The 2018 annual letter for Overseas Asset Management’s Asian Recovery Fund is now out. You can access and download it directly from the firm’s website. We have covered Desmond Kinch’s writings in the past as they typically contain lots of interesting insights; this year is no different, so reading it is well worth your time.

A few excerpts below (I have kept it short as some of these are already familiar themes from his previous letters + because you are better off reading the letter in its entirety):

• Bifurcated world: On a P/E, Cyclically Adjusted P/E (CAPE), P/B, or P/S valuation, Asia ex Japan equities are now at one of the cheapest levels relative to US equities seen during the past 20 years. On an absolute basis, Asia ex Japan equities are close to, though not quite at trough valuations seen during the global bear market of 2000-03 or the GFC in 2007-8. In broad terms, Asia ex Japan equities are cheaper than average and are much closer to all-time low valuations than they are to all-time high valuations. This is in stark contrast to US equities.
• Currency: Dollar cycles have averaged about 15 years; they think the peak of this cycle was in January 2017, which more or less coincided with the Economist’s “Mighty Dollar” cover story. They viewed the dollar’s strength in 2018 as a bear market rally, following its large decline in 2017. Dollar strength has tended to coincide with periods of US equities outperforming non-US equities, even in local currency terms, and vice versa. Given the current valuation discount of Asia ex Japan equities to US equities, this may be an important turning point.
• Counter to all the negative sentiment towards Asia: There are lots of legitimate fears, but the more important question is how much are these fears already reflected in equity prices. There are also several positives. Valuations in Asia ex Japan are relatively low. Corporate earnings growth has been robust for the past two years. Central banks in Asia ex Japan have generally kept real interest rates positive and not engaged in the experiments undertaken in the developed world.  Whilst US equity ownership is at a cyclical high, in much of Asia, equity ownership is very low with secular growth in ownership likely as more formal pension saving arrangements are put in place. Finally, other intangible aspects of Asian cultures (e.g. focus on education, aspirational attitudes) are also positives.
• Outlook: Impossible to say whether this is the start of a major global bear market or just a big correction. They are inclined towards the latter view, but concede that there is a considerable risk it could be the former. If they are right that the dollar cycle has turned, and fundamentals such as purchasing power parity suggest that the dollar is indeed very overvalued, then we may be entering a period where Asia ex Japan equities outperform US equities by a very wide margin.