Source: Morgan Stanley

A Return to Basics as Asean Stocks Near Tipping Scales


FEBRUARY 06, 2015

Traders stand near a screen showing the Indonesia Stock Exchange Composite Index in Jakarta. (Reuters Photo)

Over the past 10 and four years, the MSCI indexes of the so-called “Asean Four” — Indonesia, Singapore, the Philippines and Thailand — have outperformed the Asia ex-Japan index by between 3,500 and 11,500 basis points, as well as the Emerging Market Index by between 10,500 bps and 2,000 bps.

However, a combination of slower growth, a strengthening US dollar and an uneven external funding environment is likely to limit absolute returns this year among markets of the Association of Southeast Asian Nations’ members states.

As such, bottom-up stock-picking is likely to become more prominent amid lackluster overall returns.

We identify three investment themes for 2015 to navigate through a potentially more volatile year for returns: productivity, profitability, and positioning.

Source: Morgan Stanley


Companies that are able to successfully deliver productivity-led earnings growth are likely to outperform their peers independent of whether expected reforms gain momentum within a country.

A more productive firm will produce more with the same inputs, offer cost advantages, or make a better product with the same inputs.

Emerging market economies have had a strong period of growth until recently.

For example, Indonesia and Thailand posted average annual gross domestic product growth of 6 percent and 5 percent, respectively, from 2009-2012.

However, sustaining such growth could prove more difficult amid persistently weak external demand, potentially tighter or more volatile financing conditions and less favorable terms of trade.

Our productivity score, a product of incremental return on equity, productive growth and superior economic returns, is a yardstick to measure productivity. We believe that incremental return on equity is the best measure of efficiency.

It is basically an aggregate measure of the effectiveness and efficiency of an organization in generating incremental output with incremental resources available.

Companies could focus on productivity gains in practically every function, such as marketing, distribution, manufacturing, logistics and the supply chain.

We use “value in productivity” calculations — a product of earnings yield and our productivity score — to arrive at relative valuations among companies with respect to their fundamentals.


We prefer markets and stocks that have potential for margin expansion and are at troughs in terms of cyclical profitability. We expect investors to refocus on earnings as the key driver for returns in 2015.

In an environment of relatively full valuations, slowing revenue growth, and US dollar appreciation, the focus turns to profitability.

This is more so the case when falling crude oil prices could mean low-flation persists. Low-flation could drive diverse outcomes for corporate profitability.

Investors could err on the side of caution when factoring in cost savings or pressures in their forecasts because of potentially volatile commodity prices.

Therefore, margin momentum will be a useful stock selection tool.

Volatility in the Singapore, Thailand and Indonesia equity markets, particularly in the past 12-24 months, has largely been driven by a change in the cost of capital, as reflected in changes in price-equity valuations.

The cost of capital is one of two general factors that drive equity markets, the other being cash flows.

And, from 2003-2013, it was changes in cash flows, reflected in earnings-per-share growth, that drove these markets.


We favor an increase in exposure to domestic cyclical stocks while reducing exposure to defensive stocks.

In an environment of low-flation and potential rate cuts in ASEAN, we expect domestic cyclical stocks to continue to outperform.

Also, the attractive relative valuation of domestic cyclical stocks, combined with the relatively unattractive dividend yields of defensive stocks, could continue to drive domestic cyclical stocks’ out-performance.

The Morgan Stanley Research global macro team believes that central banks generally are likely to maintain an accommodative bias, being more concerned that growth and inflation will come in too low rather than too high.

Also, low-flation caused by falling crude oil prices could drive policy easing in Asean. Furthermore, it will likely ease domestic funding pressure, improving the underlying growth fundamentals for domestic cyclical stocks.

Domestic cyclical stocks include those of banks, property companies, and discretionary consumer firms.

Defensives stocks include those of telecom firms, real estate investment trusts and utilities companies.

Since May 2013, the Morgan Stanley Asean Defensive Stock Index has underperformed the Morgan Stanley Asean Domestic Cyclical Stock Index amid quantitative easing in the United States and eurozone and a sharp decline in crude oil prices.

Hozefa Topiwalla is an equity strategist and managing director of Morgan Stanley Asean.

Hozefa Topiwalla