Wednesday, December 16, 2009

Asian Equities In 2010 - A Survey Of Views & My Take

Will the Rally Continue or Will a Correction Follow?

  • Citi expects 9-14% increase in Asian equities in 2010, with North Asia (especially Korea and Taiwan) outperforming South Asia. Asset market returns slow as a recovery takes hold, as returns underperform expected earnings increases. Technology and bank earnings are outperforming other sectors. The U.S. dollar and U.S. interest rate normalization pose the greatest risks to Asian market liquidity.

  • DBS expects index returns of at least 16%, based on expected 27% earnings growth for 2010 and 16% for 2011, keeping valuations neutral. The low global interest rate environment, expectations of Asian currency appreciation could push markets further. Sectors benefiting from stronger Chinese consumption should outperform and the energy sector is supported by government investment. DBS is overweight China, Taiwan and Singapore, Neutral on India, Hong Kong and Korea while underweight Malaysia, Indonesia and Thailand. U.S. rate normalization is a risk. Taiwan and Singapore have biggest chance for earnings upgrades as expectations have not yet returned to pre-crisis levels given the depth of the economic correction.

  • Upsides: Better-than-expected earnings reports, relatively healthier macroeconomic fundamentals, aggressive fiscal stimulus spending, capital inflows and ample liquidity will have positive impact. Equities are also attractive for foreign investors relative to debt markets amid increasing bond issuance.

  • Downsides: Foreign Institutional Investors concerned about the U.S. economic recovery and global liquidity might resort to profit-taking. Risk about asset bubbles, tightening measures by central banks and rising valuations might affect both domestic and foreign investors.

  • Analyst Johnna Chau, Citi: "Stocks do well when faced with upward revisions" of earnings. South Korea and Taiwan, and sectors like technology, consumer discretionary and materials remain attractive.

  • Analyst Joanne Goh, DBS: Following the strong rally since March 2009, profit taking may lead to a correction (though not severe) due to worries over high valuations, withdrawal of stimulus measures and asset bubbles. Possible macro policy changes in China might bring some volatility in Hong Kong and China. But export-oriented countries with high industrial and technology exposure (Singapore, Thailand, Korea and Taiwan) will benefit during the course of synchronized global recovery.

  • FT's Lex: In the past, Asia's stock market performance was highly correlated with that of western counterparts. However, Asian equities may plot a more "independent course" backed by less leveraged economy, better capitalized banking sector, huge FX reserves and healthier fiscal position.

  • EIU: Given the region's ultimate reliance on exports to the U.S. and EU, investor sentiment will remain susceptible to economic setbacks in those markets.

  • Background

  • As of end April 2009, market capitalization of Asian Pacific markets (US$10.2 trillion) had exceeded that of European markets (US$9.3 trillion, including Africa and the Middle East) as Asian stock prices soared at a faster pace than the European ones.

  • Banks remain the single largest sector in Asian equity markets. However, financials' share has decreased to 20.1% as of June 2009 from 43% in 1975. In opposite, the share of cyclicals has risen to 38.7% (including basic materials, industrials, oil & gas, and technology) from 18% (industrials) in 1975.

  • 2008 Review: The peak-to-trough decline in Asian equities in 2008 of more than 70% for some markets, surpassed the 60% fall in local currency terms during the 1998 Asian financial crisis. Sustained outflows from offshore Asian funds took the total net redemptions during January-October 2008 to a record high such that all money that had flown in during 2007 flowed out.

  • Market Integration: The correlation between U.S. and Asian markets picked up sharply in H2 2008 (peaking in mid-October 2008). However, average correlations for emerging Asian equity markets are generally higher between the region's markets than with U.S. markets.

  • Government intervention: Amid the global credit crisis and capital outflows in Q4 2008, several countries including Taiwan, Pakistan, Vietnam, Thailand intervened in the stock market by narrowing the trading band, introducing stabilization fund to contain volatility, banning short-selling, and directing government funds to buy shares.

  • 10-year government bond yield as of September 7, 2009: Indonesia: 10.6%, Vietnam: 10.0%, the Philippines: 7.9%, South Korea: 5.4%, Malaysia: 4.2%, Thailand: 3.7%, China: 3.5%, Hong Kong: 2.4%, Singapore: 2.5%, Japan: 1.4%.

  • ADB: Most government bond yield curves in the region have steepened and have shifted upward through early-July in 2009, due to surging liquidity as governments issue new debt to finance fiscal stimulus, expectations of future inflationary pressures from increasing liquidity and improving expectation of economic recovery.

  • Many governments seeking to sell bonds to foreign investors including India, Malaysia, Indonesia, Vietnam, Philippines have been met with a tepid response so far due to global factors (risk aversion in EMs in general, credit crunch, flight to safety to U.S. treasuries) and domestic factors (narrowing interest rate differential with the U.S. due to ongoing policy rate cuts by Asian central banks, slowing growth).

  • Rising government bond issues will pose challenges to companies turning to local markets for refinancing and raising new funds as firms already face tight access to credit in domestic and foreign capital markets.

  • Analyst Michael E. Love, Moody's: In developed economies, such as Japan, Korea, Australia and New Zealand, yields on the benchmark 10-year notes have risen as government's tap debt markets to fund fiscal deficits. In emerging markets, yields have varied from country by country, with government borrowing, monetary easing and capital inflows exerting different effects. In Indonesia, the yield on the 10-year note has trended downward as the stock market has surged and the central bank has given strong hints more rate cuts are forthcoming. In Malaysia, Thailand and India, where central banks have less room to cut rates, yields have trended up.

  • During late 2008 and early 2009, heightened global risk aversion and investor redemption from emerging markets have sparked capital outflows from Asia and hence currency depreciation. Since March 2009, however, all major Asian currencies are on an appreciating path, backed by capital inflows, improving liquidity conditions, the weakening U.S. dollar (USD) and sustainable trade balances. However, appreciation has been contained by central bank intervention, undoing the reduction in global imbalances during the crisis and reducing hopes that Asia will give up its currency policy to rebalance domestic and global growth.

  • The YTD currency performance as of October 13, 2009: The best-performers-> Thailand: 4.23%, India: 4.89%, South Korea: 7.36%, Indonesia: 19.81%, New Zealand: 27.54%, Australia: 28.69%. Currencies showing modest gains-> China: 0.03%, Japan: 1.01%, Taiwan: 1.61%, Malaysia: 1.86%, the Philippines: 2.10%, Singapore: 2.68%. The worst-performers-> Pakistan: -4.94%, Vietnam: -2.07%, Hong Kong: -0.01%.

  • Surging equity inflows: Global risk appetite has led to buoyant FII inflows into the Asian equity markets with YTD net inflows of US$14.4 billion as of June 24, 2009, significantly up from US$10.8 billion in H1 2009 and US$9.6 billion in H2 2008 (EPFR via WSJ). Rising but attractive valuations, faster economic rebound and aggressive fiscal and monetary stimulus policies have supported the rally. But any fading of global risk appetite or correction in global equity markets pose risk to Asian currencies.

  • Revival of global carry trade: Attractive yields and appreciation pressure on currencies offer attractive carry trade opportunities in Asia. This is supported by increasing local and foreign currency bond issues by governments to finance the rising fiscal deficits.

  • Economist Johanna Chau, Citi: Expecting that risk appetites sustain and the U.S. dollar remains weak in the near-term, Asian currencies will continue to appreciate, with "inflation/asset price cycle now moving higher."

  • Easing external balances: Asian export growth is still in negative territory though export drop has been easing since March 2009. Imports are contracting more than exports in some countries, containing risks to the trade balances. In some countries, export recovery might lag the recovery in imports and commodity prices, putting pressure on the trade balances.

  • Improving liquidity conditions: The USD liquidity has improved considerably in most countries compared to late 2008. Countries have access to the bilateral and Chiang Mai currency swap agreements as well as aid from bilateral and multilateral agencies and international groups.

  • FT: The real concern for Asia is weak USD, not a weak Chinese renminbi, as it reduces demand for Asian exports. Commodity exporting countries like Australia and Indonesia and tech exporters like Taiwan and South Korea have actually benefited from a weaker renminbi due to increasing demand from China. Manufacturing-based countries, including Malaysia and the Philippines, competing directly with China are at risk.

  • Analyst Philip Wee, DBS: Asian currencies will continue to appreciate, as the magnitude of capital inflows is greater than the size of central banks' interventions.

  • The central banks might use non-monetary measures to contain currency appreciation. Countries like Taiwan, New Zealand, Japan and South Korea have already implemented or hinted at measures to limit capital inflows and control currency conversion by firms and households.

  • Continued intervention is raising liquidity in Asian economies, leading to asset bubbles and inflationary pressures -- a replay of the 2003-07 cycle. The impossible trinity and inadequate sterilization will challenge the monetary policy as central banks will be forced to tighten liquidity and raise rates despite weak private and export demand.

  • Bloomberg: Raising interest rates to contain inflation will make the currencies even more attractive for carry-trades.

  • EIU: Due to weak exports, Asia will allow only a "modest" appreciation of the currencies especially as Chinese renminbi remains effectively pegged to the U.S. dollar. Allowing currency appreciation will help central banks tighten the monetary policy, reduce export-dependence and hence global imbalances.

  • ADB: East Asian currencies would continue to strengthen over time, but near-term outlook is highly uncertain. This is because global investors do not seem to regain pre-crisis level of the risk appetite and economic indicators in the region are still fragile. Comparing current levels of real effective exchange rates with historical averages of the past 20 years, Taiwan dollar, South Korean won and Malaysian ringgit have the greatest potential for appreciation.

  • My Take (which will be elaborated in my later postings): 2010 will still be good for equities in general, including Asian equities. I still see rates being kept low in developed nations, in particular the US, EU, Japan and UK. I also see USD being in a controlled weakening phase (even though you might hear otherwise whenever Obama, Geithner or the Fed try to calm the markets). That is the crux for 2010, weaker USD, which will underpin upside for US stocks, which in turn will rub off well on other markets. However, 2010 will not see as strong a performance as 2009. I still see 20% on average for Asian markets, i.e. FBM KLCI target of 1,500. Malaysia should be the outperformer in 2010 compared to other Asian markets as pressure will mount on ringgit to appreciate, causing surges of hot money into the markets. That needs to be watched diligently by Bank Negara or else we will have a recurring bubble.

    p/s photos: Ishihara Atsumi


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