Is a Recession Required to Put APAC Earnings at Risk?
Articles & stories

Is a Recession Required to Put APAC Earnings at Risk?

On average, the 12 US recessions since 1950 have lasted 10 months, with a 2% drawdown in GDP. The impact of a future US recession would be lower, as EM Asia's share of global GDP is now meaningfully higher, and exports to US/EU are a much lower share of GDP. On the other hand, four months of Chinese COVID lockdowns may have affected global goods demand as much as a typical US recession over 10 months might.

Historically, market drawdowns owing to US recessions tend to be deeper and longer than GDP, with APAC markets peaking 2-13 months before recessions started and falling 26-60% over 2-20 months. Of the two drivers of this downside — earnings and the price-to-earnings ratio — the recent fall in price-to-earnings is already close to corrections around past US recessions.

The recent correction (20% over 12 months), in our view, is so far not due to an expected US recession. If it were, the lag between market peak and recession would be the longest it's been in half a century. It is more likely a valuation reset coinciding with the rise in risk-free rate (higher US treasury yields) and equity-risk premium (geopolitical, macroeconomic and regulatory risks, like in China). APAC P/E is now 1% below the 2011-19 average.

However, APAC EPS has historically fallen between 20-45% in past US recessions (markets bottomed when earnings did), but have fallen by less than 5% from the peak so far. Even without a US recession, an elevated base, a goods-to-services switch in demand, a shrinking US fiscal deficit, and a downward lash of the supply-chain bullwhip contribute to potential EPS cuts being a grave risk to markets.

We believe IT and Materials may be the most vulnerable to cuts (72% of incremental APAC earnings since 2019 vs. 27% normally). The Energy sector's risk is similar to Materials due to cyclically elevated revenues and low P/E, with structural ESG risks. Still, the Energy sector is exposed to services, and high prices may persist from fiscal support for demand and uncertain supply.

@Neelkanth Mishra