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JPMorgan goes defensive as Asian valuation cycle quickens

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U.S. tax cuts and a deteriorating trade backdrop risk speeding up the valuation cycle in Asian equities, and are prompting J.P. Morgan Asset Management to buy more defensive stocks like toll-road operators.

While Asia is only two to three years into the recovery from the 2015-2016 downturn, there’s a rising possibility of a shortened economic cycle, said Julie Ho, a Hong Kong-based portfolio manager at J.P. Morgan Asset. That may be pushing the region’s stocks closer to a late-cycle environment, said Ho, who co-manages around $4.4 billion of Asian equities.

“The remarkable late-cycle fiscal expansion in the U.S. raises a valid question as to whether a more aggressive monetary tightening might be required at some point in the future,” she said in an email interview. “The trade disputes represent a tail risk, which has affected sentiment and may potentially impact the real economy should there be no resolution.”

Ho said she’s building back exposure to Chinese and Australian toll-road operators, Indian regulated utilities and Singaporean and Australian real-estate investment trusts. Banks should also fare well as rising interest rates drive better net-interest margins and return on equity, said Ho, who co-manages the JPMorgan Asia Equity Dividend Fund and the JPMorgan Asia Pacific Income Fund.

The MSCI Asia Pacific Excluding Japan Index fell for a fourth day on Tuesday, declining 0.1%. The gauge has dropped around 14% from a peak in late January.

How long are valuation cycles and why is this one different?

  • A typical valuation cycle in stocks has tended to last about 5 - 7 years, with troughs in 1998, 2003, 2008 and in 2015 and 2016, which was led by a drop in commodity prices.
  • “My base case is that we’re in mid-cycle, and that’s supported by current profitability, which has recovered but is not excessive, and valuations, which are actually still below long-term averages.”
  • But there’s a rising possibility of a shortened cycle, due to the late-cycle status of the dominant U.S. economy and the ongoing trade disputes.
  • “Although we don’t expect a recession anytime soon, in a typical late cycle, characteristics that distinguish resilient equity portfolios include low beta and value-style investing.”
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How is your investment approach changing to reflect this?

  • “Equities can still deliver attractive returns as the economy enters late cycle and we’re constructive on Asian stocks, especially when considering their valuation.”
  • "With earnings still expected to grow in the mid-to-high single digit range, our expectation is that Asian equities will trade within their long-term average of 1.5 to 1.8 price-to-book.”
  • At the moment, the biggest overweights are in financials and defensives.
  • “Historically, we have had between 20% and 65% of our equity income portfolios in defensive stocks, which is a wide range and shows that we can alter our strategy materially if valuations justify it. Today we are at just under 30% in defensives. We are not looking to be explicitly defensive yet, but have increased the weight from its lows.”

Specifically, what sectors and companies are you favoring?

  • “We’re positive on Hong Kong and Singaporean banks. Both markets track the U.S. interest-rate cycle and continue to have solid loan growth demand.”
  • “Stocks with defensive characteristics — utilities or so-called bond proxies — once looked prohibitively expensive for valuation-driven investors. Today, that’s no longer the case, as many of those stocks have de-rated.”
  • For example, “ Jiangsu Expressway Co., which owns and operates the Shanghai-Nanjing Expressway, de-rated by more than -30% on a price-to-earnings basis from July 2016 to July of last year. Yet they operate one of the most trafficked and mature toll roads and boasts an uninterrupted dividend policy and a history of stable growth."
  • “Similarly, Australian toll-road company Transurban Group’s P/E has de-rated -25%, despite having generated underlying earnings growth of more than 10% and being constantly underpinned by solid free cash flow and attractive dividend growth.”
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