Asia’s growth recovery has been bumpy and uneven both across the region and within individual economies. Investors should expect continued divergence.
Asia’s growth recovery has so far been predictably bumpy and uneven, both across the region and within individual economies. Countries geared to electronics and semiconductor manufacturing have continued to fare well, while those with more services-oriented (particularly tourism-dependent) economies have lagged. Continued pandemic waves have also disrupted the recovery. India, Malaysia and the Philippines have suffered setbacks as outbreaks have prompted further lockdowns. Even in Taiwan, which had a stellar record of containment, a wave of new infections prompted lockdowns and restrictive measures, showing that until vaccination rates improve, the recovery path will remain bumpy. At the sector level the recovery has also been uneven. Using China as an example, the key drivers remain exports and investment, while consumption has lagged. Precautionary savings have remained elevated and services consumption has been relatively weak.
But keeping an eye on the big picture, we expect Asia to broadly remain on a healthy recovery path. The export cycle should become more broad-based, moving beyond the tech sector, as global growth remains solid. Technology demand remains robust and inventories are at record low levels, meaning inventory restocking demand should boost industrial output growth in coming months. Business investment is likely to strengthen in the U.S. (further supporting exports) and higher commodity prices will benefit commodity exporters in the region.
For investors, the bottom line is to expect continued divergence. Vaccinations, growth drivers, and policy are diverging widely across the region, and investors need to invest selectively and actively. When looking across countries and sectors, we think three factors will be key to watch over the rest of 2021: vaccination progress, exports (particularly semiconductors), and China’s recovery.
First, vaccination progress will be a key factor both for the region as a whole and in terms of relative performance within the region, for three reasons. Vaccinations are the key to reopening borders – regions that rely more heavily on tourism and the free flow of people cannot fully recover until borders reopen and that can’t happen until the region reaches a level of herd immunity. Thailand and Hong Kong stand out as at risk. Second, new waves and rolling lockdowns will be a persistent threat, and this depresses business and consumer confidence, leaving business investment and consumption broadly weaker. This is a key reason behind China’s lagging domestic demand. Lastly, services can’t fully recover. Spending on travel, restaurants, and other services are negatively impacted in light of continued restrictions and health concerns. This disproportionately affects countries with large service sectors such as India and the Philippines.
Although lagging most developed markets throughout this year, the region has made tremendous progress in recent weeks. China and Singapore are relatively ahead of the game, with 43% and 46% of those populations receiving at least one dose respectively. Even those that were lagging significantly behind are now making progress towards their vaccination goals.
For example, South Korea is now at 25%, and Japan reached 15% following the recent push. China, Singapore, South Korea and Taiwan are expected to have over 60% of their population receive at least one dose of a vaccine by the end of this year, which is believed to be a reasonable inflection point to achieve community immunity (i.e. full resumption of economic activity without infection control concerns).
Uneven COVID containment and uneven vaccination progress has and will be a key driving force behind regional dispersion, and we continue to favor the countries making progress, such as China, Korea, and Singapore. We are also closely watching for signs of progress in the vaccine laggards that could disproportionately benefit from re-opening, such as Southeast Asia.
Second, exports have been a key factor driving Asia’s recovery, and will likely remain so. Economies highly geared to global trade such as China, South Korea and Taiwan have benefited from the strong stimulus in the U.S., and as mentioned above, we expect that to continue as global re-opening and growth shifts from the U.S. to the rest of the world. While demand for goods should moderate as re-opening shifts spending towards services (for anyone who’s watched a recent NBA playoff game – the jam-packed arenas are a perfect example), global growth is likely to remain above trend, supporting continued export growth.
While overall trade has been a key factor for the region, one product has defined 2021 more than any other: semiconductors. Extraordinarily strong semiconductor demand has been a key reason behind the economic outperformance of Northeast Asia and furthers our view that the region will see continued dispersion. The current shortage in semiconductors has been ongoing since the end of 2020 and has been primarily driven by strong demand due to a variety of factors: pandemic effects (work/study from home, etc), EV demand, 5G smartphones, cloud computing, cryptocurrency mining, and automation. US-China trade tensions have added to supply shortages due to US restrictions on technology exports to China’s Semiconductor Manufacturing International Corporation(SMIC), which accounted for ~5% of global chip production in 2020, and stockpiling by Huawei and other Chinese firms.
The ongoing chip shortages will further the differentiation within Asia. Chip producers will clearly benefit, while manufacturers of autos and consumer electronics will suffer due to limited supply and higher raw and intermediate input (i.e., chips) prices. Taiwan and South Korea stand out as the clearest beneficiaries. Taiwan’s dominant position in global foundries and Korea’s strong position in the memory market mean that both countries materially benefit from rising chip prices and stronger tech demand. By contrast, Thailand could suffer given the large share of automotives in manufacturing production (13.8%). For China, the impact could be negative but limited, as supply shortages could limit electronics production.
The third factor is China. China’s cycle has an outsized influence on the region and recent data shows the recovery to be moderating. The recovery also remains uneven; growth in the industrial sector is robust while the consumer recovery still lags. The persistence of the divergence was driven by the virus resurgence in Asia in Q2. As the global supply chains experienced further disruptions, China picked up a lot of the export orders that other countries suddenly could not fill. But China itself was also not completely unscathed, even with its far more effective virus containment. The identification of local clusters in Guangdong province, which accounts for 22% of China’s total exports, hampered Chinese companies’ abilities to ship goods out in time. These incidents also weighed on the consumption growth recovery.
But these disruptions are fading. Heading into 2H, we still expect the disruptions of the pandemic- in terms of both positive and negative shocks - to continue subsiding. On the export side, given the backdrop of strong consumer demand in developed markets, the underlying strength in the export sector is unlikely to materially reverse. But the supply of vaccines in the developing world should generally start to improve in 2H, helping to ease supply bottlenecks to some degree. Meanwhile, the domestic labor market continues to heal, and as vaccination rates pick up further, consumer spending should catch up to the improvement in income growth.
Another consequence of the pandemic is distortions on prices. Given supply chains are global, China has also seen a rapid rise in prices in its industrial sectors over the last few months. The producer price index (PPI) rose by 9% y-o-y in May. Many sectors are at or close to the highest capacity utilization rate possible. In turn, regulators have introduced a series of policy changes (from reining in speculation to releasing reserves) in order to temper prices. So far the transmission to consumer prices has been limited. This is partly because China’s consumer recovery was gradual to begin with, and also due to the fact that monetary and fiscal policies have been tightening in the background. So while we expect consumer inflation to pick up in the next few months, we expect the overall inflation level to be healthy.
How to invest over the rest of 2021?
We expect Asia to remain on a healthy recovery path, albeit one with wide divergences between economies. Last year saw one of the widest dispersions between the best and worst performing Asian markets in many years and we expect that type of trend to continue. Large differences in terms of COVID containment and vaccination progress, share of goods versus services, and the path of policy will continue to create large relative differences, leaving a more active approach as the best strategy for investing in the region. We still favor Northeast Asia (China, Korea, and Taiwan) given their exposure to structural forces such as digitalization and semiconductor demand, but as vaccinations pick up the recovery will eventually spread to South and Southeast Asia supporting both their currencies and equity markets.
Strong exports, even if not accelerating further, will continue to support the RMB. From this perspective, RMB-based assets are still a good way to gain exposure to the strong global recovery. Meanwhile, for the equity market, regulation will play a pretty key role. We do not expect China’s more counter-cyclical policy stance to materially shift. So in the short term, a more diversified portfolio may help to reduce exposure to regulatory risks. From a long-term perspective, China’s Five Year Plan is a good guide in terms of the sectors that will outperform. We believe investors should pay attention to Beijing’s focus on industrial upgrading, sustainability (towards the carbon neutrality target), and boosting domestic demand.
All market and economic data as of June 21, 2021 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
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