The panic selling in global capital markets continued unabated amongst record volatility of late, with headlines drawing parallels to the equity market dislocations of 1929 and 1987. In major pockets of the fixed income arena, participants and commentators have alluded to a liquidity crunch, dysfunctional markets, forced sellers and a lack of executable bids. As is often the case with bear market shocks, correlations quickly move towards one.
Despite the nature of the region’s sharp response to the coronavirus pandemic, and the notable degree of success in containing Covid-19 thus far, Asia’s own equity markets have been unable to escape the financial fallout. At the time of writing, the broad index has fallen from its January peak to register a –21% return year-to-date and -18% on a rolling 12-month basis, returning the market to levels seen three years prior:
Predicting short-term market movements is a futile exercise at the best of times, made more difficult by the added complication of the frequency and magnitude of global government policy responses and the progression of the outbreak. Nevertheless, in order to attain a longer-term perspective on what the road ahead may look like for Asia investors, re-visiting the path travelled can often be a sensible place to start. A brief review of prior major bear markets may help us to understand the potential impact on regional earnings and multiples.
Over the past quarter of a century, five major crises have developed that triggered a broad-based earnings contraction across the Asian region. In chronological order, these events were the Asian financial crisis, the Dotcom bubble, the Global Financial Crisis, the Eurozone crisis and the China devaluation. As evidenced in the table below, whilst the trend for earnings was negative for all markets during each episode, the impact across individual countries varied considerably:
The Asian crisis delivered the largest contraction in aggregate earnings (a reduction of 56%) for Asian listed companies in recent history, whilst the Dotcom Bubble and the Global Financial Crisis led to aggregate corporate earnings shrinking by some 50% and 40% respectively. For context, the average earnings contraction (from peak to trough) through all major crises in Asia over the past quarter of a century has been c.36%. As we stand here today, earnings growth has been weakening in Asia since August 2018 (currently –19% from peak levels), but prior experiences suggest a further decline of approximately 17-20% to reach historical average levels:
Observing the virus through the lens of statistics, it would be reasonable to assume that things will get worse before they get better. Covid-19 has now infiltrated 196 countries, with the number of cases around the world growing exponentially to register over 450,000 as crisis hotspots continue to erupt outside of the Southern European epicentre, notably in the Eastern Mediterranean and the Americas. Within Asia, India looks particularly vulnerable should community transmission materialise given the deep cultural sense of community and worship, her vast, sprawling slums and an overburdened and underprepared healthcare system.
While the full scale and impact of the hit to regional and global economic growth will only be visible with the benefit of hindsight, the most recent macro datapoints from China (industrial production, retail sales and manufacturing), the UK and the Eurozone (business activity) all indicate a 1st quarter collapse in numbers, and point towards a global recession of the scale we have not seen in modern history.
It coincides with political leaders around the world jostling to institute increasingly more draconian measures in a bid to slow the spread of the virus. In many countries this has rapidly escalated towards the lockdown of entire countries.
Taken together, the impact to earnings could conceivably be far more severe and prolonged than currently being modelled by the investment community. Whilst we can completely sympathise with what is an incredibly complex and fast-moving situation, a further raft of company warnings and related earnings downgrades would seem inevitable.
Standing here today, the broader Asia ex Japan region is trading at a 12-month forward price-to-earnings multiple of 12.6x, just below regional average and median average levels of 13.8x and 13.6x since 1995. Although we have witnessed a pick-up in downward revisions to earnings forecasts since the beginning of the year, the street has only very recently begun playing catch up in mapping the growing uncertainties caused by Covid-19 against forward looking earnings forecasts for corporate Asia:
A further c.20% contraction in aggregate regional company earnings from existing levels would place the current peak-to-trough correction in-line with the average drawdown witnessed during past crises. Should this occur without a commensurate drop in share prices, Asia’s broad valuation would be c.14-15x, depending on various estimates. A cursory review of the historical price-to-earnings valuation chart suggests that is still some way from what could be considered by investors to be ‘depressed’ or ‘cheap’ levels.
For context, a band of 10.5x-11.5x has provided reasonably consistent support for Asia ex Japan earnings multiples since 1997, with the GFC a notable outlier at 8.2x:
On that basis, almost all markets in the region would seem to have scope for further multiple compression to at least previous crisis levels, an outcome that, at this moment, seems entirely plausible. Most relevant in how the current global economic shock plays out appears predicated on how much unemployment, and how many bankruptcies, can be avoided to determine the possible trajectory of any recovery. Furthermore, governments may find themselves required to reimpose drastic measures again to prevent a resurgence of the outbreak in the future. We will continue to monitor developments and, what we consider to be important datapoints, carefully.
Taking a step back, we at TEAM Asset Management remain confident that, at some point, markets will recover. Without question, when that time comes, the investment landscape that confronts us is likely to look very different to six weeks ago. We are undoubtedly living through a generational moment. From a global standpoint, we remain fundamentally bullish on the Asia consumer story, despite this sharp dislocation in markets. What has been encouraging of late is several requests from clients who are asking whether Asia has ‘bottomed’, and ‘what would we be buying?’ In this view, we have attempted to address the first question. We will address the second in a paper to follow.