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March 28, 2018

MRP Turns Bullish on ASEAN Economies, Adding a New Long Theme

At its inception in 1967, the Association of Southeast Asian Nations (aka the “ASEAN” bloc) was intended to put an end to guerrilla conflicts between Indonesia, Malaysia and the Philippines. Since then, ASEAN has emerged into an important economic bloc thanks to its strong growth, rising urban population, favorable demographics, growing middle class, and geographic proximity to China and India. Now, a manufacturing awakening and digital transformation are redefining the ASEAN future.

Manufacturing Awakening

China emerged as a global manufacturing hub because it had four key elements: Low salaries; a worker pool with engineering & technical skills; access to raw materials; and well-developed infrastructure. But, over the past decade, China’s labor costs have risen significantly. Moreover, the working-age population has been declining since 2011 when it peaked at 925 million people. Less experienced workers have had to move into high-skilled roles to keep up with China’s breakneck manufacturing expansion, with a detrimental impact on the quality of Chinese manufactured goods.

With China facing these challenges, multinationals are looking elsewhere for that crucial combination of low-cost labor and higher standards of production. This is creating an opportunity for ASEAN economies to step in. Vietnam, in particular, has been securing new factory investments due to its low-cost labor, and 74% of the Vietnamese workforce is under the age of 50. ASEAN also has plenty of raw materials, access to a better educated workforce, talented engineering graduates, and improving infrastructure. These factors should help pave the way for ASEAN to become emerging Asia’s new low-cost manufacturing hub.

In fact, the shift has already begun as several high profile companies have started to move operations to the region. Walmart, Ikea, Nike and Adidas have opened factories in Vietnam; Toyota is building cars in Thailand; Apparel giants Calvin Klein and Tommy Hilfiger have begun to produce garments in Indonesia which is emerging into a new textile manufacturing center. A wider U.S.-China trade war could accelerate that transition. U.S. companies that rely heavily on imports from China, such as electronics brands and retailers, may be forced to redesign their supply chains around tariffs.

The manufacturing economy has been gathering pace. The latest readings of the ASEAN Manufacturing Purchasing Managers’ Index (PMI) show expansions in output, new orders, and employment, with five of the seven countries covered by the survey reporting improved business conditions.

Digital Transformation

New and disruptive technologies are impacting almost every industry and propelling the growth of tech startups in the ASEAN region. One example highlighted in today’s DIBs articles is Grab, which began as a simple taxi-hailing app in Kuala Lumpur in 2012. In just a few years, Grab has become the region’s dominant ride-hailing service operating in 191 cities across Singapore, Indonesia, the Philippines, Malaysia, Thailand, Vietnam, Myanmar and Cambodia, and offering tens of millions of rides daily.

This success is reflective of a broader trend - the rise of the ASEAN digital economy - and supports analyst forecasts that Southeast Asia’s internet economy, spanning online travel to ride-hailing, is on track to exceed $200 billion by 2025, a fourfold increase from 2017. The growth is being driven by a surging number of new smartphone users. Southeast Asia already has 330 million monthly active internet users, which is equivalent to the size of the U.S. population. The fact that the tech environment is still at an early growth stage is promising for many consumer-driven industries. For example, the ASEAN e-commerce penetration rate of 2-5% is relatively low compared to more established markets like China with 19% penetration, South Korea with 20% and the U.S. with 10%.

The ASEAN bloc’s combined GDP of $2.72 trillion in 2017 is projected to expand by 5.1% in 2018 and 5.9% in 2019, which is faster than the forecasted global growth rate of 3.9% over the same period. At this rate, ASEAN will be the fourth largest economy in the world by 2030, moving up from seventh position in 2017. Collectively, ASEAN has the world’s third largest population with 648 million people. An estimated 90 million more people will move to urban areas by 2030, which means that within the next decade, half of the world's middle class will live within a six-hour flight from Bangkok.

The digital transformation we are witnessing, along with the creation of a common market, evolving consumer tastes & habits, and the availability of a knowledge-based workforce are powerful advantages that will propel ASEAN economies forward. Although ASEAN produces more than 7% of the world’s exports, it accounts for just 3.3% of global GDP. However, that is likely to change in the future, with both its share of exports and GPD rising. As noted earlier, ASEAN now has the conditions that created China’s manufacturing boom, and could become the next manufacturing hub in Asia.

It’s political leverage is also rising. While none of the ASEAN countries carry much political heft individually, together they represent a considerable force that can help counterbalance China’s growing geopolitical footprint. In other words, ASEAN has emerged as a surprising bulwark against incremental Chinese expansion, joining India, and Japan.

MRP has been bullish on emerging markets equities since December 2015 when we shared our view that the U.S. dollar was about to begin a cycle of weakness that would be beneficial to emerging markets. Now, we are shifting from a broad EM theme to more idiosyncratic country or regional themes.

ASEAN economies look interesting for all the reasons noted above and because they are less reliant on exports than North Asian economies, which could suffer if a full-on global trade war does indeed erupt. Furthermore, ASEAN valuations are still relatively cheap, their stocks markets are more domestically-focused, and earnings have so far lagged the underlying macro momentum.

These are all reasons to be bullish on the ASEAN bloc, which MRP is adding as a Long theme. Accordingly, we are removing the broad EM theme from our list, as we believe it is time to be more selective within the EM universe. Investors can gain exposure to the ASEAN theme via the Global X FTSE Southeast Asia ETF (ASEA).

ASEAN vs Emerging Markets vs S&P 500