>Asia Strategy (MACQUARIE RESEARCH)

Where do we go from here?

Event
■ We provide an update on the latest valuations and risk/reward trade-off for Asian equities.

Outlook
■ Asia ex Japan has rallied strongly over the last seven weeks, rising 27.5% from its local trough on 2 March. The rally has, however, been supported by improving fundamentals – stresses in the (global) financial sector have eased; there is growing evidence that the global economic cycle may be forming a floor; investors’ appetite for risk (particularly for emerging markets) has risen; and, importantly, our earnings revisions indicator for Asia ex Japan has
continued to move higher.

■ Moreover, with Asia ex Japan now trading on 13.9x forward earnings, 10.8x trailing earnings, 1.5x BV and 6.7x cash flow, valuations – particularly on those metrics that are the most reliable signals of value – remain well below long-run average levels. The only exception to this is forward PER, which, impacted by both a rising market and falling earnings, is now above its longrun average of 13.0x.

■ Low valuations and improving earnings revisions mean the 12-month risk/reward trade-off for Asian equities is extremely favourable. If history is any guide, the odds of losing money on a 12-month view are currently a mere 12%, while the odds of a better than 10% return are 70%. History suggests that Korea is likely to give the most beta over this time horizon, while along the sector dimension tech, banks and consumer discretionary sectors are the sectors most likely to outperform.

■ The three-month outlook is, however, considerably more uncertain. Markets have run hard, investor sentiment towards – and appetite for – emerging markets is certainly very elevated at present (relative to other risky asset classes, that is) and we are very mindful of the potential for this to pull back in the coming weeks and months.

■ On the other hand, backtesting of fundamentals does suggest a palatable 3-month risk/reward trade-off, earnings revisions suggest the near-term balance of risks could be to the upside and the overwhelming investor sentiment is to buy on any decent pullback (which suggests that any pullback is likely to be limited in terms of duration and magnitude).

To see full report: ASIA STRATEGY