While the first quarter of 2016 was negative for Chinese equities, the Invesco International and Global Growth team is cautiously optimistic on China in the near term given the government’s stimulus measures. We’re even more optimistic in the longer term as China transitions from an export-led economy to a consumer- and services-driven one. In Japan, however, we see that government stimulus has not been effective, and growth remains elusive.
China: Valuations look too high in most sectors
The Shanghai Stock Exchange Composite Index was down almost 15% in the first quarter, and the Hang Seng Index was down more than 5%.1 And yet, the price-to-earnings (P/E) ratio of Chinese equities is roughly at its average for the past five years,2 so the region overall is offering less growth for the same valuation.
In terms of sectors, we’re seeing pockets of opportunity right now from an EQV (Earnings, Quality and Valuation) perspective, particularly in consumer staples, where valuations have gone against the trend and come down. Two of our newer names, WH Group Ltd. and Kweichow Moutai Co., Ltd. (1.87% and 1.66% of Invesco International Growth Class, respectively, and 1.56% and 1.45% of Invesco Global Growth Class, respectively), are both in the Chinese consumer staples sector. WH Group, which we added in the second quarter of 2015, is the largest pork producer in the world, and Kweichow Moutai, which we added in the third quarter of 2015, is an iconic brand in Chinese spirits.
Japan: Growth outlook is subdued
In Japan, foreign investors seem to be losing faith as they were large net sellers of Japanese equities in the first quarter. Economic stimulus from the Bank of Japan (BoJ) has not been effective, and we see risk of a weaker profit cycle and strengthening yen hurting Japan’s export-driven economy.
We believe the government may be hitting a point of policy exhaustion after the massive expansion of the BoJ’s balance sheet as well as taking interest rates to a negative level. The economy saw negative gross-domestic-product (GDP) growth again in the final quarter of fiscal year 2015, and fiscal year 2016 is expected to bring only 0.5% of GDP growth for the year.3
The weak economy, lack of capital expenditures and strong yen were significant contributors to negative earnings-per-share revisions, which were down 4% during the first quarter.4 The consensus return on equity for Japanese equities over the next 12 months is projected to be less than 10%.5 We’re constantly looking for opportunities in Japan, especially in the face of market pullbacks. The forward P/E ratio of the MSCI Japan Index is 12.7 times versus its five-year average of 13.5 times,6 meaning that new opportunities may turn up if Japan continues to underperform. However, the main limiting factor, from our point of view, is that high-quality companies are still expensive from a valuation standpoint.
Looking at Asia overall, valuations currently look attractive in Southeast Asian countries such as the Philippines, Thailand, Singapore, Indonesia and Malaysia.