Why a weaker US dollar is good for Asian equities

-- | 10/04/2018

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Emma Wall: Hello, and welcome to the Morningstar series, "Market Reaction." I'm Emma Wall and I'm joined today by Richard Titherington, Chief Investment Officer for JPMorgan Emerging Markets Asia Pacific.

Hello, Richard.

Richard Titherington: Hi.

Wall: So, you've talked of a weaker U.S. dollar being a tailwind for Asian equities. I thought we could take a step back and explain why the U.S. dollar and emerging markets, in specific, Asian equities, are correlated in this way?

Titherington: Well, I think, there's a couple of reasons for that. The first one is, of course, when the dollar is weakening, that tends to be a positive for the global economy, because financial conditions, monetary conditions are improving.

So, liquidity is rising. And when you have the global economy recovering in that kind of way, that tends to be a positive for Asian and emerging market equities, because they are that bit more geared into the global economy.

The other thing, which of course, is important is that to a certain extent the dollar is a bit of a risk barometer. When people are nervous, they tend to move towards the dollar. So, in periods where you have market volatility or market fear, the dollar tends to rise as a safe heaven and of course, in periods of market fear or volatility that tends to be negative for equities. So, those, I think, are the two key reasons for it.

Wall: And looking specifically at now, we of course, have had this global growth over the last year which has been synchronised much to the surprise of many people, I think. But we haven't had low volatility in the last couple of months. So, what's unique about this particular situation which is causing sort of that U.S. dollar weakness and indeed, the positive for the Asian equities?

Titherington: Well, what's interesting, I think, is that, as you say, volatility has picked up. But actually, the dollar hasn't strengthened. So, although there is a lot of concern around whether it's trade or whether it's market valuation, the fact that the dollar is staying stable or even weakening gives me a bit of confidence.

Although I would expect 2018 to be a year of higher volatility, I think it's important to remember 2017 was unusual or kind of the best of all possible worlds, and we should expect 2018 to be a more volatile year. The very fact that that isn't being a company by the dollar spiking means that the outlook for Asian equities, I think, still looks pretty positive.

Wall: And U.S. dollar being weak is not the only reason why you are positive on the region at the moment. Perhaps you could explain what else is helping to sort of support Asian equities in 2018?

Titherington: Well, I think, there's a couple of things going on. Firstly, as we talked about earlier on, rising global growth is good for Asia. What does that mean? It means that corporate profitability is improving, and as corporate profitability improves, again, that tends to be a positive for more cyclical companies in Asia.

And then thirdly, what we're seeing as we are moving from 2017 into 2018 is an environment where more companies are giving you positive earnings surprises. And generally, markets like it when you have positive earnings surprises. So, those three things all working together mean that the outlook for Asian equities, I think, still continues to look pretty good.

Wall: And what about sentiment? Because a couple of years ago, particularly in the developed market investors space, U.K. retail investors, very nervous about China and the surrounding region and that meant, of course, that the flows were negative and indeed that affects volatility. Now, it seems that people are pretty sanguine about the region. They don't seem to be as concerned as they once were. Does that also provide a tailwind?

Titherington: It does. I mean, one shouldn't be complacent about it. But you are right, if you went back two years ago, everything about China was bad, everything about emerging markets was bad. The only place to be was in the U.S. Whereas if you look today, although there are still things to worry about in terms of China, people are more optimistic about the outlook for China.

The Chinese economy is doing relatively well and China being the biggest single part of Asia that does make a difference. So, you are right. Sentiment is steadily improving towards the asset class. And as I said earlier on, the key thing is that you are seeing corporate earnings recovering and that's particularly important, I think – if you are running strategies that have a bit more growth orientation, then I think that's a big positive.

Wall: And we don't want to be accused of being overly optimistic, you did say there were a couple of things to be worried about. What are those potential clouds on the horizon?

Titherington: Well, I think, the first thing that people need to recognize is that 2018 will be more volatile in terms of market sentiment movements than 2017 was and we've seen that already at the beginning of the year. That shouldn't be a surprise to people. Second thing is, clearly, people are nervous about the tariff wars going on at the moment. I don't think that's a hugely significant issue, but it's something that people should recognise.

And of course, the third thing that we need to remember is that interest rates are going up. That could be a problem. And as I said earlier on, I would expect at some point during this year you will see an equity market sell-off. But rising interest rates reflect the fact that the global economy is doing better. And broadly speaking, Asia is a big beneficiary of an improving economic cycle.

Wall: Richard, thank you very much.

Titherington: Great pleasure.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

This report appeared on www.morningstar.com.au 2021 Morningstar Australasia Pty Limited

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