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Asia on sale

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While not enjoying 2017-like returns, stocks are having a decent year. Developed market equities are up more than 4% in dollar terms. Things look even better in the United States, with the S&P 500 Index up around 7%. As many markets started the year at already full valuations, investors could be forgiven for thinking that there are few bargains left. Interestingly, much of Asia appears really cheap.

As of the end of July, Japanese equities remain the cheapest equity market in the developed world. The Topix Index (TPX) is trading at 1.8 times price-to-book (P/B), roughly half the level of the S&P 500. The current discount is close to the lowest since 2012, a period that preceded a three-year, 150% rally.

The Asian discount applies to a number of emerging markets as well. For example, Korean equities remains not only the cheapest equity market but by some measures the cheapest asset class (see Chart 1). Korean equities even look inexpensive relative to the already discounted emerging market space. The current valuation represents a 40% discount to the rest of EM, the largest discount since the 1997 Asian financial crisis.

Note: Past performance is not a reliable indicator of future performance.

Why so cheap?

Historically, many of these markets have traded at a discount. Korea normally screens cheap. Similarly, for many years Japan has traded at a discount to the rest of the world. However, while the discount may have been justified in the past, much has changed in recent years.

Japan has witnessed a significant improvement in both corporate governance and profitability. The return-on-equity (ROE) for the TPX now stands at 11.1%, close to a multi-decade high and more than twice the level of six years ago. Japan’s low valuation seems even harder to justify given this improvement in corporate profitability and still ultra-accommodative monetary conditions.

Rather than fundamentals, today’s Asia discount can likely be attributed to three trends: stellar U.S. earnings growth, a stronger dollar as a headwind for EM stocks and rising trade frictions. In the United States, 20% earnings growth has led many investors to abandon international markets. At the same time, a stronger dollar has created a genuine headwind for emerging market equities. Finally, many countries in Asia have been vulnerable to rising trade concerns. The Shanghai Composite is down roughly 15% from the May peak and more than 20% since late January.

Bottom Line

While trade and the dollar remains real issues, these concerns already appear reflected in the price. As I discussed recently, the broader emerging market complex is cheap, with countries like Korea and Taiwan looking cheaper than most. As a result, Japan and much of Asia appears to be that increasingly rare find: a bargain.

Russ Koesterich, CFA is Portfolio Manager for BlackRock's Global Allocation Team. This material is prepared by BlackRock and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of 31 August 2018 and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain ‘forward-looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. In Australia, issued by BlackRock Investment Management (Australia) Limited ABN 13 006 165 975, AFSL 230 523 (BIMAL). This material is not a securities recommendation or an offer or solicitation with respect to the purchase or sale of any securities in any jurisdiction. The material provides general information only and does not take into account your individual objectives, financial situation, needs or circumstances. Before making any investment decision, you should therefore assess whether the material is appropriate for you and obtain financial advice tailored to you having regard to your individual objectives, financial situation, needs and circumstances. BIMAL, its officers, employees and agents believe that the information in this material and the sources on which it is based (which may be sourced from third parties) are correct as at the date of publication. While every care has been taken in the preparation of this material, no warranty of accuracy or reliability is given and no responsibility for the information is accepted by BIMAL, its officers, employees or agents. Any investment is subject to investment risk, including delays on the payment of withdrawal proceeds and the loss of income or the principal invested. While any forecasts, estimates and opinions in this material are made on a reasonable basis, actual future results and operations may differ materially from the forecasts, estimates and opinions set out in this material. No guarantee as to the repayment of capital or the performance of any product or rate of return referred to in this material is made by BIMAL or any entity in the BlackRock group of companies. This article does not reflect the views of WealthHub Securities Limited. © 2017 BlackRock, Inc. All Rights reserved. BLACKROCK is a registered trademark of BlackRock, Inc. All other trademarks are those of their respective owners. Past performance is not a reliable indicator of future performance.