Asia Pacific Investment Outlook for 2016

Introduction
In this report, I will touch on the key themes for the Asia Pacific region which are
(a) Slower GDP Growth Rate in Asia Pacific Region in 2016, (b) Weakening Asian
currencies and (c) Gradual Recovery in Oil Prices and Commodities, and their possible
impact for the bond and equities markets.

Asian economies will continue to struggle in 2016-17 due to China

Asia Pacific GDP Growth Forecast (%YOY Change)

Regional GDP Growth

ASEAN
China
India
Japan

2013
5.7
5.0
7.7
6.9
1.6

2014
5.7
4.4
7.3
7.3
-0.1

2015
5.4
4.4
6.9
7.2
1.0

2016F
5.3
5.0
6.4
7.1
1.7

2017F
5.1
5.2
5.9
6.8
1.2

Regional Inflation
ASEAN
China
India
Japan

4.6
4.4
2.6
10.7
0.4

3.6
4.4
2.1
6.7
2.7

2.8
3.4
1.7
5.6
1.0

3.5
4.4
2.4
5.9
1.4

3.6
4.4
2.4
5.8
2.2

Source: The Economist Intelligence Unit

The next 18 months will be challenging for Asian policymakers with expected slower
economic growth in 2016 (refer to above table) as they face tightening monetary policy in the
US and rising import costs due to weaker currencies.
They also have to adjust to slower demand in China as the economy shifts to a more
consumption-driven growth model. They will face these challenges at a time when there are
concerns about the build-up of leverage, particularly in China but also in the wider region,
following the global financial crisis of 2008-09.
Argentina
Mexico
Indonesia
India
South Africa
Russia
Turkey
Brazil
Chile
Thailand
South Korea
China
Malaysia
Singapore
0

100

200

300

Emerging-market private debt as % of 2014 GDP

Source: JP Morgan; BIS; IMF

Deleveraging in developed markets has been more than matched by debt accumulation in
Asian emerging markets (as can be seen in the above chart). According to McKinsey, a
consultancy, the global stock of debt outstanding rose by US$57trn between 2007 and 2014.
So far in 2015, firms have defaulted on USD95bn debt, the highest level since 2009, with
companies in emerging economies defaulting more than US firms, according to Barclays
Bank.
Cheaper oil has benefited many Asian energy importers by boosting real spending power.
This benefit will soon begin to fade and inflationary pressures will build again. Low inflation
has helped central banks to keep monetary policy looser for longer than would otherwise
have been the case.
Since the start of 2015 monetary authorities in ten economies of varying profiles have
lowered interest rates or otherwise loosened policy. Low energy prices (and inflation and
interest rates) have lifted real disposable incomes, supporting consumption spending.
But this support for growth is fading, and the first interest-rate rise by the Fed (when it
eventually arrives) will usher in a gradual period of Asian monetary tightening. When this

does happen it is likely that this will cause stock, bond and currency markets to fall, with
capital running back to safe-haven markets. This will put some borrowers under strain and
lead to a rise in non-performing loans (NPLs) in the regional banking systems.
The experience of the "taper tantrum" in 2013 (when the Fed merely suggested that its
quantitative easing (QE) programme would be wound down) suggested that economies with
twin government and external deficits were the most vulnerable to capital outflows, led by
India and Turkey. This time around I am less worried over India, where the government and
central bank are under different (and perhaps more capable) management.
The prospect of a weaker renminbi has added to policymakers' concerns. Changes to the
renminbi's reference rate mechanism in August saw the currency lose 4% of its value against
the US dollar, and triggered further depreciations in other Asian currencies. This can likely
happen again in 2016, given the underlying weaker economic conditions in China.
The adjustment in the value of the renminbi fuelled fears that there was greater concern about
the health of the Chinese economy from within the Chinese government than was previously
assumed. In fact, since the policy shift, the Chinese authorities have intervened to support the
renminbi. But capital outflows and a loss of reserves suggest that the renminbi will remain
under pressure.
Moderating growth in China will be a further headwind for Asian exporters, who have
become used to huge demand from the region's behemoth. China's use of more domestically
produced inputs in its manufactured products, rather than imported components, is a major
factor behind the slowdown in world trade, which is especially evident in Asia at present.
Despite these risks, I am of the view that there is little likelihood of a major emerging-market
blow-out, such as that last seen in 1997-98. According to estimates by the Economist
Intelligence Unit, the stock of foreign reserves in non-OECD economies stood at US$9.2trn
in 2014, compared with just over US$1trn in 1997.
This time round, fewer economies operate pegged exchange rates, and borrowing in foreign
currencies by emerging-market sovereigns is also a much smaller share of the economy than
it once was. Lastly, more emerging markets have developed local-currency bond markets.
This means that bonds do not become much more expensive to service when the US dollar
appreciates.
But even assuming that emerging markets survive the next two years without a series of
defaults, the outlook for growth still remains challenging. Terms of trade for emerging
markets are unlikely to improve significantly in the coming years, as commodity prices will
increase only slowly and Chinese demand, for so many years a catalyst for emerging-market
export growth, is slowing permanently.
Looking at the first table on page one, ASEAN economies are expected to grow 4.4 percent
in 2015, roughly stable from the previous year, before rising to 5 percent in 2016 and 5.2
percent in 2017. However, the outlook is mixed. Among the large ASEAN nations, growth
conditions will be most buoyant in the Philippines and Vietnam. The outlook was less
optimistic for Indonesia, Malaysia and Thailand.

Weak global commodity prices continue to dim the prospects for business profits and
household incomes in Indonesia and Malaysia. Meantime, in Thailand, political uncertainty is
likely to weigh on private investment, while high levels of household debt will hurt private
consumption.
Growth in developing Asia will likely be slower than previously thought as a slowdown in
China's economy hurts demand. Instead policymakers in the region will need to focus on
achieving the more difficult, long-term growth that comes through improving the business
environment and raising the rate of investment in infrastructure, but this will have to come at
a time of rising borrowing costs. The heady days of stellar growth seen during the 2000s are
now a thing of the past.

Asian EM currencies are likely to come under further pressure in 2016

Exchange Rate Forecasts Against the USD
2014
2015F
Australia
AUDUSD 0.82
0.70
New Zealand NZDUSD 0.78
0.65
Japan
USDJPY
120
125
China
USDCNY 6.21
6.60
Hong Kong
USDHKD 7.76
7.75
South Korea
USDKRW 1091
1210
India
USDINR 63.0
67.0
Indonesia
USDIDR
12388
14300
Malaysia
USDMYR 3.50
4.16
Philippines
USDPHP 44.7
47.0
Singapore
USDSGD 1.33
1.44
Thailand
USDTHB 32.9
36.5
Source: Scotia Bank

2016F
0.74
0.67
131
6.80
7.75
1190
68.0
14400
4.08
46.0
1.48
37.0

1Q2016F
0.71
0.66
128
6.65
7.75
1205
67.3
14325
4.14
47.8
1.45
36.6

2Q2016F
0.72
0.66
129
6.70
7.75
1200
67.5
14350
4.12
46.5
1.47
36.8

3Q2016F
0.73
0.67
130
6.75
7.75
1195
67.8
14375
4.10
46.3
1.48
36.9

4Q2016F
0.74
0.67
131
6.80
7.75
1190
68.0
14400
4.08
46.0
1.48
37.0

The recent rally in emerging-market currencies has been impressive, although most
currencies remain well below their levels against the dollar at the start of 2015. Further gains
are possible in the short term, particularly as emerging-market assets are now cheaper relative
to those in the developed world than they have been for years, which could attract bargain
hunters.
Historically, pressure on emerging-market currencies has tended to peak as markets anticipate
a US monetary tightening cycle and to abate once the cycle begins. But emerging-market
currencies are unlikely to mount sustained rallies unless there is an improvement in
underlying economic performance. This is not a prospect in 2016 given the build-up of
excessive leverage in some emerging markets, the slowdown in China, and the subdued
outlook for commodity prices.
The renminbi has been weakening over the past 2 years. It peaked around 6.05 against the
USD a couple of years ago and has been on a steady but uneven move down since then. The
market bias is clearly for it to be even weaker. As you can see on the table above, the
renminbi is expected to weaken further to 6.80 in 2016. The expected weakening of the
renminbi against USD will clearly have repercussions for other Asian EM currencies, as they
attempt to maintain their relative competitiveness.

Within Asia, the IDR is the most at risk to capital flight. The type of capital flows received by
Indonesia in recent years has been dominated by speculative capital flowing into financial
assets such as bonds and equities, rather than the more stable foreign direct investment in
industries.
As for the MYR, its intrinsic weaknesses are well known. It has been attacked on a number of
fronts. Weak demand for Malaysian exports, particularly oil products and natural gas, which
make up nearly a quarter of total exports, has persisted since oil prices collapsed last year.
The ringgit is closely linked to the price of Brent crude, and mirrors volatility in oil prices in
to a large extent. This decline has had a moderate impact compared to the drastic effect of the
current confidence crisis that has gripped investors.
Since the 1MDB scandal unfolded in July 2015, investor sentiment has deteriorated and the
currency has suffered along with it. Controversy over allegations about Prime Minister Najib
Razaks connections to the misappropriation of funds from the struggling state-owned
investment fund (1MDB) have fanned political uncertainty as well, and calls for the Prime
Ministers resignation have grown, even from within his own party.
Investor confidence in Malaysia was further dampened as uncertainties over the future path
of the Feds impending rake hike helped to keep the ringgit trading at historically-low
levels. However, if the general emerging economies outlook shows durable improvement,
the ringgit will recover from its current oversold levels.
As for the Singapore dollar, it has been dogged by low growth and a disinflationary setting in
the economy. The weak currencies of its regional trading partners have also not helped the
SGD against the USD, given the policy management of the SGDs trade-weighted basket.
The domestic macro conditions in Singapore also argue for the SGD to trade below the midpoint of its (nominal effective exchange rate) band.

Oil prices will recover only slowly from their collapse in 2015
I am of the view that crude oil prices will not recover back to the pre-2014 levels within the
forecast period, as modest demand growth will fail to catch up with resilient supply. Despite
a dip in US production, global crude supply will expand further in 2016 on the back of
continued output growth from OPEC and, to a lesser extent, Russia.
Combined with moderating demand growth, this will only allow a gradual increase in prices.
In 2017 consumption growth will firm in line with strengthening global economic
performance, while higher-cost suppliers outside OPECincluding in Africa and Europe
will continue to struggle, maintaining upward pressure on prices.
However, renewed expansion in US shale production will keep a lid on prices, and we project
that dated Brent Blend, the international benchmark, will rise up to US$60/barrel in 2016 and
US$73/b in 2017. This is up from an estimated US$53/b in 2015, but far below the average of
the preceding five years (US$102/b).

Commodity prices will stabilise in 2016, after four consecutive years of

decline
Commodity Price Forecasts
Oil Prices Brent (USD/lb)

2013
108.9

% Change in USD Prices

Non-oil Commodities
-7.2
Total Food, Feedstuffs &
-7.4
Beverages
Beverages
-12.2
Grains
-5.9
Oilseeds
-5.8
Sugar
-17.9
Industrial Raw Materials -6.9
Metals
-6.8
Fibres
-0.1
Rubber
-15.7
Source: The Economist Intelligence Unit

2014
98.9

2015F
53.4

2016F
60.0

2017F
72.7

-5.2
-5.2

-16.5
-18.2

2.7
3.0

5.9
4.8

21.5
-12.0
-9.0
-3.9
-5.1
-1.5
-3.6
-25.8

-9.5
-19.8
-21.4
-23.9
-13.8
-15.5
-7.7
-13.8

10.9
1.5
-1.2
0.8
2.3
3.1
-0.9
3.4

7.1
5.7
0.7
8.3
7.5
8.3
2.8
10.7

Like oil, I am of the view that prices of industrial and agricultural commodities will stage a
slow and partial recovery over the next five years. Although I expect commodity prices to
remain well below their 2011 peak in the years to come, 2016 will be a year of stabilisation,
with the Economist commodity price index registering a modest 2.7% rebound.
In part, this will be driven by a mild increase in oil prices, which will raise the production and
transportation costs of other commodities. More output cuts are likely in 2016, following the
dramatic price falls of the past few years. Furthermore, agricultural crops will be hit by less
favourable weather in 2016, including the consequences of the El Nio weather phenomenon.
Significantly, China will continue to absorb a huge quantity of raw materials, not least given
a small, construction-driven rebound in investment in 2016. Nonetheless, it is likely to take
several years to work through the high stocks accumulated during the boom years.
Hard commodities: After falling by an estimated 13.8% in 2015, the Economist industrial
raw materials (IRM) index will rise by 2.3% in 2016 and 7.5% in 2017. Major producers
have recently announced output cuts, which will somewhat reduce availability from next
year. However, more drastic reductions will be needed if elevated stocks are to tighten in a
way that could heighten pressure on prices. Given the growing likelihood that emergingmarket economic performance could disappoint, thereby weakening demand for industrial
raw materials, risks to the above forecasts are to the downside.
Soft commodities: The Economist food, feedstuffs and beverages (FFB) index will register
modest increases of 3.9% a year on average in 2016-17, following an estimated 18.2% dive in
2015. I have revised upwards the price forecasts for a number of commodities, including
cocoa and coffee, because I expect the current El Nio weather phenomenon, which is widely

anticipated to be one of the strongest on record, to disrupt harvests. Other crops will be less
affected, with wheat prices, for example, likely to fall for a fifth year in a row in 2016.
Wheat stocks have been swelled by record harvests in recent years. Wheat is also
predominantly grown in Europea region typically less affected by El Nioand a decent
crop is in prospect in Australia despite earlier concerns over El Nio-induced drought.
However, because of the strength of this year's El Nio, there are mostly upside risks to my
price forecasts for agricultural commodities.

Fixed Income Outlook Asia Pacific

Emerging East Asias bond markets have seen rising yields as investors shift away from
emerging markets. Weaker growth and depreciating currencies have combined to make
emerging market bonds less attractive to investors.
Bond yields in advanced economies have remained broadly stable, with inflationary pressures
muted amid hesitant economic recoveries. Falling oil prices have further dampened
inflationary pressures.
The brighter economic outlook in the United States (US) suggests that the Federal Reserve
could be poised to raise interest rates as early as December 2015. However, recent weakness
in developing economies and declining oil prices may make the Federal Reserve more
cautious in raising interest rates.
Movements in 10-year local currency (LCY) government bond yields in emerging East Asia
were mixed during 3Q2015. While stock markets have experienced large losses, bond prices
in several economies have held up. In the Peoples Republic of China (PRC) and the
Philippines, bond yields have even fallen.
On the other hand, Indonesian, Malaysian, and Vietnamese bond markets experienced large
increases in yields. Both Indonesia and Malaysia have a large foreign investor share in their
bond markets and therefore are exposed to the shift in investor preferences away from
emerging markets.
Going forward, the bond yields for smaller Asian countries will likely to rise as liquidity will
flow to larger Asia countries in China and India as they open up their bond markets. The
yuans likely ascent to the IMFs reserves basket can potentially lure US$1 trillion of foreign
money to Chinese debt in the coming years.
India, with outstanding sovereign paper equivalent to US$639 billion, announced in
September a plan to lift the cap on foreign ownership to 5 percent by early 2018 from 3.8
percent.
Overseas investors hold around 1 percent of the US$3.6 trillion of Chinese local-currency
government notes, compared with 40 percent in Indonesia, 32 percent in Malaysia and 17
percent in Thailand.
There is a risk of lower liquidity in smaller Asian bond markets as foreign investors choose to
express their views on Asian bonds via China and India. As a result, the liquidity premium is

likely to rise and smaller markets with lower yields including Taiwan, Hong Kong and the
Philippines would probably be most affected.
Among the Asian bond markets, I am in favour of India, given that it has a stronger and more
capable government and a very competent central bank governor who manage to arrest the
decline of the Rupee. Among Asian high yield bonds, I advocate a selective exposure to
Chinese property credits on the belief that the PBoCs easier monetary stance will be
supportive of further recovery in the property market ahead.
My least favourite is that of Malaysia bonds, as the economy is experiencing deteriorating
fundamentals as well as political scandal. The same applies for Indonesian bonds given that
they are most vulnerable to capital outflow should market sentiment towards EM deteriorate.
I have a neutral view on Philippine local currency bonds as valuations are not compelling.

Equities Outlook Asia Pacific

I am still cautious overall on China, given the countrys aging population, increasing labour
costs and its very high debt ratio which now stands at 240% of GDP (a major part of this are
from state-owned enterprises and local governments).
However, I expect market will be resilient going forward as government rolls out further
supportive economic policies and further monetary easing with the possibility of one to two
time interest rate cuts, as well as RRR cuts by 150 basis points. The market as a whole is
reasonably priced with the HSCE trading at PE of 7.1x estimated 2015 earnings, 6.7x
estimated 2016 earnings and P/B of 0.93x.
I advocate a selective exposure to some sectors. The sectors that I like in China are those
which are related to cleaner environment and consumer-related. I believe these sectors are
likely to stay resilient in the event of increased market volatility.
According to a forecast from McKinsey & Company, Chinas middle class will grow from
the current 150 million people (10.7% of population) to 472 million people (32.7% of
population) in 2020. Boston Consulting Group predicts that urban private consumption will
rise from the current USD3.2 trillion to USD5.6 trillion in 2020.
Share of middle class adults and wealth in 2015 by region
Middle Class as Middle Class
Beyond Middle
% of
Share of
Class as % of
Population
Wealth (%)
Population
North America
38.8
21.0
12.1
Europe
33.1
40.6
5.2
Asia-Pacific
15.1
41.6
1.9
China
10.7
32.2
0.6
Latin America
10.6
35.1
0.7
Africa
3.3
32.1
0.2
India
3.0
22.6
0.2
World
13.9
32.3
2.0
Source: Credit Suisse

Beyond Middle
Class Share of
Wealth (%)
77.6
56.1
49.9
35.4
38.5
30.6
41.4
60.1

For cleaner environment or environmental-friendly plays, I like Beijing Enterprise (392.HK),

China Resources Gas (1193.HK), Boer Power (1685.HK),CGN Power (1816.HK) ,Nexteer
(1316.HK) and Wasion Group (3393.HK) beneficiary of acceleration of power reform and
water pricing reform.
The recent cut (RMB 0.7/cum) in natural gas price with effect from 20 November 2015 will
in the long run, boost demand/consumption for natural gas. Besides, the government has also
allowed for both city gas companies and upstream suppliers to negotiate natural gas prices
with an upside cap of 20% and no downside limit, starting Nov 16 2015.
This will benefit city gas companies in the long run as this allows natural gas prices to better
reflect market demand and supply, thus gradually achieving the goal of natural gas pricing
reform. With natural gas expected to remain in oversupply situation, as a result of massive
natural gas imports over the next few years, the cost of natural gas for city gas distribution
companies will be lower, implying better margins goring forward.
For consumer-related plays, I like CAR (699.HK), Samsonite (1910.HK) and China Aircraft
Leasing (1848.HK) which are exposed to Chinese tourism sector. CAR, the largest rental car
company will benefit from growing demand for business and leisure travels in China;
undemanding valuation of 17.3x 2016 PER with 2-year EPS CAGR of 54%.
Another consumer play that I like is Ping Ann Insurance (2318.HK) insurance premium
growth has been strong so far in 2015 and further boost will come with the expectation that
government will launch favourable supportive policies such as tax-exempt annuities,
I like those property companies especially those that are heavily exposed to 1st-tier cities
which are major beneficiaries of lower interest rates and my picks are China Overseas Land
(688.HK), China Vanke (2202.HK) and Sunac China (1918.HK).
Techtronic (669.HK) is a good exposure to the continued recovery of US housing market. On
19 November 2015, US-based Home Depot, the worlds largest home improvement retailer
(which is also Techtronics largest customer), reported better-than-expected 3Q2015 results
for Aug-Oct 2015 period. Home Depot also indicated that its power tools and power tool
accessories both experienced double-digit sales growth. This confirms the robust trend of US
home improvement sector.

Valuation of My Conviction Stock Picks

Stock
Code

Company

1910.HK
0699.HK
1848.HK

Samsonite
CAR
China Aircraft
Leasing
Ping An Ins
China Resources
Gas
Beijing Ent.
CGN Power
Boer Power
Wasion Group
China Overseas
Land
China Vanke
Sunac China
Techtronic
Nexteer

2318.HK
1193.HK
0392.HK
1816.HK
1685.HK
3393.HK
0688.HK
2202.HK
1918.HK
0669.HK
1316.HK

Price
(2/12/15)
(HKD)
23.00
13.66
8.10

Target
Price
(HKD)
27.40
17.60
12.42

Upside
(%)

2015PE
(x)

2016PE P/B
(x)
(x)

ROE
(%)

19.1
28.8
53.3

19.2
30.3
14.3

16.0
16.9
10.8

3.4
4.8
2.6

15.1
15.4
22.4

44.25
22.00

58.60
27.80

32.4
26.3

14.9
15.9

12.5
13.1

2.0
2.5

16.6
15.4

47.25
2.94
15.06
9.08
27.40

55.20
3.60
24.00
11.80
48.90

16.8
22.4
59.4
30.0
78.5

11.7
18.3
17.4
13.6
7.4

10.0
14.7
13.7
10.9
6.6

0.9
1.8
4.5
2.2
1.4

8.5
12.7
22.1
15.8
22.8

21.25
5.83
30.30
8.57

34.50
7.15
36.00
13.15

60.0
22.6
18.8
53.4

12.0
4.9
22.3
15.6

10.2
4.0
18.4
12.4

2.2
1.0
3.6
3.9

19.3
21.5
16.2
25.8

Within Asean, I am in favour of the equities markets in Vietnam and the Philippines, which
both have very demographic profiles which are needed for future stronger economic growth
rates.
Unlike other emerging markets in Asia that are struggling with weak domestic demand and
exports, Vietnams GDP is expected to continue growing at a solid pace. FocusEconomics
Consensus Forecast panelists expect the economy to grow 6.4% in 2015, which is unchanged
from last months estimate. For 2016, the panel projects that the economy will expand 6.5%.
The growth comes from the governments ongoing efforts to improve the business
environment by gradually reforming state-owned enterprises and the banking sector.
Vietnam is also expected to benefit in the long run from the recent signing of the TransPacific Partnership (TPP) free-trade agreement. If ratified by all participating states, the TPP
will help Vietnam compensate its recurrent trade deficit with China through a surplus in trade
with TPP members. It is also argued that the TPP will help Vietnam carry out the political
and economic reforms necessary to become a more open economy.
The Vietnam stock market index, VN Index is valued at 11.6 times profits, the lowest in the
ASEAN region. For direct exposure to Vietnam equities, my stock picks are Vietnam Dairy
Corp or Vinamilk, Kinh Do Corporation (a bakery chain), DHG Pharmaceutical, Saigon
Securities, Vietnam Sun (taxi operator) and Vingroup JSC (the largest real estate developer).
As the Vietnam stock market is still small and liquidity can be an issue, investors can also get
exposure to Vietnams rapid economic growth rate by way of buying Malaysia-listed
Gamuda (GAM MK) which has 2 projects in Vietnam (in Hanoi and HCMC) and buying
Chinese textile and garment companies such as Shenzhou International (2313 HK), Pacific
Textile (1382 HK) and Texhong Textile (2678 HK) which can take advantage of the benefits
of TPP.

Philippines equities may be expensive compared with its historical valuation and compared
with Malaysia and Indonesia, but it has great fundamentals, low consumer debts, excellent
demographics, current account surplus and no issuance with commodities. My stock pick is
BDO Unibank Inc, a big Manila-based consumer bank that is trading at 1.8 times price-tobook.
Though based in Singapore, I am not in favour of the local equities market. One of my major
concerns is that Singapore is also one of those Asian countries (others are Thailand,
Malaysia, and South Korea) that have high household debts and Singapores total debt is over
100% of its GDP, due mainly to high exposure on mortgage debts (as can be seen in the chart
below).
High debt in a slow growing phase of the economy and if Fed starts to increase rates and this
may give rise to a full-blown financial crisis. It is for this reason that I am not so keen on
consumer stocks in the ASEAN region. In addition, SGX has yet to address its structural
issue its reducing attractiveness as a platform for big decent or well-known companies to
list their shares.
For funds that have to get exposed on Singapore equities, I suggest a defensive posture while
aiming for some growth. My picks are QT Vascular (a manufacturer of vascular disease
treatment products), ISEC Healthcare (eye clinic chain), TalkMed (a provider of medical
oncology and palliative care services), Centurion (manages dormitories), Zico (an integrated
services firm offering advisory and transactional services, management and support services
and licensing services in the ASEAN region), Singapore Shipping Corp (its management has
very good track record in executing its business plans) and Keppel DC REIT ( a forward
yield of 6.5% is still quite attractive and benefiting from the growth of cloud computing).