In the first half of 2015, revenue for Chinese companies outside the financial sector shrank by 5 percent from year-ago levels, failing to keep pace with growth in the Mainland’s gross domestic product (GDP). Nevertheless, this group’s second-quarter operating cash flow improved sequentially after shrinking in the first quarter.
Investor sentiment toward Chinese equities remains decidedly negative—an outlook that’s unlikely to change as long as the economy continues to weaken.
After reviewing the economic data for the first half of the year, our preliminary outlook calls for China’s GDP to grow between 6.5 and 7 percent, though we will revisit this target in a few months.
The MSCI Asia Ex Japan Index has plummeted to 1.28 times book value—within range of its 2008-09 low. During the global recession of 2001, the index bottomed at 1.19 times book value and 1.22 times book value during the 2003 SARS (severe acute respiratory syndrome) outbreak.
Although the MSCI Asia Ex Japan Index trades at an attractive valuation relative to historical levels, investors continue to worry about the potential for a catastrophe similar to the 1997-98 Asian debt crisis.
But market and economic conditions have evolved considerably over the past 18 years. With the exception of India and Indonesia, most emerging economies in Asia boast external accounts that are in surplus and foreign exchange reserves that exceed short-term external debt. And at the corporate level, net debt to equity and capital expenditures to sales are also much lower than during the crisis.
Returns on equity have declined to about 11 percent, with sales falling short of expectations. This disappointing figure is a far cry from the 1.7 percent return on equity that occurred at the market’s lows in 1998 and 1999.
If the turmoil in global equity markets continues, the MSCI Asia Ex Japan Index can go lower. Historical resistance levels suggest that the index could pull back by another 10 percent.