Matthews’ Taylor on AI in Asian Emerging Markets

notches due to valuation concerns. China is still at the bottomwear scorecard. It has moved up a few slots, but challenges are There's still challenges for the outlook and more policy support is needed there.

fortunate that a lot of places that I had lived in suddenly became markets. A bit like you know, talking about Vietnam Vy going from not being an emerging market to being one in the future. I was sort of you know, they're in the Middle East and in Eastern Europe, which was which was very interesting.

those countries. We take an account volatility, so we get you know, earning what's the best earnings growth, you know, what's what's in the price of that earnings growth, and we come up with a series of over neutral and underweights.

And then from the bottom up basis, we're very fortunate to Matthews to have a team of country managers, people that are focused were you know, we run a lot of single country funds and ETFs that feed up into that, and so our country teams give us the best ideas and then the fund managers based on the fund put

the portfolio construction to work. We use a system called marginal contribution of active risk, so we really beat to adjust everything to make sure that we were taking you intended positioning and we don't have any unintended overweights and underweights, and that sets the sizes of the overweights and underweights, so the country level at the stock level, and that enables us to dial up the beta and dial down

the beta. And then finally we have an ongoing monitoring process that happens and that that cycle that's that cycle continues. Now we're probably a slightly differentiated thinking that countries matter, but you know, if you just look at the facts in an example this year, that the outperformance of Asia relative to to Latin America, the outperformance of India relative to China, the outperformance even in Latin America of Brazil

relative to Mexico. So at the end of the day, we're picking stocks, but we have this country framework that enables us to hopefully damp and risk or take the opportunity of whether it's a you know, a good a good country story. For instance, you know, we do across many strategies have a non index overweight to Vietnam because you know, we like the growth story there. In the valuations we think of a lot more upside.

road to sustainable cash flow. And then those companies that are mature that you know that the balance sheet is good and that we have good cash flow. We think cashflow goes into earnings is the most important thing because what we're really looking for is the sustainability of earnings and the sustainability of dividend streams within that.

You know, for instance, the whole AI build, how that's seen in the supply chain in areas and then in Hong Kong, you know where we also cover maybe couple a lot of the Asian markets. From here, it's really been on the ground visiting companies. We have a huge amount of fund managers traveling you know constantly and seeing companies, and we place a really big emphasis on meeting management, you know, both in the offices or on the ground seeing the competitors and also with our you know esg team,

we do a lot of engagement with companies. So we write to them on factors and we go and see them and we attend a GMS and we think that's very very important because although we have this country framework where we think we can add value at a country level by selecting countries, at the end of the day we are buying companies and so we have to get that balance. You know, we're really looking for the right stop for the environment. But it's very important what the

what the management is up to. I mean, we could go to a management that we've seen as you know, not up to standard that we think is changing. So you know, one of the engagement parts of engagement is is you know, where we're seeing companies that are turnaround where they are pricing in you know, an old situation, but we do believe that you know, things are changing and that change will affect one of the valuation that people will pay for that company. But you know, more

importantly the fundamentals, the cash flows. Maybe they're getting rid of you know, non core activities, they're becoming more more transparent. That dividend policy, which could have been weak, is getting much stronger. They're more aware about capital management. You know, if we see situations like that, then that's a perfect story that we like to look for. That's sort of you know, I suppose a turnaround story.

and the growth is there. And then you've also got the semi side as well. So obviously career much more affected by the semiconductor side. Short term, there is a pause. I think, you know, we are seeing much more selectivity. So actually we've lightened positions in Taiwan. We've really lightened positions in career, much more on the domestic side of career. But in the longer run, you know, we are still invested in certain Taiwanese companies, but we've been a lot

more STOP companies. Specific it's a very alpha orientated because we do think that you know, some stop's got overvalued in the hype, and probably the earnings will disappoint, but certainly the theme is there, and I think it's a really important I think it's a really important driver for Asia because you know, in the last five years. Probably the debate has always been India's expensive, but we like it, and the earnings are going China's cheap, but the earnings

aren't coming through. But actually there's so much more to em and you know, the sort of the extra ai the tech supply chain in North Asia is very very important. I think it's gonna be a big driver of markets going forward. And also actually the domestic demand story and the sort of value up story and career has worked pretty well. But Asian is probably my favorite place to invest at the moment, and for a number of reasons.

One is it's always relative. You know, even China looks relatively better when other markets don't look as good because they've worked and China's still been a laggard, but Asiyan has been a laggard. It's been a laggard because rates in some markets have had to go up during this this year, particularly Indonesia. The growth is coming through and it will be the main beneficiary of interest rate policy

easing in the US. It's cheap, it's under owned, and so you know it deserves a place on its own merit. But it's even more interesting now where you know, we've been taking money, taking profits from the North Asian area and India, you know, is it's still a very solid market, but it's looking quite expensive. You know, it's stead it's still steadily going up, but you can't put all your money in India in an emerging market or an asient fund at the moment. So it's a great, great balance.

And within Asian Indonesia our favorite index country, and that's probably the most sensitive to rates coming up. It's had a little bit of a sort of policy vacuum because of the handover from Jockovy to Provoa and that the new president will be he will take over in October, and so people are sort of wasting the cabinet and you know the direction there, so that might cause a bit of volatility, but you know, the growth is growth story is very good. Rates will help that growth story.

Vietnam and as I mentioned earlier, remains our favorite Asian market, but isn't in the index yet, so it depends on the degree of how much we have invested in in ETFs. And then Philippines I think is one behind it is it's a bit less liquid, but it's becoming more interesting growth, very cheap valuations, growth picking up Malayser has been a very good story. It's already done pretty well this year, so we're a little bit more selective there, but we

still like the market. And then Thailand, and actually Thailand's had a pretty good run but having underperformed for a while, but it was a very sudden movement when we had a change in politics. So we we're a bit worried about the growth in Thailand. Still it's not really coming through, but we're just you know, really seeing how this political change will affect that growth there. So that's probably the market we're less convinced about.

those earnings all the time. It's very easy to track earning's upgrades and earnings down grades, and that can obviously sort of adjust. So you know, when we start to reach our target prices, then that is a warning point. So when we would change and now then it depends obviously on the relative illness of how that target price is relative to everything else in your portfolio and other ideas coming in. But we have a very disciplined approach

on that. I mean, I'll give you an example. At the beginning of the year, we increased our having been very underway China. We increase positions in the end of January to China because the market had really underperformed and it was eight point five times earnings, and we thought that there was sort of better news coming out from the government property and actually the larger stocks in the in the index when talking to the companies were you know,

we're going to have less subsidies. They were promising more capital management in terms of higher paybacks, buybacks, and that happened actually, and some of the larger stocks have have done pretty well. We increased our positions there. But then by the middle of May, the market had gone to eleven and a half time's earnings, and we thought, given that we hadn't seen that much of an economic recovery, a lot of good news was priced in, so we lightened up those positions, and you know, so that it

made it May, It does make a big difference. And then when you have you know, on a on a change of government for instance. I mean we went into the beginning of the year a bit more cautious on Mexico on valuations. Market was pricing in a very good situation and we knew there was some election coming up. But when the election came up, and you know, it was obviously unfriendly to that, we thought to investors we had to assign a lower pe for Mexico, you know,

depending on because of that political risk. On the other hand, Brazil went down almost to six and a half seven times earnings, with the sort of news on Mexico where actually the situation wasn't as bad, and we took that as an opportunity to increase our Brazilian exposure. And the

companies know that we had met on in Brazil. We're not giving the same negativeness as the market, and so we just sort there's a good upside there in our target price that we weren't expecting Brazil to go back to ten eleven times earnings, but certainly could go back to sort of eight eight and a half times earnings. And so that valuation is used really as a as a reward risk tool, and it just it just sort of tries to keep you safe. You look at it

every day, say what, what's what's priced? In Valuations alone aren't aren't aren't a catalyst, but they are definitely a level. You know, for instance, in China at the moment, you know, the valuation of China is at eight point seven times I think in the MSCI China, but that is you know, looking at an earnings growth of about fourteen percent. Now, given the macro data that's come through, you've seen a couple of seal side houses in the last twenty four

hours take the China GDP number down. You know, you could say that, you know, if that if the fourteen percent growth of the consensus expecting was taken down to six or seven, then obviously China's trading on eleven times and so isn't so cheap. So you really have to you have to balance the valuations with what's happening on the earning side.

on the ground. I think, you know, at the moment, the government is probably a little bit more prepared to see the situation declining because the word of deflation has been sort of put up to the party and that that's always a scary word. But I do think the catalysts will take time. So I do think there will be more support on the property side for China. I do think we'll get more support on the demand side, but I do think it will take time, so I

do not see an immediate catalyst. We also have the presidential election happening in the US, which you depending on which party wins, could affect you know, the economic situation in China to particularly around around tariffs. Interest rates coming down in the US actually will be a little bit of a benefit for China because that eases China has

been had quite tight monetary policy. Actually, if you look at where real interest rates are nowhere near the level of Latin American real interest rates like Brazil or Indonesia, but they are relatively high, and obviously when you've got quite a weak economy that need they need to come down. But I think the government has always been worried about the level of the currency. So once you start to see the dollar stabilize a little bit or maybe even

weakend again certain countries on rates coming down. That just gives the Chinese monetary system and ability to cut rates. But I think the real, real catalyst of China needs is on the fiscal side, and we wouldn't really see it happening in one big, you know, in one big

sort of trigger point. It will be incremental and probably incrementally driven in the net between after the election and going into next summer, after the Workers Council in Economic Workers Council in December and then the two sessions in March.

comes down to why is the FED cutting? And so you know, if the FED is cutting and we you knowed the US economy is not going to a recession, and even if it does, it's a shallow recession, then that is pretty positive for markets because it's cutting and it's going to help growth. If it's cutting because the US economy is going into recession, then it's actually risk off. It's positive for the dollar, it's not positive for global markets. Our scenario is the FED is cutting, the US economy

is strong. US economy, even with rate cutting and the slowdown in the US economy, is going to grow more than Europe and Japan, but there are certain other so countries in emerging markets that can grow more. So overall, the international growth is not going to surpass US growth, but emerging market growth will. And then it depends then in that scenario, what's going to do well. So anything

that benefits from interest rate cuts. The normal domestic story, you know, Latin America, particularly Brazil, as I am, a great benefit, but in the past it's also been the cyclical side of North Asia, the sort of semi side, the hardware side in Taiwan and Korea, And as we discussed you know a few minutes ago, that area is relatively expensive having performed, so I think we'll get a different rally this time. So I don't think it's a

great catalyst for Taiwan and career. It might even be a reason for money to come moreover to some of the more domestically driven, consumption driven markets. I think in India, you know, it's pretty much neutral. I think India benefits much more in my opinion, from the oil price coming down, because that's one of the inflationary issues, but also inflation in India very much depends on them monsoon, and that seems to be okay. The small cap effect is not

a rate issue. It's the fact that you know, the MSCI India about four or five years ago had roughly seventy stocks in it. It now has roughly one hundred

and fifty stocks. And those newer stocks are more reflective of the new India, you know, they're more reflective of the cap expends, the infrastructure you know, they're moving into two other air is the competition financials have got more competition, the housing policy that's changing, and so I do think that there will be more of a still continuing to

be a structural change in India. You know, the larger sectors in India that did incredibly well, the financials, the IT companies, they were more a reflection they were doing well when India wasn't doing well. They were more a reflection of those great good conglomerates that managed to keep costs down and grow market share in a difficult environment,

take share from other companies. That's changing now you're getting more competition coming in, You're getting a wider nests of the economic growth, and so it's more of a balanced view, and I think the larger sectors probably don't do as well going forward, although in the short term there's a huge valuation gap between you know, mid cap and small cap and large cap at the moment, and the area that's the that offers the most value in India is

actually the financials, the larger banks, because they've been they've suffered from everyone taking money out of them and putting them into the faster growing errors. We are seeing now with Moody three point zero, and I think this is a really important question to look at for the next

few years. Is I think international money will really embrace India in the next year, but they're looking at the valuations going Actually, you know, the area I want to buy is really expensive, so they might buy these bigger

sectors just to get exposure there. And why I'd say, well, we should see more international exposure to India is I think what Mody three point zero did with the volatility around the election was it showed that India was a democracy, that there are checks and balances, and I think from international investors given the situation over the last few years in Russia and you know in China and other markets,

people prefer to buy democracies. And you know, you can't really ignore the growth story of India all the fact that it's going to be you know that it really is the leading democracy and emerging markets, and the growth rates probably a bit more balanced. I mean probably Underno. D one point zero and two point zero you had a real boost on infrastructure and you know milk Od's viewers build it make in India and it will trickle

down to consumption. But one of the problems has been is that only a certain part of society's got wealthier at the top of the property market, the stock market, but it hasn't really filtered down into the overall economy. So it hasn't impacted GDP per capita as much. I say, even China has over the last ten years, where you know, the wealthy have got less wealthy, but the gdpeper capita

of the average person and has got wealthia. And so I think now with Modi three point zero, there's going to be a transition and a balance, and so I think you'll see more focus on domestic demand, on consumption,

on help for the population. I don't think we'll go back to the sort of handouts that this area is not doing well, so we're going to hand out more support, you know, because I think the Modi government really believed that the best way of getting long term growth in India is infrastructure, urbanization, a more efficiency, more service, more manufacturing jobs, and so I do think that's a transition going point. So I do think, you know that that mid cap small cap bias in India might remain for

a while, and it's also supported by local funds. You know, you see the amount of local money going into the market every month that it's incredible, it's structural, and so that's obviously been a very very big support, and they prefer to buy these faster.

I mean, I think when you look at the exports of China, they haven't particularly gone down as a percentage of global exports, but they've just gone different places, you know, and you know, US imports have come from different places. So I do think there'll be a rebalancing like that.

I mean, obviously, you know, trade tariffs. You know, if Trump's talking about sixty percent tarifs to China, you know, I think that you know, probably China is is more immune to that than it was the first time around, because it's obviously had this threat, it's preparing for it. It's probably less of an impact on the market, but

it's obviously not good news. It's inflationary. You know, it's not good news if tariffs and other areas come up as well, and that's something that will what we know we'll obviously have to impact, will impact into emerging market growth.

It will also impact probably rates coming down quicker. You know, maybe that you know, if you've got that inflationary impact, I mean, my my, my inkling would be that you know, even if Trump got in, it wouldn't be as severe as the talk as it has been in the past, but it was obviously something that is that we're that we're aware of. And I think that in that way,

you know, it makes it, you know. That's why we really do prefer in this environment, particularly after the run in South Korea and Taiwan, we really prefer those markets that have really domestic demand and are very old economy stories that you know already these economies are picking up two years later after COVID. The banking system wasn't like the US or the UK or Europe, where you know, aggregate demand was kept in check by the government. You know,

aggregate demand fell in these countries. There weren't subsidies, there wasn't much fiscal spending, so it's a slower recovery and interest rates being cut in the US just helps that recovery. And so that's really where we focused on the moment. There much of that area is much more immune, much more protected from overall trade. India is much more protected from overall trade. So that's where our biases at the moment. And just really you know, wait, wait, wait, wait, wait and see.

you know also from the debt markets as well. Ninety percent of Asian debt issuance is taken up by Asian investors, and it makes emerging markets much you know, more protected from international capital coming in and out. And I think that's a very very important point. So we tend to prefer to invest in those markets overall as an entity.

And obviously it's a very differentiated market. The balance sheets are much better, I mean, even compared to the Taper tantrum years twenty thirteen, twenty fourteen, the current account balances of a are much better. The debt levels are lower, the inflation structural inflation is much lower. So they're in a much much better state than they were before. And that's been reflected in credit ratings and sovereign ratings. And then I think the opportunities are much more broader. It's

not just a China story. But obviously China has a huge element. You know, if you've got in these domestic stories like India, like Indonesia, like the Philippines. We still have the cyclical commodity stories like Brazil, but now you've also got the the AI and tech stories like South Korea and Taiwan. And I think Japan coming back into the fold is very important as well, because there's a lot of links between career and Taiwan and Japan in

that sort of supply chain. So yeah, I don't think you know much much more more positive in a medium term story. But I think at the end of the day, you've got to ask the question is em is underperformed. For the last ten years, the US has outperformed, you know, ten years before that, emerging markets performed. And it always goes down to our formula. The earnings came through. So you used to have eight to ten percent earnings twenty years ago for ten years and that led to good returns.

If you look at the US since the nineteen forty five, you've had on average, you know, seven seven and a half percent earnings growth, seven to seven and a half nearly eight percent performance in the the US stock market. I mean, obviously in the last ten years with tech with AI recovering from k best than the rest of the world, those earnings and returns have been much better.

But you know, we foresee it the next five to ten years in Asia, particularly where we're getting back to that eight to ten earnings growth without any real valuation lift supported by domestic demand, which is which is a positive story because you know, local investors put more money in their own markets, they take money out of their own bond markets. You know, they buy their growth stories.

So yeah, the outlook, we have to get through obviously the race cycle, the election, but they're going forward there. We do see some tremendously good opportunities across emerging markets in Asia.