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Credit Suisse expects 10-15% upside for Asian equities in 2012
Credit Suisse’s Global Emerging Markets and Asia Pacific Strategist Sakthi Siva told reporters in Singapore and Hong Kong that Asian markets were already pricing in a recession in the developed Western economies, but not a financial crisis. Ms. Siva said that the price to book ratio for Asia Pacific ex-Japan had already fallen to 1.52 times, close to the 1.4 times level reached during the 2001 recession. She also noted that Asian balance sheets were strong, with the region’s gearing (net debt to equity ratio) having fallen from a high of 47% in 1998 to an expected 23% for 2011.
Ms. Siva discussed the impact of the Eurozone debt crisis on Asia, noting that there was a -0.89 correlation between Euribor spreads - the difference between the Euro interbank offered rate and overnight index swaps – and the MSCI Asia ex-Japan Index. In other words, there has been a very strong correlation between increases in European banks’ cost of short term funding and declines for Asian equities, and vice-versa. However, Ms. Siva also pointed out that most of the seven double-dip recession indicators followed by her team point towards a soft landing for the global economy.
Focusing on peaking inflation rates and monetary policy easing as a key driver for Asian equity performance in 2012, Ms. Siva said that Consumer Price Index (CPI) gains had peaked across global emerging markets in June, adding that Credit Suisse expected CPI to slow further in the next few months and pointing out that central banks in Indonesia and Australia had already begun to cut rates, while China had started reducing the Reserve Ratio Requirement (RRR) for its banks. With the RRR at a record high of 21%, Ms. Siva observed that China had plenty of room for policy easing and that previous RRR cuts had been associated with strong gains for Chinese equities.
Looking at the equity investment implications of the macro environment, Ms. Siva said companies with a structural growth and return on equity story would be a natural choice for investors at the moment. However, she pointed out that many well-known companies of this kind traded at a substantial premium to the rest of the region, and argued that companies with a trend of rising return on equity were more attractive. Ms. Siva suggested Keppel, COLI, Cheung Kong and TSMC as examples of stocks with rising return on equity, and said that Kia and Hyundai Motors also offered value as these companies were gaining market share.
Ms. Siva also said she preferred “trough valuation stories,” or stocks where the absolute price to book ratio is at the lows of 2008 or 2009, and which trade at a discount according to Credit Suisse’s price to book versus return on equity valuation model. Stocks in this category include COLI, China Mobile, Bank of China, China Construction Bank, Industrial and Commercial Bank of China, Hang Seng Bank, POSCO, Cheung Kong, UOB, Sun Hung Kai, Hyundai Heavy, BHP Billiton and Rio Tinto.
Presenting Credit Suisse’s model Asian equities portfolio for 2012, Ms. Siva summarized her views on investment opportunities next year, saying she believed structural return on equity stories were overvalued and that she preferred trough valuation stories and markets with “policy bullets”, or scope to ease monetary policy.
She added that Credit Suisse had an Overweight call on the four most undervalued markets in the region – China, Korea, Hong Kong and Australia – and that she continued to prefer markets that are “under-owned” by foreign investors, such as Korea and China, over more “crowded” markets such as India or those in South East Asia. In terms of sectors, Ms. Siva said the four most undervalued sectors in Asia, according to Credit Suisse’s price to book versus return on equity valuation model, are Basic Materials, Financials, Energy and Real Estate.
Finally, Ms. Siva pointed out that her year-end target of 527 for the MSCI Asia ex-Japan Index was “probability-weighted” and had been calculated after attaching different probabilities to different macro scenarios for 2012. She said the target took into account a 15% probability of a 2008-style financial crisis, a 25% probability of a “muddle through” scenario similar to that of the last few months and a 60% probability of a “mini 2009” in which quantitative easing by the European Central Bank helped to fuel a rally in equity markets.