be thinking of companies with high labour costs, a lot of replicable tasks and a lot of areas for efficiency gains and maybe new revenue opportunities. For us in Asia, that would be IT services and software and eGaming. For those you get a lot in Korea, China and India. But you'll observe as well, I think through US results season just gone by, the beats are now coming from software or enterprise related companies, not necessarily the infra plays anymore.
* Reference to any particular security is purely for illustrative purposes only and does not constitute a recommendation to buy, sell or hold any security or to be relied upon as financial advice in any way.
The second one was capital returns. We will really talk about that a little bit. But the big areas of change have been within China, new economy companies who've been buying back and cancelling shares in abundant numbers throughout the year and they've got the cash piles and the cash flow to continue doing this and they're a big constituent within the benchmark. So that's happened. But also on the financial side, we see increasing amounts of banks having excess capital now. A far cry from where we were post GFC (Global Financial Crisis), but they are either paying it back or buying back stock and cancelling shares. So that's been a new element that's come up really in the last year or so, both in terms of banks, new economy and career value up that we talked about previously.
MZ: And I guess that fits really nicely with one of the things that the equities team here at Nikko looks at is fundamental change. So what should the mean when you talk about fundamental change. You've mentioned small cap, you've mentioned interest rates, you've mentioned sort of the tech cycle capital return. Know where would you go in those areas, which would you highlight as the key area for a fundamental change where you'd be looking?
PM: Well first and foremost, what gets us really excited is fundamental change at the company level. Why is that? On It's because it's harder to find when you do find it. It can be differentiated from some of those bigger top-down changes we talked about. You can still add alpha2 that way. And again, areas that that's leading us to right now. I would be we talked a little bit about IT services and software, some company level change in terms of governance improvements or management improvements and efficiency gains and parts of ASEAN as well have been really, really interesting and haven't been in favour for a long time.
Areas like Malaysia, for example, where there's a lot of change, both at the top-down level and bottom up.
MZ: Thank you very much. And what about China and all of that?
PM: China is in control of its own destiny in terms of the stock market. What we've as I mentioned earlier, confidence is very, very low. These fantastic companies are at very cheap valuations in China. But what we need is a bit more conviction around the top-down direction for that to be realized. We focus a lot more on domestic orientated companies, try and not get too tied up within the geopolitical or trade tension ideas. We think that's a better way to focus going forwards.
MZ: Great. Thank you very much, Peter.
PM: Thanks, Mohammed.
