A number of south-east Asian emerging markets (EM) are achieving some of the strongest economic growth rates in the world. Malaysia’s economy expanded by 8.9% y/y in the second quarter, while the Philippines saw its economy grow by 7.4% over the same period.
The Association of South-east Asian Nations (ASEAN) EM of Indonesia, Malaysia, the Philippines and Thailand are a contrasting group, with different growth drivers. What is common across all of them this year has been the benefit of economic re-opening after the pandemic, which has come later than in other global economies.
From an equity market perspective, all the ASEAN markets have been more resilient than wider EM which are down -18.6% year-to-date in dollar terms, as measured by the MSCI Emerging Markets Index at 13 September. The outcome for ASEAN has varied quite significantly though, from Indonesia, which has returned +12% to the Philippines, which is down -13.5% year-to-date. This is despite currency weakness in all four markets.
This all begs the question, are there opportunities within the ASEAN region?
Where does economic growth go from here?
Economic growth across the ASEAN economies is recovering as restrictions on activity introduced during the Covid-19 crisis are gradually lifted. Strong commodity prices earlier this year were also beneficial for Indonesia and Malaysia. Thailand has been something of a laggard on this front, with GDP growth climbing only very modestly to 2.5% y/y in the second quarter.
However, with the easing of entry requirements, tourism is rebounding and arrivals in July exceeded one million for the first time since the beginning of the pandemic. Tourism accounted for more than 20% of GDP before the pandemic, and the pickup in visitor numbers is feeding through to consumer confidence.
The outlook for growth is more complex and increasingly overshadowed by rising inflation, which is now prompting the respective central banks to raise interest rates. Higher energy and food prices are also having an impact on fiscal policy. For example, Indonesia recently announced a compensatory cash allowance for low-income families and workers in advance of a 30% fuel price hike. While Malaysia does not breakout energy subsidies in its budget, these are expected to be higher given the rise in oil prices.
Commodity prices, for industrial metals in particular, are now falling. This could have implications for external account balances in Indonesia and Malaysia. Meanwhile, the outlook for manufactured exports is clouded by expectations for a slowdown in global trade.
In Indonesia, long-term reforms under the Omnibus law, a package of changes to tax and labour market legislation, are an important support and should help to improve productivity and output. There are already signs that these are taking effect, with foreign direct investment (FDI) picking up. The increase in FDI is also linked to some relocation of manufacturing from China, as companies move to diversify their supply chains. Malaysia too is benefitting from this trend.
Another factor to bear in mind is politics.
The Philippines elected a new leader in May, with Ferdinand “Bongbong” Marcos coming to power. Despite some populist policy rhetoric on the campaign trail, policy priorities so far appear to be market friendly. It nonetheless calls for close monitoring.
Greater uncertainty over the policy outlook may come in Malaysia, where a general election is due by July 2023, and there is speculation that this could be imminent. Former Prime Minister Najib Razak lost his final appeal in August and began a 12-year prison sentence for criminal breach of trust, money laundering and abuse of power. He has applied for a royal pardon and will remain a member of parliament until a decision is made.
The political landscape has become increasingly fragmented and there is concern that, without sufficient political consensus, progress on much-needed structural reforms may be limited. Although there is the prospect of some improvement in the political outlook this is not clear yet.
In Thailand, a general election is scheduled to be held by March 2023. After a coup d’état in 2014, Thailand held elections in 2019, albeit with the senate appointed by the junta. Prior to the Covid-19 pandemic, Thailand had experienced anti-government protests, and recent opinion polling shows that the opposition Pheu Thai Party has a wide lead, with Paethongtarn Shinawatra the leading candidate for prime minister.
Paethongtarn is the daughter of former primer minister Thaksin Shinawatra, who was removed in a military coup in 2006, and the niece of former prime minister Yingluck Shinawatra, who was removed from power by the constitutional court in 2013. The constitutional court recently suspended current Prime Minister Prayut Chan-o-cha on the grounds that he has exceeded the constitutionally mandated eight years in office. Pending a final ruling, this could lead to an early election.
As with most economies around the world, inflation has been rising across ASEAN, albeit from a lower level. This is most evident in Thailand, where headline inflation hit 7.9% y/y in August, well ahead of the 2% target. Inflation is also above target in the Philippines and is near the upper end of the target range in Indonesia. Malaysia’s central bank does not state an explicit inflation target.
ASEAN central banks have started to take action to control inflation this year. The Philippines’ central bank has hiked by a total of 175 basis points (bps) to 3.75%, while Malaysia’s central bank has taken its key rate up by 75 bps to 2.5% this year. The central banks of Thailand and Indonesia have been slower to respond, only beginning to take policy rates higher in August. These were the first rate hikes since 2018.
It is worth noting, though, that despite these moves, real policy rates in Malaysia and Thailand remain firmly in negative territory.
Aggregate valuations for each ASEAN index market vary, in part reflecting some nuance in the outlook for each, as well as the available sector and stock opportunities in each market.
On a combined basis (price-earnings ratio, price-book ratio and dividend yield), valuations in Thailand, the Philippines and Indonesia are sightly behind their historical median but are not cheap when compared with other EM. Profitability in Malaysia and Thailand is also the lowest in EM, while Malaysia has seen little improvement since 2019, with some deterioration in return-on-equity in Thailand.
Malaysia is one market which does look cheap, particularly if a windfall tax on banks is phased out in 2023. However, the macroeconomic outlook faces various long-term challenges, which at least in part accounts for some of the cheapness.
It is a similar picture for ASEAN currencies. All four currencies are cheap but are less appealing when compared with other EM.
A mixed picture for south-east Asia EM
The good news for south-east Asia EM is that these economies are recovering as they start to benefit from the broader economic reopening. This is very welcome after a tough period during the pandemic.
The bad news it that much of this reopening has been anticipated by markets and is reflected in valuations. In addition, there are various challenges which could weigh on the outlook. At the market level, we do not favour the ASEAN EM. However, there are some interesting stock opportunities within the region, and a more specific, holistic assessment is warranted for each ASEAN EM.
In Indonesia, although reforms are supportive in the long term, valuations in aggregate do not stand out as attractive. In Malaysia, valuations are reasonable, but political uncertainty continues to cloud the outlook. In Thailand, the re-opening of tourism is positive, but the domestic economy continues to be sluggish. Political risk is also on the rise ahead of legislative elections. At the same time, there are some appealing companies in all three markets.
The Philippines is perhaps our least favoured south-east Asian EM. The service-oriented economy is recovering but valuations are not attractive and bottom-up stock opportunities are limited.