>The End of the Earnings Recession (MORGAN STANLEY)

We believe we are now at the tail-end of the earnings recession. Our proprietary top-down EPS
model suggests that earnings troughed in the quarter that just ended. This would make the current earnings recession in EM the second longest in length (11 months) and second biggest in magnitude (–39%).

Earnings should recover because economic activity has clearly rebounded (particularly in China, India, Brazil, Indonesia, Poland, and Israel). Second, currencies have risen significantly against the US$ since 2Q, boosting the US$ value of local earnings streams. Third, for export-oriented stocks there has been a recovery in volume and pricing. Our top-down earnings model currently forecasts EPS to grow by +28% in US$ terms during calendar year 2010. This places the MSCI EM index on a prospective 2010E P/E of 14.4x. Morgan Stanley bottom-up analysts (39%) and consensus (33%) are somewhat more bullish, which requires monitoring.

China and Israel are the only countries to have escaped earnings recession. Regionally earnings have declined by –51% from the peak in Asia, –25% in LatAm, and –29% in EMEA. Whilst we still expect many Asian companies to be in the vanguard of earnings recovery, Latin America in aggregate is actually showing the earliest signs of turning the corner. The region has been largely immune from the currency and interest rate overshooting and banking system instability that were so present in the 1994 and 1997/8 cycles.

By sector the four biggest declines have been: IT (–88%) Industrials (–64%), Materials (–51%) and
Consumer discretionary (–32%). The latter is now turning up and we expect a V-shaped recovery in IT earnings. Materials and Energy (Morgan Stanley analysts are more bullish than consensus) will likely turn the corner soon thereafter.

Asia Pac ex-Japan focus list change. Switch Sinogold to Lihir and Bharti Airtel to Telekom Indonesia.

To see full report: ASIA STRATEGY