MSCI Asia ex Japan index gearing up for a slowdown

After the rout in Asian equity markets, the valuation of the MSCI Asia ex Japan index is just 6% away from the lows hit during the global financial crisis in 2008 and 10% away from the levels seen during 2001-03.

The index, closely tracked by global fund managers, is trading at 1.3 the trailing priceto-book value (PB). Historical evidence since 2000 suggests that whenever the trailing PB valuation is 1.3-1.48 times, the index has always gained with an average return of 31.6% over the next 12 months.

If PB drops below 1.3 times, the upside on an average could be 56% in one year. The trailing PB of the MSCI AxJ was at a similar level at 1.22 times in March 2003 and 1.19 in 2001 during global recession. The important thing to note is that falling valuations do not offer respite to short- and medium-term investors. The 3-month performance of the MSCI AxJ has on an average been 4.1% if PB is in the range of 1.3-1.48 times.

CLSA, a broker, said in a note based on trailing PB methodology that Singapore, Korea and Indonesia have the highest upside from current levels while India, Malaysia and Philippines have the lowest upside from current levels. The note added that from a sector perspective, tech hardware, auto & banks stand out as having the highest upside, while consumer durables & pharma have a downside with a 12-month view.

The caveat for the investors is that markets could overshoot the 2008-09 lows as China’s ability to stimulate its economy is less than what it was in 2008-09 given higher levels of debt. Also, due to overinvestment in various manufacturing units, it would be an uphill task to earn a higher return on equity (RoE).