Coming into 2018, investors were largely optimistic about global markets, in the belief that for the first time since 2010, the world was showing synchronised global economic growth1, which should in turn lead to higher corporate profits and therefore continued upward share price movements.
But the optimism did not last long as in February, stronger-than-expected wage growth in the US alarmed global markets by its implications for inflation, and the direction of US interest rates.
It might seem counter-intuitive that good economic news would trigger a stock market fall, but markets suddenly fretted that the US economy, boosted by the Trump Administration’s tax cuts, was overheating – which could force the Federal Reserve’s hand on interest-rate rises.
The US markets promptly slumped. The Dow Jones Industrial Average plunged more than 3,200 points, or 12%, in just two weeks – including two 1,000-point plunges while the US Treasury bond yields surged to a four-year high, at 2.9%.
This market sell-off also affected Asian markets, resulting in sharp falls in Japan’s Nikkei index, Hong Kong’s Hang Seng index, the KOSPI in South Korea and China’s Shanghai Composite index.
Markets were further pressured down by the Trump administrations surprise move in March to introduce tariffs on a range of US imports, in a strategy clearly aimed at China, which again unnerved US and global stock markets – particularly as Beijing responded with plans for reciprocal tariffs, fostering concerns of a highly unwelcome trade war2.
Asian markets have since been wrestling with a rapidly escalating trade war between the US and China, two Fed rate hikes, sabre-rattling (and then unprecedented progress) on the Korean Peninsula, as well as global economic growth slowing on the back of tighter US monetary policy and a strengthening dollar. The global markets’ concerns about higher US interest rates have been realised, with a deteriorating global liquidity backdrop, as rate hikes (and the prospect of more to come) continue to lure offshore US dollar holdings back to the United States and many Asian currencies weakening against the resurgent greenback. Higher oil prices are also weighing on economic conditions across Asia, with higher petrol and diesel prices having an impact on disposable incomes3.
More recently, markets have been further hit by the Trump Administration escalating the trade conflict by imposing 10% tariffs on US$200 billion worth of Chinese imports, with plans to lift those duties to 25% at the end of the year4. In response, having advised the US that it would retaliate against new trade barriers, Beijing has announced retaliatory action. This has prompted the White House to talk about “phase three” of US action: tariffs on approximately US$267 billion worth of additional imports5.
Trade war fear has turned a promising 2018 sour for many Asian markets
In China, the benchmark Shanghai Composite Index is officially in a bear market, down more than 24% from its January peak, and at its lowest level since June 2016. The slide, which makes the Chinese benchmark one of the world’s worst performers this year, coincides with Beijing’s further concerted efforts to deleverage the Chinese economy, its continued crackdown on ‘shadow banking’ and its campaign to reduce pollution and inefficient use of resources in heavy industry.
In Hong Kong, the Hang Seng index is down more than 17% from its January peak, while the China H-shares Index (which tracks companies incorporated in mainland China and listed in Hong Kong) is also down 23%. Hong Kong is considered especially vulnerable to volatility in the US and China, given that its currency is pegged to the dollar and therefore tied to US monetary policy, while many of its companies generate most of their earnings in China.
In South Korea, the KOSPI index remains 11.1% off its January peak, and down 6.4% for 2018. In Indonesia, the IDX Composite index is down 11.8% from its February high. In Malaysia, the FTSE Bursa Malaysia KLCI Index is down 4.3% on its April peak – having been almost 8% down at one point – and is now almost square for the year. In Singapore, the Straits Times Index has lost 11.1% from its April peak, and 8.9% for 2018 to date. In Thailand, the Bangkok SET Index has come off 4.8% from its January high.
Asian stock declines are not uniform across the region
In Japan, the Nikkei index has mounted a recovery of almost 15% since March, to just 1.9% shy of its January peak and is up 4% for the year. In India, the Bombay Stock Exchange (BSE) Sensex index has escaped the turmoil and is up just under 9% for 2018.
Paradoxically, across Asia, countries’ real economies are reasonably strong and market movements reflect a sense of nervousness about the macro-economic implications of the trade conflict. The economic fundamentals of the countries are widely seen as being very different from the “Asian Crisis” of 1997.
The Asian markets have varying degrees of idiosyncratic issues
For instance, the 1MDB political scandal in Malaysia, South Korea’s relationship with North Korea, Indonesia’s slumping currency, and Japan’s internal re-arrangement, as the Abe government continues its ambitious reform program.
More recently, reassuring comments from Chinese President Xi Jinping, confirming that Chinese authorities will not purposely devalue the yuan in response to trade tensions, have been interpreted as reassuring investor confidence in China (and in broader Asia) to the effect that China is not seeking to inflame the trade situation further6.
Left to themselves and without these broader concerns, Asian stock markets have the capacity to return to focusing more on the long-term factors that drive economies and markets, such as improving gross domestic product (GDP), consumer confidence, business investment and corporate earnings.
In Japan, companies reported an increase of 19% in their pre-tax profits for the April-June period, and according to Daiwa Securities, analysts expect their annual pre-tax profits to rise by 11.4% for the financial year ending March 2019. Daiwa expects companies to raise their conservative outlooks when they report mid-term results later this year7.
In the short term, the trade turbulence has pushed many investors into the perceived safe-haven of the yen, and a stronger yen cuts Japanese exporters’ profits. However in the longer term, the strong profit outlook at many Japanese companies can be taken as supporting the investment case for Japanese stocks8.
An investment case can also be made for the other major Asian outperformer, India, where India’s equity markets, driven by potent tailwinds, could yield attractive returns in coming years. India’s economy expanded at an annual rate of 8.2% in the June quarter, the fastest among all major economies.
Although, like many Asian markets, India is being buffeted by the macro-economic and geo-political outlook9 with long-term factors such as India’s favourable demographics, stable democratic institutions, strong education system, transformative digital infrastructure improvements, aspirational population and entrepreneurial business class, as giving investors the potential to generate positive returns from its large and diverse stock market.
For now however, nearly all Asian markets are facing elevated risk through the contagion effect of the Trade war outcomes between the US and China, mainly through uncertainty that impacts confidence and positive business activity. For investors as always, it is important to do your own informed research or seek the advice of a professional.
This document has been created by Westpac Financial Services Limited (ABN 20 000 241 127, AFSL 233716). It provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such. This article is current as at 20 September 2018 and may contain material provided by third parties derived from sources believed to be accurate at its issue date. While such material is published with necessary permission, no company in the Westpac Group accepts any responsibility for the accuracy or completeness of, or endorses any such material. Except where contrary to law, we intend by this notice to exclude liability for this material.
This information does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness, having regard to your personal objectives, financial situation and needs, before acting on it.
Past performance is not a reliable indicator of future performance. © Westpac Financial Services Limited 2018