Venturing into ASEAN

• Fear of contagion crisis and trade war have driven currencies and equities down but ASEAN-5 economies still remain fundamentally sound.
• ASEAN-4 economies are more consumption-driven and intra-ASEAN trade weighs more than trade with China.
• Financial valuations are looking more attractive, stay for the long haul.

The turmoil in Argentina and Turkey has led to sell-off in currencies and equities of countries belonging to the EM group, with those that have a twin deficit in their fiscal budget and current account balance suffering heavier losses in their currencies, e.g. Indonesia and Philippines. For heavy exporters, their stock indices suffered losses due to their relations with China. However, the economies of the ASEAN-5 are fundamentally sound and they should be able to ride the wave of fear through. Furthermore, the ASEAN economies are looking to benefit from demographic changes and higher economic integration as addressed in our previous article.

Chart 1: Currency Performance (YTD) vs Current Account Balance (% of GDP)

Chart 2: Index Returns (YTD) vs Current Account Balance (% of GDP)

What is Contagious?

Countries that have a current account deficit and high external debt could face a widening current account deficit and refinancing risks as the USD appreciates. A weaker local currency could cause imported inflation and high external debt denominated by foreign currency would see higher refinancing costs and subsequently, higher default risk, case in point being Argentina.

Focusing on Indonesia and Philippines, the reality is that they are well-equipped to deal with the strength of the USD.  Although both countries have a current account deficit of -1.72% and -0.76% of their GDP, they are not as high as Argentina’s -4.80%.  On the external debt front, they are nowhere as high as Argentina’s 39.8%, although Indonesia comes close at about 35%.

Chart 3: External Debt (% of GDP) for Philippines and Indonesia

Furthermore, Indonesia and Philippines still possess a healthy amount of international reserves – USD 114.8 billion and USD 75.1 billion respectively as of end-September. For Indonesia, this allows financing of 6.3 months of imports and servicing of government external debt, twice as high the international standard of reserve adequacy of 3 months of imports. For Philippines, it covers 6.4 times of their short term debt.

Interest rates have also risen to combat against the depreciation of the local currencies with Indonesia hiking five times from 4.25% to 5.75% this year, while Philippines have increased interest rates by 150 basis points with more expected hikes coming in as inflation rises higher than expected (as of end-September). While higher interest rates will affect growth prospects in the near-term, central banks will have more room to navigate after the contagion fears blow over, which will spark a recovery in domestic consumption and corporate earnings.

It seems that investors are fleeing the EM and Asia equities space to the safety and strength of the US due to trade tensions and contagion fears, especially when risk free rates in the US are the highest in a few years, rather than having concerns over fundamentals of the countries. Stock indices of certain countries have become much more attractive (e.g. Singapore) as the sell-off continues.

Expect Volatility In The Near Term

Looking at the components of GDP of the ASEAN-5, domestic consumption for all of them except Singapore contributes to more than 50% of their national GDP while net exports contributes to below 10% of GDP, with Philippines being a net importer. Looking at exports volume as a percentage of GDP, we can conclude that only Indonesia will remain relatively unscathed from trade tensions and a slowdown in China’s economy.

However, intra-ASEAN trade still outweighs trade to China with ongoing plans looking to further increase intra-ASEAN trade volume. While effects of a full-blown trade war and a slowdown in China’s economy will still be felt, it should be rather muted for Malaysia and Thailand. The two countries may even benefit from foreign direct investment being redirected from China.

Chart 4: Components Of GDP In 2017

Chart 5: Exports & Imports In 2017 (As % Of GDP)

Chart 6: Percentage Of Exports To China & ASEAN In 2017

Thus, we will expect relatively higher volatility to persist in the near term due to uncertainty surrounding trade tensions, and when Indonesia, Philippines and Thailand hold their elections in the first half of 2019.

Furthermore, with how oil prices have been climbing and all of the ASEAN-5 economies being a net oil importer, we could see higher imported inflation staying for the near future, with Philippines being more adversely affected due to their weaker currency and fiscal deficit. Indonesia faces a similar problem but the government is increasing their oil subsidies. Malaysia and Thailand also have oil subsidies given by their governments, thus imported inflation should be controlled for these countries.

However, as we are taking a long term view on the ASEAN region, volatility could be seen as an opportunity to accumulate more holdings at a lower price.

Financial Valuations

Since we are heading into the fourth quarter of 2018, we will be examining the 2019 Price-to-Earnings (PE) Ratios for the equity indices of the various countries. Estimated 2019 PE ratios for Thailand and Malaysia are fairly high, with them being higher than our fair PE ratio. Singapore’s and Indonesia’s 2019 PE ratios are looking attractive, with both of them being some values off their fair PE ratio. Recent events have made these stock indices cheaper and we believe investors can start accumulating their holdings through dollar-cost averaging and holding on for long-term gains.

Chart 7: Estimated 2019 PE Ratios for Stock Indices

The Price-to-Book (PB) ratios of the stock indices of the ASEAN-5 countries tell a similar story. All of the indices except Singapore trades at a PB ratio near to 2.0X. However, recent events have caused them to trade at a PB ratio that is below their 10-year average, bar Thailand.

Chart 8: PB Ratios of ASEAN-5 Stock Indices

Boarding the Investment Train

With how currencies have been performing this year, potential returns could come via two channels – local currency gains and equity returns. The Indonesian rupiah and Philippines peso have depreciated -7.6% and -5.2% year-to-date respectively while the Malaysian ringgit and Thai Baht have appreciated 0.9% and 3.1% year-to-date respectively against the SGD. With the central banks of Philippines and Indonesia repeatedly hiking interest rates, we should see their respective currencies appreciating in the long run, thus extending returns.

For this region, we prefer an active management strategy as fund managers have the liberty to scrutinise and choose stocks depending on their fund strategy. Furthermore, fund managers have the choice to invest in small-cap companies, allowing for higher growth potential but at a cost of higher volatility.

We do not have a recommended fund for the ASEAN region but the JP Morgan ASEAN Equity fund is worth taking a look. The fund overweighs the financial sector, which we believe will be a key player in stimulating and realising potential growth in the region. The fund manager also has more than a decade worth of experience in investing in the Asian equity space.

For those preferring a passively managed fund, they can look at the CIMB FTSE ASEAN 40 ETF which comprises 40 leading stocks from the ASEAN-5 economies.

Those who have exposure to Singapore stocks and wishes to have more exposure to the developing economies in ASEAN can check out the PREMIAE ASEAN ETF. The ETF tracks the recently incepted Dow Jones Emerging ASEAN Titans 100 Index, which seeks to measure the performance of 100 of the largest companies from Indonesia, Malaysia, Philippines, Thailand, and Vietnam.

Investors who are more adventurous and want higher exposure to the individual countries can look at our recommended funds:

The Research Team is part of iFAST Financial Pte Ltd.