International | Jul 07 2006
By Chris Shaw
Asian markets lost as much as 18% of their value in just 26 trading days in May and June, so it is by no means a stretch to say investor sentiment is now far less positive than it has been in recent years when some markets in the region were generating returns of 40% annually.
Sadly for investors, HSBC suggests the days of such high returns are behind us, though looking forward it is not all doom and gloom. The bank has updated its strategy for Pan-Asia markets, suggesting investors accept the fact sentiment is likely to take a few months at least to recover given the speed and size of the recent correction. Returns for the coming year are forecast at around 8%.
It suggests the key points going forward will be further clarity on a number of questions, including whether or not the US can avoid a hard landing, how sharp is the rate of decline in the global industrial cycle, what level of risk is attached to earnings in Asian markets and were commodity prices in a bubble prior to their correction.
Supporting its view any improvement will be gradual are some market specific factors, such as a widening of credit spreads, an increase in redemptions from mutual funds and an increase in investors’ risk aversion levels, all of which it expects will take some time to disappear.
There are economic factors in favour of an eventual recovery though, the bank pointing out a bear market is unlikely to develop while equity valuations remain reasonable as is currently the case. On the bank’s numbers, the peak forward P/E ratio for Asia ex-Japan was below 14x prior to the correction and is just above 11x now, so the markets are certainly not expensive.
Additionally, the bank suggests economies in the Asian region are generally quite healthy as foreign exchange reserve levels are high, external debts are low and budget deficits generally are manageable.
But as always with markets sentiment remains the key, and here things don’t look so good for the next few months. The bank sees the newsflow tending towards the poor side given the trend is clearly for inflation to move higher, while there is also evidence the global economic cycle is faltering as momentum in Asia is showing signs of slowing and GDP forecasts for the current year are no longer being revised higher.
Similarly consensus earnings estimates are trending lower throughout the region, the bank noting estimates for 2006 were cut in June on average by 3.4% and for 2007 by 3%, a worrying sign given historically mid-year forecasts are revised down further in the second half of the year.
Flows of funds from foreign investors are unlikely to help, as HSBC suggests outflows will continue in coming months. It notes while US$11bn was redeemed during the correction, this represents only about 9% of the total foreign fund inflow since 2003. In the bank’s view the outflows reflects both an increase in credit spreads and an increase in the cost of equity thanks to higher interest rates.
The bank is not alone in its view of Asian market prospects, as Deutsche Bank also sees recent events as a correction rather than a bear market thanks to ongoing strong global growth and stronger underlying economies. It suggests the inflationary and interest rate concerns have been overdone, which also supports its positive longer-term view.
So how should investors approach Asian markets given such a backdrop? HSBC has made it easy by breaking down its calls by market and by sector, detailing reasons behind its views in each case. In terms of markets the bank remains positive on China and Korea, the first given the economy remains strong and earnings are in fact being revised higher. As a result, it suggests a market where GDP growth is 9-10% and the market P/E is below 11x appears a bargain. Korea is sees as offering a combination of growth and value, as earnings forecasts are too low given almost no increase in earnings is being priced in despite the economy expected to grow at almost 6% this year. It sees the Korean market as the cheapest in the Asian region.
Other overweight recommendations are for Singapore and Malaysia as these markets provide the best defensive exposures. In Malaysia’s case the bank notes there is a low correlation with global equities and there appears to be low earnings volatility in the market thanks to the country having the highest weighting in defensive sectors. Singapore offers a combination of low P/E ratios and solid growth prospects.
In contrast, HSBC is neutral on both Japan and Hong Kong, as it suggests it remains too early in its recovery for the Japanese market to display defensive characteristics, while in Hong Kong property prices are tipped to fall further, putting pressure on equities. Deutsche Bank is even less positive on Japan, suggesting the market is expensive especially as there are now increasing concerns over the durability of the economic recovery. The broker notes foreign inflows have stalled and it sees the market underperforming until firms and analysts revise up their earnings expectations, which it expects to occur later in the year.
Underweight positions are recommended for markets with high beta and cyclicality, which means India given its market remains expensive even after the correction, Taiwan given overly optimistic earnings forecasts and Thailand thanks to political uncertainty. Other overweight ratings are Indonesia and the Philippines.
In sector terms HSBC advises the key is avoiding risk, so it suggests investors go underweight cyclical stocks and focus on defensive earnings and companies offering stable growth. Such stocks include those in the consumer staples sectors such as food, retailers and pharmaceutical stocks, as well as the healthcare and financial sectors. It also recommends taking overweight positions in telco stocks, but being underweight the technology sector.
