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Hong Kong. A year after Asian stocks began to rise, investors should turn their attention to Southeast Asia, which lagged the wider rally and where exporters are set to thrive on growth in China and India.

Southeast Asian markets, suffering from export weakness and political risk, were overshadowed until late last year by China’s investment-fueled growth, which boosted neighbors South Korea and Taiwan.

That rebound has now fed through to Southeast Asia, whose exporters look set to turn around quicker than economists had expected to drive economic growth in the region. One result — Malaysia’s surprise decision last week to raise its policy rate for the first time since 2006.

Investors will likely focus more on high returns and value with some tipping another strong year for Indonesian bonds and Thailand as offering the strongest earnings yields.

They will largely push aside serious political risks. Indonesian stocks have been hurt recently by a call for a criminal investigation of its two top political reformers, Finance Minister Sri Mulyani and Vice President Boediono.

Tuesday marked the one-year anniversary of the S&P 500’s 13-year closing low. Since then, the MSCI index of non-Japan Asia-Pacific stocks has risen 105 percent. In contrast, Malaysia’s main index has risen 57 percent, Thailand’s 75 percent and the Philippines’, 78 percent.

Indonesia was one of Asia’s star attractions last year, thanks to domestically driven growth, relatively low inflation and high bond yields that continue to attract foreign investors.

In addition, equity markets in Malaysia, the Philippines and Thailand have been outperforming non-Japan Asia this year based on value and may continue to do so as growth forecasts rise.

“Taiwan, China, Korea — these stories have been very well documented for more than a year and to some extent Southeast Asian markets have been neglected by investors,” said Tai Hui, an economist with Standard Chartered in Singapore.

“As markets calm down, investors will be looking for new trade ideas and the forgotten ones will be brought back.”

In Malaysia, Indonesia and Thailand, exports to China are running far above their long-term averages while shipments to the United States and Europe are lagging, indicating a greater reliance on Chinese growth.

India’s trade with Southeast Asia is worth only a fifth of China’s, but Tai Hui believed it would catch up quickly because of its domestically-driven growth model. Higher growth of course means interest rates later this year, but holding local currency bonds may continue to be lucrative, with currency strength and high coupon payments offsetting potential capital losses.

Take Indonesia for example. After equity-like returns of near 40 percent in dollar terms on rupiah bonds in 2009, HSBC expects another 10 percent to13 percent this year, factoring in a full percentage point of rate increases.

“Funds are beginning to gravitate toward Asean debt because of their strong fiscal positions relative to what they were like in the wake of the Asian financial crisis and prospects of currency gains,” said Desmond Soon, head of fixed income at DBS Asset Management in Singapore.

Memories of central banks constantly behind the curve in dealing with double-digit inflation are one reason why investors have been slow to gain exposure to Southeast Asia.

But Malaysia’s move last week, at a time when inflation was subdued and growth just picking up, is seen as a sign of changing times, where policy makers are becoming more proactive on containing price pressures, a plus of bonds.

Equities also look like they have some upside. Southeast Asian stocks have been outperforming the region so far this year, resilient to the waves of profit-taking hurting last year’s standouts, like South Korea, Taiwan and Hong Kong.

An equal-weighted index based on the MSCI indexes for Indonesia, Malaysia, Philippines and Thailand has risen 2.9 percent year-to-date, and without Indonesia is up 2.3 percent. However, the MSCI index of non-Japan Asia Pacific stocks slipped 0.6 percent in the same period.

Earnings yields, expected earnings per share divided by share price, are quite attractive compared with government bond yields, especially in Thailand.

Thailand’s average earnings yield based on 12-month forecasts is 10 percent, above the 5-year bond yield of 3.43 percent.

Paul Chan, chief investment officer with Invesco in Hong Kong, said Thailand had become one of his top picks based on its cheap valuation and improving growth. He has become cautious on China because of the risk of a reversal in aggressive lending.

Indeed, Sean Darby, regional strategist with Nomura International in Hong Kong, recommended increasing allocations for Southeast Asian stocks to mediate the risk that unexpected policy changes in India and China hurt financial returns.

He is particularly keen on shares of banks. “While investors are distracted by the events in sovereign credit markets or concerns over inflation in China and India, the hidden value of portfolio diversification is increasingly becoming evident,” Darby said.



Reuters