Where To Find Value In Emerging Asia

Includes: ECNS, MCHI
by: Russ Koesterich, CFA

This week, I’m updating my views on some of the emerging market countries in Asia.

While I’m upgrading Chinese equities from neutral to overweight, I’m downgrading South Korean and Indian stocks from neutral to underweight.

Starting with China and South Korea – the two countries are both highly exposed to global growth, but China currently appears to be the better positioned of the two and is likely to hold up much better from a growth perspective.

First, while Chinese equities have performed well year to date, they are down over the past 12 months. As a result, Chinese equities are cheap compared to other Asian emerging market countries, trading at 1.6x book value.

Recent economic data also suggest that growth in China is stabilizing and supports a soft landing. The most recent purchasing managers index, a key measure of manufacturing activity, came out last week at a better-than-expected 50.5, and retail sales growth is actually up to 18.1% year-over-year. Finally, Chinese inflation, which we all know was a big problem in 2011, is falling. It’s down to 4.1% from 5.5% in November and 6.5% in August.

To be sure, South Korean equities are also cheap compared to other emerging markets. This, however, is normal. South Korea typically commands a big discount due to ongoing uncertainty over North Korea. The cheapness of South Korean stocks is also justified given the country’s worsening economic outlook. South Korea’s economic readings have particularly suffered recently.

Finally, I’m downgrading India in response to the country’s recent surge in valuations and persistently high inflation. Indian stocks appear expensive once again. They are up more than 20% year to date and are currently trading at 2.6x book value. This compares with the Asian emerging market average of 2.4x book value.

In addition, growth in India is still strongly below trend and while the country’s profitability is respectable, it has been on a downward trend over the last couple of months. Finally, Indian inflation, while down from a couple of months ago, is still in the danger territory at 9.3%. All in all, Indian stocks are simply too expensive given current fundamentals.

International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Securities focusing on a single country may be subject to higher volatility.

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