Jonathan Garner: A Bullish Turn on Asia and Emerging Markets

As Asia and Emerging Markets move from a year of major adjustment in 2022 towards a less daunting 2023, investors may want to change their approach for the beginning of a new bull market.

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Welcome to Thoughts on the Market. I'm Jonathan Garner, Chief Asia and Emerging Market Equity Strategist at Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, in this episode on our 2023 outlook, I'll focus on why we recently turned more bullish on our coverage. It's Thursday, 1st of December at 8 a.m. in Singapore. 

2022 was a year of major adjustment, with accelerating geopolitical shifts towards a multipolar world, alongside macro volatility caused by a surge in developed markets inflation, and the sharpest Fed tightening cycle since the Paul Volcker era 40 years ago. This took the U.S. dollar back to early 1980s peaks in real terms, and global equities fell sharply, with most markets down by double digit percentages. North Asian markets performed worse as a slowdown in tech spending, and persistently weak growth in China, weighed on market sentiment. But structural improvement in macro stability and governance frameworks was rewarded for Japan equities, as well as markets in Brazil, India and Indonesia. 

Our 2023 global macro outlook paints a much less daunting picture for equity markets, despite a slower overall GDP growth profile globally than in 2022. Current market concerns are anchored on inflation and that central banks will keep hiking until the cycle ends with a deep recession, a financial accident en route, or perhaps worse - that they leave the job half done. But, and crucially, our economists forecast that U.S. core PCE inflation will fall to 2.5% annualized in the second half of next year. Alongside slowing labor market indicators, our team sees January as the last Fed hike, with rates cuts coming as soon as the fourth quarter of 2023, down to a rate of 2.375% at the end of 2024. 

Meanwhile, inflation pressures in Asia remain more subdued than elsewhere. This top down outlook of growth, inflation and interest rates all declining in the U.S. and continued reasonable growth and inflation patterns in Asia should lead to a weaker trend in the U.S. dollar, which tends to be associated with better performance from Asia and emerging market equities.

Meanwhile, for the China economy, we think a gradual easing of COVID restrictions and credit constraints on the property sector deliver a cyclical recovery, which drives growth reacceleration from 3.2% in 2022 to 5.0% in 2023. Consumer discretionary spending, which is well represented in the offshore China equity markets, should show the greatest upturn year on year as 2023 progresses. Crucially, this means that we expect corporate return on equity in China, which has declined in both absolute and relative terms in recent years, to pick up on a sustained basis from the current depressed level of 9.5%. 

We also think that end market weakness in semiconductors and technology spending, consequent upon the reversal of the COVID era boom, should gradually abate. Our technology and hardware teams expect PC and server end markets to trough in the fourth quarter of this year, whereas smartphone has already bottomed in the third quarter. They recommend looking beyond the near-term weakness to recognize upside risks, with valuations for the sector now at prior market troughs and the current pain and fundamentals priced in by recent earnings estimates downgrades in our view. We therefore upgraded Korea and Taiwan and the overall Asia technology sector in early October and expect these parts of our coverage to lead the new bull market into 2023. 

Finally, given greater GDP growth resilience and less sector exposure to global downturns, Southeast Asian markets such as Singapore, Malaysia, Indonesia and Thailand, collectively ASEAN, tend to outperform emerging markets in Asia during bear markets, but underperform in bull markets given their low beta nature. Having seen a sharp spike in ASEAN versus Asia, relative performance in the prior bear market, which we think is now ending, our view is that the trend should reverse from here. 

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