ANDREW Swan, Managing Director, is the Head of Asian & Global Emerging Markets Equities for the Fundamental Equity division of BlackRock’s Active Equity Group. He is responsible for managing several regional equity portfolios, setting regional equity investment strategy and developing BlackRock’s Asian investment platform and capabilities.

We believe global reflation could emerge as a core theme in 2018 — and Asia remains the best proxy to global growth. We expect value and related cyclical sectors to outperform in this environment and are positioned accordingly.

Asian earnings are now firmly recovering, fueled by exports (on the back of a global cyclical pick up). And as key reforms are starting to bear fruits in various Asian countries and sectors, profitability is improving throughout. The stabilization of growth in China and the supply-side reforms implemented there should not be underestimated for its impact on lifting the whole region. This is placing Asia in a much more attractive position than it has been for some time.

Furthermore, despite the strong rally in 2017, valuations in Asian equity markets have only just reached their long-term historical averages. We believe there is still room for valuations to re-rate higher as growth this time round is more sustainable and of a higher quality. Lastly, we believe flows should play a key role for the asset class over the next few months given investor positioning in Asian equities remains light and appetite for risk is increasing.

Key risks to our asset class are trade relations with the US, how the US Fed reacts to improving fundamentals, and if the USD were to strengthen sharply.

Aggressive steepening of US interest rates could lead to excessive dollar strength and is a key risk we are monitoring as Asian equities tends to be negatively correlated with USD. That said, if as we expect, central banks increase yields gradually in response to underlying economic growth, we view this as a positive for Asia.

We don’t think impact of tariffs on steel and aluminium has a large impact on Asia and in particular the impact on China is rather limited given that only 2% US steel comes from China and steel makes up <1% of China’s exports1.

Instead, we have been keeping a close eye on US investigations under section 301, which covers intellectual property and technology transfer. China has been formally under scrutiny since August 2017 and affirmative findings may lead to actions by the US administration. If this leads the US to target Chinese companies, we expect China to retaliate proportionately. We believe rare earths may be China’s most effective leverage tool as US no longer has any production and China accounts for 78% of US imports (and 80% of global)2. This could escalate U.S.-China tensions in the short term, although we expect China to make serious efforts to avoid a trade war.

We don’t think we can assess sector wide implications at this stage. In general, lower tax rates raises returns on capital, potentially diverting investment from the rest of the world to the US. We think the new tax law in the US poses a bigger risk for Europe and Latin America than Asia. Multi-national corporations that were, on the margin, considering offshoring some production may pause to take advantage of the lower domestic rates, but the factors of production that are Asia-oriented, especially those related to the electronics supply chain, are very unlikely to move back to the US. The labor cost advantages, economies of scale, and the component ecosystem is well-engrained in Asia, with little risk of foreign direct investment diversion to the US.

We like China on continued strong macro recovery coupled with better supply side discipline. We also like India on signs of pick up in its rural economy post better monsoon and demonetization, as well as a shift in government’s focus from reform to growth. We take a prudent view towards Taiwan due to our cautious view on IT and remain neutral to Singapore as we see limited stock opportunities there.

From a sector perspective, we like sectors such as materials, and industrials as we believe reflation will be the key theme of 2018. We remain prudent towards Information Technology on valuation concerns and consensus positioning.

We expect near term volatility to be elevated for our region and thus remain focused on seeking out bottom up, stock specific investment ideas.

¹International Trade Administration, United States Department of Commerce, March 2018
²Statista, March 2018

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