Tuesday, March 16, 2010

>ASIA STRATEGY: Value buying opportunities emerging

■ We provide an update on valuations, key cyclical indicators, and where we see value emerging across the region after recent market volatility.

■ With global economic growth firming – albeit in fits and starts -- and monetary conditions likely to remain very loose for an extended period of time, the macro backdrop is, broadly speaking, supportive of healthy equity market conditions. Earnings forecasts are also far from unreasonable, in our view, compared to previous recoveries. All this adds up to a healthy outlook for Asian equities on a 12-month view (for more details on this see our recent note “Asia strategy: Would you buy Asia at 2.5xP/BV? You should!”, 2 February 2010).

■ But in the near term, Asia ex Japan is likely to remain range bound or even drift lower. Current valuation levels in many cases make for an underwhelming near-term risk/reward trade-off, and key cyclical indicators such as earnings revisions1 and the OECD LI (that are tightly correlated with Asian markets) are falling and are likely to continue to do so in the near term.

■ It is hard to overstate the importance of the fact that our earnings revisions indicator is falling – average returns are -25% when it is falling and Asia ex Japan has risen only once when this indicator has been falling and that was way back in 1991, when China's economy was about 7% of its current size, India had a GDP per capita of US$315, and Korea‟s export-to-GDP ratio was
about half what it is today.

Despite this subdued near-term outlook for equity markets, there are pockets of value in Asia:

  • Stocks that are plain and simply cheap, in an absolute level sense, have a high probability of outperforming. This applies under all market conditions. The best valuation metric to use here is P/BV and our latest screen features quite lot of Korean stocks (as it usually tends to) but also a surprisingly high number of Hong Kong/China stocks.

  • China. China has been treated harshly in the recent sell-off, with the market the second worst performing this year. We say harsh because we don't think China deserves this high-beta status – its earnings growth is relatively stable, it has a strong structural element to its growth rate (making it relatively resilient to external shocks), and it has policy flexibility. Looking ahead, with valuations now really quite attractive, growth likely to remain strong, earnings expectations very reasonable, and 2Q by far and away the (traditionally) strongest quarter for China, now is a very good point to start accumulating China stocks.
  • Telcos. Not sexy. And some argue that they are a value trap. But telcos are, by far, the cheapest sector in Asia ex Japan and many of the stocks feature heavily on our screens for both value and dividend yield. With the balance of risks to markets skewed slightly to the downside in the near term, the odds of this sector continuing its recent run of outperformance is high, in our view.

To read the full report: ASIA STRATEGY