Macquarie Research, Asian Strategy 2011- More where that came from

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Asian Strategy 2011
More where that came from
Demand recovery and capital inflows: steady as she goes
 We expect Asian markets to sustain a steadfast recovery in 2011, despite
occasional eruptions of risk and uncertainty, as US and global demand growth
continue to gradually improve and easy global monetary conditions tighten at
only a hesitant pace. On top of this, the MSCI Asia ex-Japan Index‟ 17% gain
in 2010 and mundane 12.8x forward PER set a fairly achievable standard and
modest starting base for similar mid-high „teens performance in 2011.

 Despite fears of a „giant sucking sound‟ from rebounding developed markets
that reverses Asia‟s strong two-year portfolio inflow trend, we think few things
would be better for the longer-term sustainability of Asia‟s equity rally than a
broadening – and thus less precarious – global demand recovery.
 While the eventual end of Federal Reserve dollar-printing may grow visible in
the months ahead, actual Fed balance sheet contraction – the real risk for
emerging markets – remains a story for 2012. Indeed, with major central bank
balance sheets still hyper-extended, a pickup in money velocity as global
growth revives should sustain reflationary impulses in 2011. Our economics
team expects higher CPI in 2011 in every major Asian economy except India.
 With this, a shift from global fixed-income outperformance toward equity
outperformance would entice liquidity out of bonds in search of more growthand
inflation-sensitive exposure. This would enable continued capital inflows
to Asia over the next 12 months – particularly as regional currencies sustain
2010‟s gains against the US dollar, supported by widening local/US interestrate
differentials and politically driven Chinese RMB appreciation.
Easy multiples, conservative EPS forecasts, low real rates
 The Asian equity opportunity is underscored by unchallenging market
valuations and easy earnings assumptions. The last time China‟s inflation
passed above the 5% mark (July 2007), for example, MSCI Asia ex-Japan
was selling at nearly 16x consensus forward PER (nearly two full standard
deviations above 10-year mean). Today it is just 0.3 standard deviations –
and on consensus 2011 EPS growth of just 13%, leaving room for upgrades.
 With inflation nudging higher, Asian real interest rates are more likely to fall or
remain very low through 2011 even as nominal interest rates creep up –
another support for equity multiples via domestic liquidity flows, as well as for
cyclical/reflation-driven sectors, as falling real interest rates punish savings.
 Our key country Overweights for now remain the underowned, inexpensive,
and externally oriented Korea and Taiwan markets. We think a key
performance differentiator for 2011 will be timing the end of Hong Kong /
China‟s underperformance, but we suspect that turning point may not come
until 2Q11. Our main sector preferences as we head into the New Year
include Tech, Energy, Financials and Industrials (Figure 1, inside. Our
complete stock „Focus List is found in Appendix, Figure 21).
Risks: inflation breakout, protectionism
 Key risks to our 2011 view include a possible oil price spike that drives much
faster Fed policy tightening; or worsening US-China trade frictions.