Asia, ex Japan, equities are expected to catch up with developed markets in 2017 given the region’s attractive valuations and structural reform progress in key markets such as China and India, says  Tim Orchard, Chief Investment Officer, Asia Pacific ex-Japan at Fidelity International.

“We believe Asia ex Japan equities could outperform in 2017 not only due to attractive valuations but also because the region has made decent progress in its reform agenda. Asia ex-Japan equities have underperformed since 2011 as investors focused on declining commodity prices, the strong US dollar and the potential fragility of China’s credit-driven growth. Valuations remain below long run averages” says Mr Orchard. 

“Given the more tumultuous developments outside of Asia – be that the partial annexation of a European sovereign nation, Brexit or the short-term policy uncertainty created by the US election result – it seems credible to argue that emerging Asia should not necessarily carry a significant political governance discount to her Western brethren.”

He continues:

“Over the longer term, investors should focus on the execution of various structural reform agendas in key markets,” says Mr Orchard. “Progress has been made in India with major goods and services tax (GST) reform and demonetization. Whilst this will inevitably damage near-term growth, it is nonetheless a positive reflection of India’s Prime Minister Modi’s desire for reform. We believe that whilst the cyclical downturn may be prolonged, the longer-term growth story in India remains intact. Similarly in Indonesia, examples include land acquisition reform and the recent tax amnesty, both of which suggest that progress has been made.”

“China, the region’s largest economy, is maintaining sufficient nominal growth whilst slowly rebalancing the economy away from credit-driven fixed asset growth and toward sustainable private consumption. However, debt levels are increasing rapidly and overcapacity in certain sectors remain causes for concern. However, this is an ideal environment for active stock picking and our bottom-up research shows that while a number of companies are still misallocating capital, many others are improving both from a corporate governance and a capital allocation point of view,” says Mr Orchard. “We believe that any potential A-share inclusion in MSCI indices could be a catalyst for Chinese equities. A-shares could have a significant weight in the MSCI Asia ex Japan index once full fungibility is achieved. In the longer term, we believe R&D innovation will be the driver of the Chinese market.”

Concerns have also been raised over Asia’s ability to cope with the spectre of higher US interest rates. Mr Orchard says: “In previous rate hike cycles, Asian markets on average have performed well in a rising US interest rate environment which reflects the fact higher rates typically reflect robust global growth. Although this cycle may exhibit different characteristics, we believe the US Federal Reserve is likely to raise interest rates at a measured pace in order to sustain the momentum of the economic recovery.”

“The more obvious risks to this positive view are twofold. First, should any interest rate rise reflect stagflationary rather than growth tendencies, Asia may not fair so well; and it is undoubtedly the case that any protectionist flare up is likely to impact many of Asia’s economies negatively,” Mr Orchard concludes.