“The objective of this new plan, called OMT (Outright Monetary Transactions) is expected to provide Sovereign states with benefits similar to those provided to European Banks via the Long-Term Refinancing Operations (LTRO) announced last year – lower funding costs, and improved availability of funds.

“High bond rates make it almost impossible for the heavily indebted sovereign states to deleverage, as the heavily indebted sovereign states need to issue more debt in order to pay the high interest cost. This initiative will still leave parts of Europe with low growth, high unemployment and continuing need to de-leverage but the announcement of the new plan has effectively boosted market sentiment, and provided a solution to the continuing refinancing requirements of certain sovereign states.”

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Market sentiment regarding China has become noticeably bearish, as the market fears growth in China will continue to slow.

They have been disappointed lately, with a range of Chinese economic indicators reporting on the downside and the country reported to be in its deepest slump since the 2008 global financial crisis.

A range of stimuli from the central government in Beijing also appears to have done little to boost the growth of the world’s second largest economy and its 1.3 billion people.

“But we are already seeing some signs that the growth slow-down is stabilising,” says David Urquhart, Portfolio Manager of the Fidelity Asia Fund, “at around the 7.5-8% GDP rate. 

“As GDP growth expectations have been revised down, the price to earnings (P/E) ratio of Chinese companies has also fallen to 8.3x [comparatively cheap versus its five year average of 12.1x and also versus the Australian market on 11.2x]. Yet earning per share (EPS) growth in China is expected to outpace that of Australia in both 2012 and 2013. As a result, Chinese shares that can deliver on current growth expectations are now looking attractive.”

Mr Urquhart notes “China is in the midst of rebalancing its economy, and GDP growth is shifting away from being heavily dependent on export growth and infrastructure spend, and towards domestic consumption. As this process of rebalancing continues growth rates will be lower than they have been over the past decade, but these changes will shift China to a more sustainable growth path.

“The composition of Chinese GDP growth has already begun to shift.  In the first half of this year, China’s GDP grew 7.8%, of which (a) investment growth added +3.9%; (b) consumption added +4.5% (so over 57% of GDP growth) while (c) net exports subtracted -0.6%. Only a few years ago growth was fairly evenly split between all three of these factors.
“Since the end of 2009 in the aftermath of the GFC, net exports have not contributed to GDP growth. Weak external demand from the US and Europe has removed this previously strong GDP growth driver.

“This also means that some micro data that was an indicator of growth in the past is now less relevant. For example, if one focuses on electricity generation growth, this has been growing at 1.48% year on year (YoY) in April and 3.25% in May.  However while this data is very relevant for growth in manufacturing/exports and infrastructure, it is not so meaningful in measuring consumption growth.  So by continuing to focus on this as an indicator of GDP growth could easily make one more bearish about China’s growth prospects than one should be. Consumption related data is now much more important an indicator of Chinese GDP growth.”

Mr Urquhart adds “in addition to rebalancing its economy, in 2011 China faced the challenge of high inflation. This saw the Chinese remove fiscal stimulus (eg infrastructure spend on high speed rail was frozen and restrictions on bank lending were put in place for key industries like cement, steel, real estate etc). In other words, monetary policy was very tight.  In 2012, with inflation now under control, we have seen some reversal of this tight monetary policy – RRR reductions, interest rate reductions and some easing in restrictions on bank lending.

“Unlike during the GFC, strong fiscal stimulus is seen as neither necessary nor desirable, particularly as we are starting to see some benefits of policy easing that should come through later this year.”

He suggests the latest HSBC PMI is one of a number of indicators demonstrating signs that China’s growth slow-down could be nearing an end. Other indicators also support this:

• China’s export trade grew 15.3% and 11.3% YoY in May and June after only 4.9% growth in April and shrinking in January 2012
• Industrial production growth has also accelerated from +3.8% YoY growth in Jan and Feb to +10.7% in June
• New loans by large banks doubled in the first half of July versus the first half of June
• Rail and highway investment rose by 34% month-on-month and 28% month-on-month in June versus 7% and 8% in May.

Mr Urquhart says “stable growth (rather than slowing growth) combined with attractive equity market valuations make China an interesting investment proposition. 

“Increased confidence that China can deliver GDP growth of better than 7% should see China’s flat equity market performance year to date in 2012, improve substantially. China’s growth concerns have been priced into the market at current valuations of 8.3x p/e and 1.5x book value.”

He notes “in other parts of Asia, we have also seen positive GDP growth surprises and/or positive earnings revisions – in countries like Singapore, the Philippines and Thailand – and have also seen strong equity market performance (each up between 15-24%).” 

This document is issued by FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”).  Fidelity Australia is a member of the FIL Limited group of companies commonly known as Fidelity Worldwide Investment. This document is intended for use by advisers and wholesale investors. Retail investors should not rely on any information in this document without first seeking advice from their financial adviser. This document has been prepared without taking into account your objectives, financial situation or needs.  You should consider these matters before acting on the information.  You also should consider the Product Disclosure Statements (“PDS”) for respective Fidelity products before making a decision whether to acquire or hold the product.  The relevant PDS can be obtained by contacting Fidelity Australia on 1800 119 270 or by downloading from our website at www.fidelity.com.au. The issuer of Fidelity’s managed investment schemes is FIL Responsible Entity (Australia) Limited ABN 33 148 059 009. Details about Fidelity Australia’s provision of financial services to retail clients are set out in our Financial Services Guide, a copy of which can be downloaded from our website at www.fidelity.com.au. © 2012 FIL Responsible Entity (Australia) Limited. Fidelity, Fidelity Worldwide Investment and the Fidelity Worldwide Investment logo and F symbol are trademarks of FIL Limited.

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Global and local factors lie behind the 29.6% in the MSCI Asia ex-Japan Index in US dollars from its low on October 5 last year to February 29. (Due to a higher Australian dollar, though, the index only rose 15.6% in Australian dollars.)

The global factors are the better news on the US economy and less bad news on the eurozone debt crisis. But local factors are playing important roles too, in particular, that China and India are loosening monetary policy now that inflation is slowing. This lowers the risk of an economic crunch in either country.

In October and January, the People’s Bank of China lowered the percentage of cash that banks must hold as reserve by 0.5%, in a bid to protect economic growth – authorities are worried that the struggles of Europe and the US will hinder export growth. Beijing officials have more scope to prod economic growth because lower pork prices are helping to push down inflation towards the central bank’s comfort zone of 4%. Consumers prices rose 4.5% in the 12 months ended January, down from a recent peak of 6.5% in the 12 months ended July.

While the Shanghai Composite Index only rose 3% from October 5 to February 29,  a better guide is the Hang Seng China Enterprise Index, as it is a gauge of how foreign investors view China. This index, which tracks the shares of Chinese companies listed in Hong Kong that form the majority of the stocks in the MSCI China Index, soared 38% from October 5 to February 29.

The Reserve Bank of India surprised investors in late January when it cut the cash reserve ratio for banks to 5.5% from 6%, the first time in three years it has reduced the amount of deposits that banks must hold as reserves. The surprise easing in monetary policy comes after two years of tightening monetary policy, including 13 hikes in interest rates, to control inflation. India’s central bank is able to loosen monetary policy because inflation is less of a threat. Wholesale inflation fell to 6.6% in the 12 months to January, its lowest reading in more than two years. From October 5 to February 29, India’s Sensex Index climbed 12%. (For the first two months of 2012, the index gained 14.4%.)

Elsewhere in Asia, authorities have taken steps to protect their economies from any damage stemming from the eurozone crisis. Since the start of October, central banks in Indonesia, Pakistan, the Philippines and Thailand have cut benchmark interest rates to help their economies, while many governments have introduced stimulus measures.

Still a bargain
Even with the recent surge in share prices, Asia’s stocks are still cheaper than global stocks overall.

The price-earnings ratio for the MSCI Asia ex-Japan Index was 12.5 times on March 2 compared with 14.6 times for the MSCI World Index, according to Bloomberg data.

Yet Asia’s stocks have plenty of scope to rise further. Stocks from companies in the world’s fastest-growing region are offering an adequate dividend yield (2.6% on March 2 compared with 2.7% for the MSCI World Index) and earnings prospects are bright, especially as authorities have plenty of scope on the monetary and fiscal sides to insulate their economies from any upheavals from outside the region.

David Urquhart, Portfolio Manager of the Fidelity Asia Fund, said that after being bombarded by bad news over the past 12 months, Asian stock markets were at the second cheapest they have been in decades.

“Historically, these markets have performed well once they dropped to the recent inexpensive valuations of 11 times price-to-earnings ratio,” he says.

“Over the past 20 years, when valuations have been this low we have seen rallies on average of between 16% and 30% over the subsequent 12 months.”

China (now on a price-earnings ratio of 10.6 times as measured by the MSCI China Index) “should be able to grow 7.5% to 8% during 2012,” David says. “This market should trade closer to its five-year average of 12.8 times earnings as confidence returns about China’s ability to continue to deliver healthy economic growth.” So the rally may last a while yet.

This document is issued by FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”).  Fidelity Australia is a member of the FIL Limited group of companies commonly known as Fidelity Worldwide Investment. This document is intended for use by advisers and wholesale investors. Retail investors should not rely on any information in this document without first seeking advice from their financial adviser. This document has been prepared without taking into account your objectives, financial situation or needs.  You should consider these matters before acting on the information.  You also should consider the Product Disclosure Statements (“PDS”) for respective Fidelity products before making a decision whether to acquire or hold the product.  The relevant PDS can be obtained by contacting Fidelity Australia on 1800 119 270 or by downloading from our website at www.fidelity.com.au. The issuer of Fidelity’s managed investment schemes is FIL Responsible Entity (Australia) Limited ABN 33 148 059 009. Details about Fidelity Australia’s provision of financial services to retail clients are set out in our Financial Services Guide, a copy of which can be downloaded from our website at www.fidelity.com.au. © 2012 FIL Responsible Entity (Australia) Limited. Fidelity, Fidelity Worldwide Investment and the Fidelity Worldwide Investment logo and F symbol are trademarks of FIL Limited.

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Australians investing in Asia are no longer just tapping the capital growth of Asian stocks, they’re also increasingly receiving significant share income through rising dividend payouts, notes fund manager Fidelity. 

“We’re seeing more companies in Asia paying more dividends,” points out David Urquhart, Portfolio Manager of the Fidelity Asia Fund. 

Mr Urquhart says “the combination of strong balance sheets and improving return on equity has seen Asian companies’ willingness and ability to pay dividends increase strongly over the past decade. 

“The increased willingness to pay dividends is the result of management’s improved understanding that shareholders like to see a regular cash return on their investment, particularly from companies whose balance sheets are strong and that can comfortably fund their future capital expenditure to grow the business. Management also increasingly recognises that dividends provide a competitive advantage to attract investors, compared to companies that don’t pay dividends or lower payouts.    

“The ability to pay dividends is due to improved profitability. Most Asian companies are in a much better position to pay dividends, due to stronger profitability, today compared to a decade ago. Having paid down debt from the relatively high levels seen during the ’90s, Asian companies are now better able to return some money to shareholders via dividends,” (as opposed to having a larger portion of pre-tax profits going to banks in the form of interest payments). 

As to what countries, sectors and companies are paying better dividends, Mr Urquhart noted “typically the slower growth companies have the higher dividend payout ratios in each market. Telcos and utilities tend to have the highest payout as a percentage of earnings and also have the highest dividend yields. 

“There are a number of companies in Taiwan with dividend yields of around 8% as their business are generating strong cash, and they have no large capacity expansion plans over the next few years.   

“In contrast, the region’s faster growing companies typically want to reinvest a reasonable proportion of their profits to expand their businesses and so have lower dividends if at all. For retail companies this can be adding new stores, or for manufacturers it could be investing in expanding capacity and perhaps investment in research and development. For these companies with strong growth opportunities, it is expected that the returns to shareholders would largely come from capital gains and that dividends would grow more or less in-line with the growth in earnings they achieve.”

The Sydney-based Mr Urquhart notes there is still some way to go in terms of the region’s dividend growth. “The average dividend yield for companies in the Asia region is currently about 2.5%. This compares to around 4% for Australian companies.” 

Dividend yields vary country by country and are quite diverse, he added, noting the Taiwanese market delivers an average dividend yield of 3% compared to India with an average yield of 1.1%. 

Mr Urquhart noted “a key point of focus for investors is not necessarily what the dividend yield is today, but how quickly dividends can grow. Many investors focus on earnings growth, trends in profitability and ability of companies to generate of free cash flow as indicators of future dividend paying ability.”

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“Asian markets are attractively priced following the recent market correction,” said David Urquhart, Portfolio Manager of the Fidelity Asia Fund. “The region is now trading at a forward price to earnings ration (P/E) of 10.5x, which is at a deep discount to the five year average of around 13x. This is more than one standard deviation away from the five year average and is the second cheapest that you could buy Asian markets in a decade.

“Asian corporate balance sheets continue to be in very healthy shape, and economic growth continues in Asia. On a Price to Book basis the current valuations are 1.8x book value, versus five year average of 2.1x and with the return on equity much higher than that of 10 years ago.

“So, from a valuation standpoint, this is the second best time to be buying Asian stocks in 10 years. There are risks in the US and Europe but these risks are more than priced in at the moment. I am still comfortable with the growth outlook in Asia, which should significantly outpace the rest of the world in the coming years.”

Mr Urquhart said there are also some positives for Asia that arise from slower global growth. Many Asian economies – including China, Singapore, Korea Taiwan and India – introduced policy tightening measures due to their strong growth. “Slower global growth and the resultant lower commodity prices, especially oil prices with Asia being a big energy importer, will help to reduce some of the inflationary pressures in Asian economies. This will provide policy makers a reprieve on what was expected to be further tightening measures.

As a result, “I have recently moved China from underweight to a small overweight. Currently, China is trading at a forward P/E of 9.5x, which is at a significant discount to its 5-year average of 13.5x. I am definitely seeing more attractive buying ideas in China.”

He added that “in an environment of slowing global growth, the focus has shifted away from growth opportunities – where risks of disappointment are increasing, and more on the value opportunities that exist in the market. Typically when you see the P/E of a stock that is the same as the sustainable dividend yield you are getting a great buying opportunity. This is especially so when these companies still have good prospects for growth. Recently there have been an increasing number of attractive opportunities that have emerged.”

As for the impact of the slowing US economy on the region, Mr Urquhart said “S&P’s recent downgrade of the US Treasury debt from AAA to AA+ is a psychological blow to the American pride, but the economic consequences are minimal. When we see companies downgraded a notch from AAA, there is no material impact on the cost of funds or availability of funding. The market reaction – US bonds actually rallying – is consistent with this view. Rather, it highlights that the main concern of the market is about weaker than expected US growth in Q2, the apparently more difficult policy response environment – delays in getting the debt ceiling lifted – and so the market is placing a higher probability of recession in the US.

As for the prospect of a double dip recession in the US, Mr Urquhart said “We have just seen of US listed companies report Q2 results, and with 83% of them having reported, earnings are on average 5% better than expected. Clearly corporate America continues to be in good health and this is also being reflected strong hiring by the private sector. Unfortunately the government (local and federal) are going through austerity measures to reduce debt and this is seeing some dismissals and so the overall unemployment remains more subdued. Despite the slower growth expectations, I don’t foresee a double-dip scenario in the US. Q2 growth in the US was impacted by the supply chain disruption caused by Japan’s tsunami, especially for the auto industry, and by higher oil prices. US growth is expected to slow to less than 2% for 2011 and 2012, rather than 2.5 – 3% that the market has previously projected. However, as we move into Q3 and Q4 the auto industry’s supply chain disruption should begin to unwind.”

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“Another province in China, Hunan, has an economy greater than that of Portugal,” he says. “Hunan province, with its $232bn economy is similar to that of Singapore.”

Mr Urquhart adds “the Chinese economy grows the equivalent of three Greek economies every year! 

“China recently reported second quarter GDP growth of 9.5% (better than market expectations) and growth in Chinese service industries accelerated to 9%, while growth in secondary industries rose 11% and industrial production jumped 15% year-on-year at the end of June.”

He notes that China recently joined the USA (along with Russia) as the only countries having more than 100 billionaires. “One in four billionaires are from in Asia and the region has more ‘ten-figure’ earners than Europe for the first time. “This is creating more local consumer demand. China (including Hong Kong) accounted for 26% of Swiss watch exports lasted year and accounts for 25% of Airbus business jet sales. China, India and Indonesia account for 30% of global mobile phone subscribers.

“Asian companies are well placed to take advantage of opportunities in their own back yard, Western companies are also continuing to invest and expand in Asia, as highlighted by recent IPOs in Hong Kong of luxury brands like Prada.

“Asian countries have recently delivered the majority of growth in the world, attracting investment by global corporations to participate in the region’s growth. 

“By investing in Asia, retail investors have been able to gain direct exposure to such investment opportunities, and avoid the drag from risks associated with the fiscal and financial sector imbalances in countries like Greece, Italy, Spain, Ireland and other ‘developed’ economies.”

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